Recent events, such as the COVID-19 pandemic and the Russia-Ukraine war, have disrupted supply predictability and extended lead times for various pharma-related products – from APIs to lab supplies. This has triggered a panic-buy mindset among pharma buyers, resulting in excess safety stocks that negatively impact working capital and increase pressure on supply chains.
How can pharma procurement teams best leverage safety stocks without setting off a chain of negative consequences?
The main disruptions currently posing challenges to the pharma industry are:
- Supply chain constraints. Pharma raw materials shortages have further exacerbated supply chains, with an expected 5-10% increase in the price of products such as chemicals – especially alcohol-based ones – and APIs during 2022 (The Smart Cube, 2022).
- Increased shipping costs. The rising demand for container shipping, coupled with a shortage of shipping containers, is likely to keep freight rates high in the short term. Pharma companies, including GSK, Bayer, and J&J, have seen a rise in logistics costs due to inflationary pressure and volatile global supply chains (The Smart Cube, 2022).
- Increased risk due to supplier geography. Globalization had removed limits on the location from which goods are purchased, raw materials are sourced, and where products are manufactured. However, this is no longer the case with newer constraints. For instance, China’s zero-COVID policy resulted in port congestions and factory shutdowns.
Safety stocks are the first port of call for supply chain specialists in times of volatile demand and supply fluctuations – yet they aren’t always the answer. How can pharma procurement specialists find the right balance between stock-out and overstock?
Safety stocks: a double-edged sword
Pharmaceutical companies have been increasing their level of safety stocks over the past two years to hedge against the risks – sometimes real, sometimes psychological – of breaking continuity of production or going out of stock.
With this comes costs. A sudden need for additional stocks can only be satisfied with sudden additional orders to suppliers, a behavior that often causes disruptions in suppliers’ planning and supply chains. This phenomenon, also known as the “bullwhip effect”, is a risk that procurement teams encounter when trying to keep their company safe. Excessive stocks also damage working capital.
Increasing safety stock levels based on a concrete need and calculated risk can make the difference between your organization staying afloat and sinking. On the other hand, letting safety stocks balloon based on an uncalculated perception of risk in the supply chain has a different name: panic buying.
How to calculate the right level of safety stocks
In pharma, as in many other industries, safety stocks are measured as a function of three factors: desired service level, demand, and lead time.
Service level answers the question: “Out of 100 orders, how many do we aim at fulfilling?” Unless prompted by a change in strategy, the answer should not be impacted by external events and should remain stable at all times. Therefore, service level concerns should not be a reason to increase safety stocks in uncertain times.
Demand can be tricky. It is true that during crises there are huge spikes in the demand for certain goods and services. However, the important question is: “In the medium-term, has the demand truly changed, or will it eventually be the same as before?” A powerful example is the disappearance of toilet paper from supermarket shelves in March 2020 – short-term demand increased, but long-term toilet paper consumption will generally not increase. Likewise, the demand for pharma products follows a normal distribution (Candan, 2016) and so is usually stable in the mid-term (i.e. 12 months plus). Demand is therefore often not a compelling reason to increase safety stocks.
Lead time is the factor that is the most changeable in the pharmaceutical supply chain. If a company is not experiencing increased lead times, there is no need to increase the level of safety stocks. If a company is experiencing increased lead times, taking action is the right thing to do – but doing so in a manner proportionate to the disruption is key.
How to manage lead time changes in the Supply Chain
- Talk with suppliers. A frequent material planning engagement with suppliers is crucial to continuously monitor their production capacity and the delivery performance of input materials; it also lets you proactively identify and resolve issues.
- Leverage best-in-class technology. Solutions such as digital scheduling tools improve daily decision-making and lead time visibility, empowering a stronger and more resilient supply chain (VanRooyen, 2022).
An Efficio pharma client recently developed a control tower tool that provides a 12-month forecast on expected shortages of critical components. This was achieved by collating the production planning information from its tier 1 and tier 2 suppliers. This is the perfect example of how strong relationships with suppliers – which translates into availability of detailed data – combined with cutting-edge technology can equip procurement teams with game-changing information.
Pharma procurement teams can also look at what is done in other industries with similarities in the supply chain, such as controlled temperature requirements or raw material perishability. A large European food company developed a strategic decision tool to segment inventory items by demand volatility and impact on turnover. This classification automatically feeds into the calculations of safety stocks per item and per warehouse. On top of that, the tool identifies opportunities for internal stock transfers across warehouses located all over the continent to adjust the availability of overstocked or understocked products. All of this is done taking into consideration the location, the shelf-life, and the virtual costs related to over- and understock of the item – another example of how technology can help us to manage thousands of SKUs successfully.
A way forward in managing the safety stocks
Safety stocks exist for a reason, and they must be used in case of risk for safety purposes. At the same time, changes in safety stock levels must not be driven by a general perception of risk.
Procurement organizations must avoid a “just to be safe” mindset when approaching safety stock level calculations and back up their decisions with facts and figures instead. Technology built upon solid relationships of trust with suppliers is usually the most effective solution to achieving these facts and figures.
We have significant experience with clients in the pharma and healthcare industry. If you would like to explore the development journey of your procurement function and related value generation and cost reduction opportunities, please contact one of our experts.