Ways to Recover Lost Margins

The past 15 years has witnessed extreme and mounting cost pressures on the pharmaceutical industry. This phenomenon has been driven by a host of changes, including:

• More costly and less productive R&D

• A saturated North American market where only a few new high-priced/high-margin drugs come to fruition

• Longer and more costly regulatory cycle times with greater drug-failure rates

• Advancing generic-drug competition and shorter patent life

• Outdated cost structures still laden with excess capacity and high-wage/high-benefit employees (although the industry has done much to change this through plant sales and layoffs).

Gregg Brandyberry

Few can argue that the golden years of the pharmaceutical industry with high-margin products and regular new blockbusters coming into the market to replace products going off patent is over.

A changing model

Although there is sales growth in exciting new global markets, these markets simply cannot command the high-priced drugs of the past. Granted, the potential exists for significantly increased sales volume over time, but the increased sales will be at a lower price and at lower margins.

To counter these trends, Big Pharma has aggressively deployed network rationalization strategies, other restructuring, outsourcing, and reorganizing, which has resulted in massive layoffs. Reducing infrastructure and operational costs has become the new norm within the industry. Some doomsayers are even predicting the demise of Big Pharma in the decades to come as there will no longer be a financial model that is attractive to investors. Now that may sound a bit farfetched, but one thing is certain: every function and every person is being called upon and challenged to become lean, to cut cost, and to do more with less.

I've written many times in the past that adopting best-practice procurement methods is a great way to reduce cost and to recover margin. My experience has shown that when the right sourcing strategies are deployed and the maximum amount of spend is truly competitively bid, the resulting savings can range from 10–30% of the starting baseline pricing of a company's total third-party purchases. Additionally, if a company is willing to focus on specifications, requirements, demand, and consumption, especially when buying indirect goods and services, significant incremental savings can be achieved on an ongoing basis.

An example of the resulting margin improvement (i.e., recovery) from a best-practice procurement-transformation initiative is as follows. Take the case of a company that generates $20 billion in annual revenues and has total costs for third-party purchases (both direct materials and indirect goods and services) of $8 billion annually with gross margins of 33% (i.e., $6.67 billion). If a company reduced its costs by 10% (i.e., $800 million), its gross margin would increase to $7.47 billion, or a gross margin gain of 12%. If a company reduced the cost by 15%, the gross margin gain would be 18%.

Based on this example, it is clear that a transformed procurement organization is a strong investment. It also should be noted that when done properly, the transformation can be accomplished at net cost post initial investment. Some organizations are even lowering the overall cost of procurement through the use of innovative technology and outsourcing strategies and are seeing a sharp rise in procurement's return on investment.

Recovery audits

With any improvement initiative, the secret to sustainability is to continue to improve and add new best practices as they become available. With that in mind, I offer some examples of what some organizations are beginning to do in this area, namely, recovery audits. Recovery audits are audits performed on past transactions to identify overpayments, recovering those overages, and putting safeguards in place to prevent recurrence. Recovery audits are becoming popular as a no-risk/low-risk method to recover overpayments associated with several areas in a company's business. The great thing about recovery audits are that there are many firms willing to perform the audit service and follow-up collections on a contingency fee basis (i.e., the firm will negotiate a split of the collected over payments). Recovery audits include payables audita, worker's compensation audita, telecommunications audita, and waste and recycling audits.

Payable audits. Payables audits are probably the most common recovery audit being performed today. Auditors look for items, such as duplicate payments, invoicing errors, wrong price paid, and other incorrect payments. Many firms have reported up to 2% overpayment on the sample data being audited. As monies are found, companies typically expand the scope of the audit.

Worker's compensation audits. The purpose of worker's compensation audits is to recover worker's compensation premium overcharges. Typically, the audit team will review the past five to seven years of insurance policies and premium calculations with the goal of finding errors and obtaining refunds. Various documents are reviewed, including final audit billing statements, experience-modification rating worksheet calculations, policy-declaration pages, auditor worksheets, loss-history summaries and claim reserves, and especially rating plans. Experience indicates that up to 70% of corporations will find that they have overpaid their carrier and will receive a refund as a result of this type of audit.

Telecommunications audits. Because the telecommunication industry has grown so complex and expensive, it is almost inevitable that waste and errors infiltrate the billing to an organization. The audit eliminates waste, corrects billing errors, and puts an organization in full control of future invoices. Auditors perform an in-depth analysis of local service, long-distance service, data lines and circuits, bandwidth usage, private lines, wireless service, teleconferencing services, equipment leases, and service contracts. Common issues that are addressed and corrected include hidden charges not on billing, overcharges versus contracted rates, incorrect long-distance carrier charges, duplicate charges, charges for unnecessary circuits, charges for services never ordered, and incorrect taxes and surcharges. History shows that corporations can lower their telecommunications bills by an average of 25% with the proper controls in place.

Waste and recycling audits. Independent specialists will perform free comprehensive waste audits that examines every aspect of a company's current waste and recycling services. These audits include contract compliance, thereby right-sizing a company's waste output to ensure that a company's out-density is within its industry standards, margin pricing, and cubic-yard evaluation. Most companies are overserviced and incur expensive bills for frequently scheduled hauler pickups. The specialists also will uncover potential revenues for a company from a more organized and aggressive recycling effort. Specialists are compensated with recovered monies on a negotiated basis or from helping to implement the necessary changes.

These are just a few examples. Recovery audits also are taking place for utilities, medical claims, merchant services (business-to-business transactions), sales and use tax recovery (for nonprofits), and property valuation, along with other areas where billing complexity exists.

Recovery audits are important tools for a company to benefit from improved practices and having additional funds returned and should be considered.

Gregg Brandyberry is CEO of Wildfire Commerce and strategic advisor for FedBid, tel. 215.327.5739, greggbrandyberry@yahoo.com.