Big Pharma’s Working Capital Performance Examined at DCAT’s Sharp Sourcing
By

Big Pharma’s working capital performance improved in 2013 compared to 2012, but still is weak comparative to other industries. How can sourcing and procurement organizations and their suppliers contribute to improving results? DCAT Value Chain Insights examines the results of EY’s annual analysis of working capital performance to reveal key benchmarking metrics and strategies for optimizing supplier performance.

As pharmaceutical companies continue to face cost pressures, they seek ways to better manage their costs and cash flows. Working capital efficiency is one important driver of financial flexibility. The pharmaceutical industry as a whole historically has had weaker working capital performance comparative to other industries, but improving working capital performance has increasingly become an important strategic goal for pharmaceutical companies. To achieve that goal, sourcing and procurement organizations are tasked with developing ways to contribute to improving working capital, such as through achieving more efficient supply chains and optimizing supplier relations. Understanding that goal is an important consideration for suppliers and contract service providers alike as they seek to participate in contributing to their customers’ goals. At DCAT’s Sharp Sourcing 2014, held July 10 in New Brunswick, New Jersey, Stephen Kunz, Executive Director  with EY’s Transaction Advisory Practice and Life Sciences Sector Leader for Working Capital, examined the pharmaceutical industry’s working capital performance for 2013, compared it to 2012 and prior-year results, and offered strategies for optimizing supplier and outsourcing relationships to improve performance.

 
 

Stephen Kunz
Executive Director,
EY’s Transaction Advisory
Practice and Life Sciences
Sector Leader for Working Capital

Working capital: the basics
In a simplified definition, working capital is defined as the value of inventory plus receivables minus payables. It reflects the amount of cash a company has tied up from when it purchases components to produce its products to when it receives payment from customers. Companies want to reduce their working capital as a means of liberating resources to fund other strategic objectives, such as mergers and acquisitions, organic-growth initiatives, and improving shareholder returns. Sourcing and procurement organizations can contribute to improving their companies’ accounts payable position through various approaches, such as better management of suppliers, increasing payment terms with suppliers, optimizing sourcing and outsourcing activities, and adopting supply-chain strategies to reduce costs and mitigate risk.

“For the pharmaceutical industry, managing working capital has become a critical element of its transformation as it embraces a less risky, more sustainable, and more cost-effective operating business model,” said Kunz. “This not only boosts return on capital, but also offers potential for higher cash returns to shareholders.”

Big Pharma’s working capital performance
Based on the EY analysis, compared with 2012, Big Pharma improved its working capital performance in 2013. The metrics were calculated from publicly available annual financial statements with adjustments to provide comparative analysis among the 15 largest pharmaceutical companies by sales. Included in the analysis were: Abbott, AbbVie, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi.

“Compared with 2012, Big Pharma managed to report an overall improvement in working capital performance in 2013,” said Kunz. “This reflects the accelerated impact of many of the actions taken in the in the last 12 to 24 months. But while progress has been achieved, its impact of the industry’s overall working capital performance has not been sufficient to reverse the deterioration seen in previous years. In addition, working capital results remain far from uniform, with some businesses continuing to improve their performance while others did not.”

Table I shows the annual change in key working capital metrics of the collective performance of the aforementioned Big Pharma companies in 2013 compared to 2012. Table II shows the changes in the key working capital metrics of the Big Pharma companies in 2013 compared to 2007. Four key metrics are evaluated: days sales outstanding (DSO), days inventory outstanding (DIO), days payable outstanding (DPO), and cash-to-cash (C2C).

C2C reflects the overall working capital efficiency of a company, so the lower the number, the more it reduces working capital and is regarded as a positive indication of working capital performance. DSO is a metric to measure accounts receivables (i.e., the time it takes for a company to receive payment for its goods/services); the lower the DSO, the better it is for reducing working capital. DIO reflects the amount of inventory from raw materials to finished products; the lower the DIO, the better it is for reducing working capital. DPO is the amount of time companies take to pay suppliers; the higher the DPO, the more advantageous it is for companies in reducing their working capital. Sourcing and procurement organizations can effectuate an improvement in DPO by extending payment terms with suppliers and other strategies to increase DPO.

Tables III and Table IV respectively show the number of Big Pharma companies and percentage change in working capital metrics in 2013 versus 2012 and from 2013 to 2007.

Table I: Annual Change in Key Working Capital Metrics, Big Pharma, 2013 from 2012

Metric

2013 Change 2013 from 2012
Days sales outstanding (DS0) 65.9 -2%
Days inventory outstanding (DIO) 49.4 +3%
Days payables outstanding (DPO) 29.6 +8%
Cash to cash 85.7 -2%


Days sales outstanding includes year-end trade receivables net of provisions, including 
value-added tax (VAT) and adding back securitized and factored receivables, divided by full-year pro forma sales and multiplied by 365 (expressed as a number of days of sales).

Days inventory outstanding represents year-end inventories net of provisions, divided by full year pro forma sales and multiplied by 365 (expressed as a number of days of sales ).

Days payable outstanding represents year-end trade payables, including VAT and adding back trade-accrued expenses, divided by full-year pro formal sales and multiplied by 365 (expressed as a number of days of sales).

Cash to cash equals days sales outstanding plus days inventory outstanding minus days payable outstanding (expressed as a number of days of sales).

Note: Averages are sales weighted. Based on annual accounts, December 2013.

Sample base from the largest pharmaceutical companies by sales  (Abbott Laboratories, AbbVie, Amgen, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi).

Source: EY

 

Table II: Change in Key Working Capital Metrics, Big Pharma, 2013 from 2007

Metric 2013 Change 2013 from 2007

Days sales outstanding (DS0) 65.9 +4%
Days inventory outstanding (DIO) 49.4 +9%
Days payables outstanding (DPO) 29.6 +20%
Cash to cash 85.7 +2%


Days sales outstanding includes year-end trade receivables net of provisions, including value-added tax (VAT) and adding back securitized and factored receivables, divided by full-year pro forma sales and multiplied by 365 (expressed as a number of days of sales).

Days inventory outstanding represents year-end inventories net of provisions, divided by full year pro forma sales and multiplied by 365 (expressed as a number of days of sales ).

Days payable outstanding represents year-end trade payables, including VAT and adding back trade-accrued expenses, divided by full-year pro formal sales and multiplied by 365 (expressed as a number of days of sales).

Cash to cash equals days sales outstanding plus days inventory outstanding minus days payable outstanding (expressed as a number of days of sales).

Note: Averages are sales weighted. Based on annual accounts, December 2013.

Sample base from the largest pharmaceutical companies by sales  (Abbott Laboratories, AbbVie, Amgen, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi).

Source: EY

 

Table III: Number of Big Pharma companies and Percentage Change in Working Capital Metrics, 2013 versus 2012.

Change Percentage Change in Metric Days sales outstanding Days inventory outstanding Days payables outstanding Cash to cash
Reduction > 5% 2 companies 0 companies 2 companies     4 companies
Reduction 0-5% 6 companies 4 companies 0 companies 5 companies
Increase > 5% 2 companies 5 companies 7 companies 3 companies
Increase 0-5% 4 companies 5 companies 5 companies 2 companies


Days sales outstanding includes year-end trade receivables net of provisions, including value-added tax (VAT) and adding back securitized and factored receivables, divided by full-year pro forma sales and multiplied by 365 (expressed as a number of days of sales).

Days inventory outstanding represents year-end inventories net of provisions, divided by full year pro forma sales and multiplied by 365 (expressed as a number of days of sales ).

Days payable outstanding represents year-end trade payables, including VAT and adding back trade-accrued expenses, divided by full-year pro formal sales and multiplied by 365 (expressed as a number of days of sales).

Cash to cash equals days sales outstanding plus days inventory outstanding minus days payable outstanding (expressed as a number of days of sales).

Note: Averages are sales weighted. Based on annual accounts, December 2013.

Sample base from the largest pharmaceutical companies by sales (Abbott Laboratories, AbbVie, Amgen, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi).

Source: EY

 

Table IV: Number of Big Pharma companies and Percentage Change in Working Capital Metrics, 2013 versus 2007.

Change Percentage Change in Metric Days sales outstanding Days inventory outstanding Days payables outstanding Cash to cash
Reduction > 5% 4 companies 4 companies 1 companies  6 companies
Reduction 0-5% 2 companies 1 companies 3 companies 2 companies
Increase > 5% 5 companies 7 companies 10 companies   4 companies
Increase 0-5% 3 companies 2 companies 0 companies 2 companies  

Days sales outstanding includes year-end trade receivables net of provisions, including value-added tax (VAT) and adding back securitized and factored receivables, divided by full-year pro forma sales and multiplied by 365 (expressed as a number of days of sales).

Days inventory outstanding represents year-end inventories net of provisions, divided by full year pro forma sales and multiplied by 365 (expressed as a number of days of sales ).

Days payable outstanding represents year-end trade payables, including VAT and adding back trade-accrued expenses, divided by full-year pro formal sales and multiplied by 365 (expressed as a number of days of sales).

Cash to cash equals days sales outstanding plus days inventory outstanding minus days payable outstanding (expressed as a number of days of sales).

Note: Averages are sales weighted. Based on annual accounts, December 2013.

Sample base from the largest pharmaceutical companies by sales  (Abbott Laboratories, AbbVie, Amgen, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi).

Source: EY

 

In comparing results from 2012 to 2013, Big Pharma managed to report an overall improvement in working capital performance. The overall improvement in working capital performance in 2013 arose from a combination of higher DPO (up 8%) and lower DSO (down 2%), partly overset by higher DIO (up 3%). Overall, C2C fell by 2% from its 2012 level, after increasing by 1% and 3%, respectively in the previous two years. Nine companies out of 15 companies reported a lower C2C year-on-year, with four of them showing a decrease of more than 5%.

Kunz outlined the reasons behind the improved performance. “Big Pharma has intensified its focus on cash and working capital during 2013, with many of the actions taken in the last 12-24 months having a much bigger impact on C2C performance,” he said. On the payables side, where sourcing and procurement can exercise influence, he said that “companies continue to see significant benefits from leveraging and consolidating spends, extending payment terms, and increasing collaboration with suppliers.” The reported changes in payables overall also reflect companies’ differing strategies and tactics. “For example, some companies have been stretching terms with their main suppliers or reducing their supplier base to achieve greater leverage in negotiations,” he said. “Others opted to pay faster in return for bigger cash discounts.”

These tactics are reflected in the metric for DPO (days payable outstanding). In 2013, every Big Pharma company but two posted a stronger performance in DPO in 2013 compared to 2012. In 2013, seven companies out of the 15 large pharmaceutical companies analyzed in the EY study increased their DPO by 5% or more, and five companies increased it by 5% or less comparative to 2012.

Comparing the pharmaceutical industry’s performance on DPO since 2007, 10 companies increased DPO by 5% or more in 2013 comparative to 2007. The EY analysis noted that the improvement was due to better management of the procurement and payable processes, including managing terms more effectively, particularly due to extended payment terms. Consolidation has also contributed to increasing the purchasing power of pharmaceutical companies in negotiating better payment terms or cash terms from their suppliers although some companies have pursued a strategy of trading off improvements in payables against reductions in costs. Changes in sourcing strategies also have played a role.

On the receivables side, Kunz said the improved performance was primarily due to further strong progress in the collection of receivables, notably in southern European countries. The overall progress in receivables performance was achieved against a background of contrasting trends in payment terms with wholesalers. On the inventory side, inventory performance deteriorated by changes in product sales and inventory mix following the loss of exclusivity for a number blockbusters as well as by the need for higher safety stocks to serve rapid-growth markets. “The overall poorer performance in inventory was partly offset by additional improvements in manufacturing and supply-chain operations,” noted Kunz.

Although 2013 represented an improvement in overall working capital performance comparative to 2012, Kunz cautioned that the pharmaceutical industry’s working capital performance still shows a deterioration with C2C up 2%. Overall, working capital results since 2007 continue to be depressed by a poor showing in inventory (DIO up 9%) and receivables (DSO up 4%), insufficiently offset by strong results in payables (DPO up 20%). The changes, noted Kunz, also are affected by the ongoing transformation of the industry’s business model and reflect several key factors: much weaker inventory performance, poor receivables performance, and on the plus side for sourcing and procurement organizations, strong payables performance.

Kunz further explained these issues. The better payables performance since 2007 “reflects better management of the procurement and payables process, including the extension of payment terms,” he said. “Consolidation in the pharmaceutical industry was a further positive factor as it created larger companies with greater buying power. Conversely, some companies may have pursued a deliberate policy of trading off improvements in payables against reductions in purchasing power.”

Kunz also explained the weaker inventory performance since 2007. “Manufacturing and supply chains in the pharmaceutical industry are much leaner than they were a few years ago,” noted Kunz. “But the resulting benefits have been more than mitigated by a number of factors, including changes in the product and geographic mix and moves to fee-for-service and direct-to-pharmacy distribution schemes. Most of the gains from increased collaboration with wholesalers also appear to have been captured.”

On the receivables side, changing dynamics, such as pharmaceutical companies’ greater revenue positions in emerging markets and increased pressures on the payer side in European pharmaceutical markets, have contributed to poor receivables performance since 2007, but the larger cause related to overall changes in distribution and payment policies. “The poor receivables performance since 2007 was primarily caused by changes in distribution and payment policies arrangements in many countries, including a move toward fee-for service and direct-to-pharmacy distribution schemes and the tendency for wholesalers to pay late or negotiate longer terms,” noted Kunz.

Benchmarking performance
Kunz also explained that there was a wide divergence among the large pharmaceutical companies in their working capital metrics in 2013. Figure 1 outlines performance based on C2C, Figure 2 on DSO, Figure 3 on DIO, and Figure 4 on DPO. In 2013, the average level of C2C for Big Pharma was 86 days, 66 days for DSO, 49 days for DIO, and 30 days for DPO. The spread in C2C was similar to the level reported in 2012, but lower than in 2007 (when it was 20 days), which suggests that laggards have been gradually closing the working capital performance with leaders.

Figure 1: Big Pharma’s 2013 Working Capital Performance: Cash to Cash 

Cash to cash equals days sales outstanding plus days inventory outstanding minus days payable outstanding (expressed as a number of days of sales).

Note: Averages are sales weighted. Based on annual accounts, December 2013.

Results from the largest pharmaceutical companies by sales  (Abbott Laboratories, AbbVie, Amgen, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi).

Source: EY

Figure 2: Big Pharma’s 2013 Working Capital Performance: Days Sales Outstanding
  

Days sales outstanding includes year-end trade receivables net of provisions, including value-added tax (VAT) and adding back securitized and factored receivables, divided by full-year pro forma sales and multiplied by 365 (expressed as a number of days of sales).

Note: Averages are sales weighted. Annual accounts, December 2013.

Results from the largest pharmaceutical companies by sales in the US and Europe (Abbott Laboratories, AbbVie, Amgen, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi).

Source: EY

 

 

Figure 3: Big Pharma’s 2013 Working Capital Performance: Days Inventory Outstanding

Days inventory outstanding represents year-end inventories net of provisions, divided by full year pro forma sales and multiplied by 365 (expressed as a number of days of sales).

Note: Averages are sales weighted. From annual accounts, December 2013.

Results from the largest pharmaceutical companies by sales  (Abbott Laboratories, AbbVie, Amgen, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi).

Source: EY

 

Figure 4: Big Pharma’s 2013 Working Capital Performance: Days Payable Outstanding

 

Days payable outstanding represents year-end trade payables, included value-added tax (VAT) and adding back trade-accrued expenses, divided by full-year pro formal sales and multiplied by 365 (expressed as a number of days of sales).

Note: Average sales are sales weighted. From annual accounts, December 2013.

Results from the largest pharmaceutical companies by sales (Abbott Laboratories, AbbVie, Amgen, AstraZeneca, Bayer, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck & Co., Merck KGaA, Novartis, Pfizer, Roche, and Sanofi).

Source: EY

 

 

 

 

 

 

 

Kunz explained that in evaluating the pharmaceutical industry’s working capital performance, several factors are influencing current performance: a wide range of payment practices; varying exposure of pharmaceutical companies to generics and non-pharmaceutical products (comparative to branded pharmaceuticals, generics typically carry much higher levels of working capital in relation to sales); varying levels of outsourcing; alliances and acquisitions; and inventory-acquisition strategies. “To evaluate working capital performance,” said Kunz, “pharmaceutical companies have to consider the trade-offs between cash, cost, and service levels that were agreed between themselves and their customers and suppliers.”

Looking ahead
So what can the pharmaceutical industry expect for 2014 in terms of its working capital performance? “Barring any material changes in payment policies with main wholesalers, our expectation for 2014 is that working capital performance for Big Pharma companies will improve slightly,” said Kunz. “Working capital results are also likely to show even wider divergences between individual companies as some embrace more substantial and sustainable operational and structural changes in the way they manage working capital. Companies where this is made a focus and good practice is embedded as an integral part of day-to-day operations are likely to see substantially more improvement than those where it is only important at period ends or where it is not a focus at all.”

To illustrate the opportunity to improve working capital performance, EY calculated the cash opportunity for pharmaceutical companies by comparing the performance of the working capital components of each company in the analysis with that of the average (low estimate) and the upper quartile (high estimate) of its peer subgroup (i.e., Big Pharma). On this basis, the EY analysis showed that between $20 billion and $37 billion of cash is unnecessarily tied up in working capital processes, equivalent to between 3.6% and 6.7% of these companies’ aggregate sales. On the payables side alone, which is the area in which sourcing and procurement organizations with their suppliers can influence, the average working capital cash opportunity for Big Pharma companies is $8 billion (representing 1.4% of sales) and upper quartile performance could translate to $16 billion, representing 35% of sales.

To achieve better working capital performance, Kunz concluded by offering several key strategies for sourcing and procurement organizations: better coordination between supply, planning, manufacturing, procurement, and logistics functions and processes; intensification of spend consolidation and standardization; more effective management of payment terms; more effective management of outsourcing arrangements; implementation of a larger, more unified shared-services organization; active management of the trade-offs between cash, cost, service levels and risk; further streamlining of manufacturing and supply chains; and more robust supply-chain risk-management policies.

Additional information, including analysis on the working capital performance of the top Japanese pharmaceutical companies, may be found in EY’s report, Cash on Prescription: Pharmaceutical Companies and Working Capital Management 2014 or Stephen Kunz, Executive Director  with EY’s Transaction Advisory Practice and Life Sciences Sector Leader for Working Capital, Stephen.Kunz@ey.com.Pharmaceutical companies and working capital management 2014

 

Leave a Reply

Your email address will not be published.

Recent Feature Articles

CDMO M&A: What Are The Important Moves?
By

By
As we near the fourth quarter of 2022, what have been the key mergers and acquisitions thus far in the CDMO/CMO sector and what new CDMOs/CMOs have entered the market? DCAT Value Chain Insights takes a look.

Industry Radar: Impact Factors for Sourcing
By

By
How is current market volatility, led by inflationary pressures, supply-chain disruptions, and geopolitical uncertainty, impacting sourcing and supply decisions? A look at what is on the industry’s radar.

EU Energy and Supply: What Will Happen Next?
By

By
The European Commission proposed this week an emergency intervention in Europe’s energy markets to address recent dramatic price rises as the EU faces the effects of a severe mismatch between energy demand and supply. What is in the proposal?

Industry Radar: Top 10 To Watch For Rest of 2022
By

By
What are the key issues and trends in play for the rest of 2022? From energy supply to inflationary pressures to new bio/pharmaceutical products launches, DCAT Value Chain Insights takes an inside look of what may be next.