Supply Chain Metrics That Matter: A Focus on Pharmaceutical Companies A Ten Year View of Progress on Supply Chain Excellence 05/12/2016

By Lora Cecere

Founder and CEO Supply Chain Insights LLC

By Regina Denman Client Services Director Supply Chain Insights LLC

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Contents

Research Disclosure

Research Methodology Understanding the Data

A Complex System with Nonlinear Relationships Driving Profitability

Improving Cycles Managing Complexity

A Closer Look at Value Driving Improvement

Supply Chain Index: A Measurement of Supply Chain Improvement Balance Strength

Resiliency Evaluating Supply Chain Excellence: Putting It All Together

Executive Overview The Race for Growth

What Is Value? Judging Supply Chain Performance

Managing Cycles A Closer Look at Generic Pharma

Industry Focus Recommendations

Conclusion Prior Reports in This Series

Methodology: Understanding the Math and Ratios Supply Chain Index Methodology: Formulas and Calculations

Balance Strength

Resiliency A Closer Look at Inventory Turns: An Important Measurement

Looking at Trends Corporate Overview Data

About Supply Chain Insights LLC About Lora Cecere

3 3 3 4 5 6 6 7 7 9

10 12 13 14 16 18 19 20 21 22 24 25 48 49 50 52 53 53 53 54 55 57 60 61 61

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Research Supply Chain Metrics That Matter is a series of industry-specific reports published throughout the

year by Supply Chain Insights LLC. The series starts in May when full-year corporate reporting is

complete for the prior year. In this report series we provide a deep focus on progress over the past

decade on supply chain excellence for a specific industry. This report is a deep analysis of the

pharmaceutical industry.

This analysis is based on data collected from financial balance sheets and income statements over

the period of 2006-2015. In these reports we examine how companies made trade-offs over the

course of the last decade. Here we analyze which pharmaceutical company’s supply chain did the

best on the delivery of a portfolio of metrics during that period.

Within the world of Supply Chain Management (SCM), each industry is unique. The pattern for

pharmaceutical companies is distinctly different than consumer products or medical device

companies. It is for this reason we believe it is dangerous to list all companies across industries in a

spreadsheet and declare a supply chain leader. Instead, we think it is more prudent to evaluate

change over time, with a focus on business results within an industry peer group.

Disclosure Your trust is important to us. As such, we are open and transparent about our financial relationships and our research processes. This independent research is 100% funded by Supply Chain Insights.

These reports are intended for you to read, share and use to improve your supply chain decisions.

Please share this data freely within your company and across your industry. All we ask for in return is

attribution when you use the materials. We publish under the Creative Commons License Attribution-

Noncommercial-Share Alike 3.0 United States and you will find our citation policy here.

Research Methodology Supply chain leaders are in a race to deliver supply chain excellence. The question is “What defines

excellence?” and “What defines value?” Here we answer these questions. To complete this analysis,

and understand the patterns, we analyze both performance and improvement of pharmaceutical

supply chains. We believe that the best supply chains out-perform their peer groups while driving

improvement.

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Performance is easier to measure than improvement. To build a method to measure improvement,

we partnered with a research team from the School of Computing, Informatics and Decision Systems

Engineering at Arizona State University (ASU) during the spring of 2014 to develop the Supply Chain

Index methodology to analyze supply chain improvement. Details on the math used in this

methodology are outlined in the Appendix of this report. We have refined this over time.

Understanding the Data In this analysis we use supply chain financial ratios as opposed to absolute numbers. The use of

ratios allows us to compare large companies to small entities, and also to compare the progress of

companies operating in different countries using differing currencies. Additionally, it allows us to

easily track progress over time.

Our first step was to determine which metrics to use. In Table 1 we share the supply chain ratios we

considered.

Table 1. Financial Ratios Considered in the Development of the Supply Chain Index

We find that most supply chain leaders measure too many indicators. To select the metrics in the

analysis we mined trends and discussed them with supply chain leaders. After a year of research we

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determined that the patterns and trade-offs between Year-Over-Year Revenue Growth, Operating

Margin, Inventory Turns and Return on Invested Capital (ROIC) were the most helpful in the

determination of performance and improvement. We term these as the Supply Chain Metrics That

Matter™.

While there are other measurements which we believe are important in the determination of supply

chain excellence—like forecast accuracy, case fill rate, carbon footprint, and inventory write-offs—we

cannot find a reliable and consistent source of data for these metrics that covers all industries and

years studied. In our research we find that the industry data sources are spotty and largely inaccurate

due to the self-reporting of data. Without a consistent data source across the industries we cannot

include these factors even though we believe they are important.

A Complex System with Nonlinear Relationships The supply chain is a complex system with increasing complexity. We believe it is the supply chain

leader’s role to build and manage supply chain performance to drive year-over-year improvements

which are balanced, strong and resilient. In our research we see that it takes at least three years. On

the journey we often find companies throwing the system out balance. As a result, leaders are able to

only drive progress on a single metric, not the entire metrics portfolio. A balanced metrics portfolio

has a higher correlation to value-based metrics of either market capitalization or market-to-tangible

book.

Our goal was to select a portfolio that would be meaningful across all industries. It is important to note

that the maximization of market capitalization requires the management of a balanced portfolio on the

effective frontier of growth, cost, cycles and complexity. We believe that supply chain leaders improve

a balanced portfolio of metrics.

Figure 1. The Effective Frontier

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In our writing it is deliberately not termed the ‘Efficient Frontier’—a term used in economic theory.

Why? Quite simply it is because the term ‘efficiency’ in supply chain processes is usually linked to the

lowest cost or the best revenue per employee. The concepts of the Effective Frontier are based on

the balance of growth agendas with cost, cycle metrics (a focus on inventory), and complexity. We

use Return on Invested Capital (ROIC) as a proxy for complexity.

In this report we analyze the progress of the pharmaceutical industry on the Effective Frontier. Across

all industries we find that nine out of ten companies are stalled at the intersection of two important

metrics, i.e. inventory turns and operating margin. While some companies made no improvement

over time, most companies were able to either improve inventory turns, or cost, but not both together.

The reasons? One of the reasons is unchecked complexity. The second is the focus on functional

metrics to the detriment of corporate performance. In the last five years 25% more items were added

to the item master of the average pharmaceutical company. As will be seen in this report, unchecked

complexity throws the supply chain out of balance.

Driving Profitability There is often an inverse relationship between margin and supply chain excellence. Industries with

the thinnest margins are more serious about delivering on the promise of supply chain leadership.

With the historically high margins in the pharmaceutical industry, driving supply chain leadership has

not been an important industry imperative. Today, with globalization, affordable healthcare, and the

drug patent cliff there is more focus on building a strong supply chain. In our analysis for this report,

we use operating margin as the measure of profitability. The methodology is equally applicable to

EBITDA.

Improving Cycles When it comes to managing cash-to-cash cycles, a small number is better than a large one. The

question in the boardroom is “How small can supply chain working capital cycles be managed to

pump cash into the organization?” There is seldom the question of “How low can we go in working

capital cycles before we put the supply chain at risk?” Cash-to-cash is a composite metric of days of

receivables, days of inventory, and days of payables. As can be seen through the charts, the greatest

improvement in supply chains in the last decade has been made in payables—lengthening payment

terms to suppliers. Inventory levels and receivables have been more constant.

In our analysis we use inventory turns as our measure of supply chain cycles. While companies want

a smaller number for days of inventory, they want to turn inventory faster. The higher the inventory

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turn value, the stronger the results. There are two primary ways to calculate inventory turns. In this

report we measure inventory turns as:

Inventory Turns = Cost of Goods Sold/Inventory

Managing Complexity By definition the pharmaceutical industry is an asset intensive industry. Manufacturing reliability is at

the core of supply chain excellence. Within the pharmaceutical company supply chain there are many

forms of complexity: increase in items, customer policies, geographic reach, changes in

manufacturing, serialization of items, cold chains, and new product launch. In the last decade

complexity abounds. As complexity rises it is hard to drive asset effectiveness.

There are many measurements of asset effectiveness: Return on Assets (ROA), Return on Net

Assets (RONA) and Return on Invested Capital (ROIC). Return on Invested Capital is a less well-

known metric compared to Return on Assets. In this report we use ROIC as a measure of asset

effectiveness.

The reasoning? Return on Assets has a narrower focus. Our research indicates that ROIC has a

better correlation with stock market capitalization, and provides a broad perspective on cash flow

generation and profitability based on shareholder equity. The formula used for ROIC is:

𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 + 𝐼𝑛𝑐𝑜𝑚𝑒 𝑇𝑎𝑥 𝑇𝑜𝑡𝑎𝑙

𝑇𝑜𝑡𝑎𝑙 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠𝐸𝑞𝑢𝑖𝑡𝑦

ROIC is a measurement of the company’s use of capital. The goal of the measurement is for the firm

to drive higher returns than the market rate of the cost of capital. As will be seen in this report, for

many companies this is a struggle.

A Closer Look at Value Traditionally the supply chain team’s focus was a cost agenda. Increasingly the organization is asking

the supply chain team to focus on value. However, to guide this journey there has to be a clear

definition of value. There is no industry-standard definition of value.

To help, we started this undertaking with an analysis between supply chain performance and market

capitalization. In 2012 we calculated the correlation of seven years of financial ratios (based on

quarterly reporting) to market capitalization (the number of outstanding shares multiplied by the share

price) on a quarterly basis. The results of this initial study on the correlation to market capitalization

are presented in Table 2.

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Table 2. Correlation of Supply Chain Financial Ratios to Market Capitalization

Within the firm, 60-80% of total costs are controlled by the supply chain team. In parallel, most of the

physical assets are driven and/or defined by supply chain strategy. While market capitalization is

often driven by economic cycles we find Price to Tangible Book Value (PTBV) is a more disciplined

look at value.

Price to Tangible Book Value is calculated by dividing the share price of a public company by its

tangible book value per share. It is a ratio depicting what investors are paying for each dollar of

physical assets. For example, let's assume that Company XYZ has 10,000,000 shares outstanding

which are trading at $3 per share. Let’s assume that the same company’s tangible book value was

$15,000,000 last year. The calculation would be:

Price to Tangible Book Value = $3 / ($15,000,000/10,000,000) = 2.0

The PTBV ratio excludes intangibles: intellectual property, patents, goodwill and other intangible

assets. It is a representation of what debt holders or investors would receive if the company liquidated

all physical assets. We feel this is a measure which supply chain leaders can impact. In this report we

use the metrics that have the highest correlation to market capitalization and also evaluate which

companies have driven the greatest improvement on Price to Tangible Book Value.

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Driving Improvement In the analysis of supply chain excellence it is a mistake to look at the metrics at an annual or limited

period of time and declare a supply chain winner. Instead, it needs to be measured as a pattern over

many years. The best supply chain improvements take at least five to six years.

Sustaining competitive advantage is difficult. A bad project, a quality issue, or a merger, drives

gyrations. As a result, most companies go through ups and downs with distinct patterns. We believe

that the patterns matter. It is for this reason in this report we analyze companies’ progress during the

time periods of 2006-2015, 2006-2009, and 2010-2015. Why these time periods? Here we are

analyzing pre-recession and post-recession progress within specific industries as defined by NAICS

code designations.

To understand the differences by industry, let’s take a closer look at the healthcare value chain.

When we compare the 2006 to 2015 industry averages, we can see that the pharmaceutical industry

improved in all of the metrics covered in this report. The pharmaceutical industry is one of the few

industries with higher performance in 2015 when compared to 2006. The reason? Historically, the

pharmaceutical industry is a supply chain laggard. As product development slowed in clinical trials,

and global complexity increased, supply chain became a more valued core competency.

Table 3. Changes in Industry Average Values of the Supply Chain Metrics That Matter When the 2006 Averages Are Compared to 2015

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Supply Chain Index: A Measurement of Supply Chain Improvement The Supply Chain Index is the measurement of improvement used in this report. The foundation of

the Supply Chain Index starts with understanding the resulting pattern when two supply chain metrics

(generally ratios) are plotted over time on an orbit chart. As shown in Figure 2, the orbit chart enables

the visualization of performance patterns. In this case the company is Amgen. The average values for

the two financial ratios of operating margin and inventory turns are shown in the box, and the annual

progress is shown as points on the chart. The best scenario is notated in the upper right-hand corner.

The pattern of Amgen’s performance, as shown in Figure 2, is very characteristic of most companies.

While there is improvement for 2013-2015, the company struggled to drive improvement in these two

critical metrics over the period of 2006-2013.

Figure 2. Example Orbit Chart of Amgen

This is not unusual. We seldom see a company making linear improvement at the intersection of

these two important metrics. As you will see in the case of pharmaceutical companies, many

companies are not even making improvement in one of the two metrics.

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Contrast the patterns of BMS and Merck in Figure 3. While BMS is operating at a higher level of

inventory turns (6.27), the company has a lower operating margin (.08). In contrast, Merck has a

higher operating margin (.15) and lower value for inventory turns (2.77). Both companies are at the

same performance level in 2015 as they were in 2006. This is despite many, many continuous

improvement and Lean projects. You might ask, “How can this be?” Answering this question is the

goal of this report.

Figure 3. Example Orbit Chart of Inventory Turns versus Operating Margin for 2006-2015 of BMS vs. Merck

Also note BMS has a tight pattern while Merck’s results have greater variability. We call this

resiliency. A tighter pattern is more resilient. In this case BMS’ results were more resilient than those

of Merck.

Due to the complexity of the charts, our first challenge in the creation of a methodology was to define

‘Supply Chain Improvement’. This was our goal in building the Supply Chain Index. We wanted to

develop a means to analyze improvement across a variety of industries, with applicability to

companies with different levels of revenue, and at different levels of supply chain maturity. With each

chart we measure balance, strength and resilience in performance metrics within a peer group for the

Supply Chain Metrics That Matter.

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Balance Balance in the supply chain is a constant struggle. Growth requires an increase

in inventory. Forecasting and managing a new product launch is difficult.

Excessively long Days of Payables leads to weakened supplier health. The

examples are endless. The two metrics which comprise our balance measure

are Revenue Growth and Return on Invested Capital.

The balance measure in the Supply Chain Index is a mathematical calculation

of the vector trajectory of the pattern between growth and ROIC for the periods of 2006-2015 and

2009-2015.To understand this measurement, imagine a four quadrant grid with growth and ROIC on

the two axes. In our calculation, the overall trajectory of this vector from Year 0 (2006) to Year 9

(2015) is simplified into a single value which represents the company’s ability to balance growth while

improving ROIC.

Companies that were able to drive improvement in both metrics scored the best, while companies

that deteriorated in both metrics scored the worst. The companies are then stack-ranked based on

factor ratings. In Figure 4 we profile Amgen at this intersection.

Figure 4. Orbit Chart of Growth vs. Return on Invested Capital (ROIC) for 2006-2015 for Amgen

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The balance factor comprises 1/3 of the total Supply Chain Index calculation. Sustained improvement

on both year-over-year growth and ROIC indicates a balanced supply chain and is reflected in a high

balance score.

Strength A successful supply chain is strong and reliable. Supply chain leaders strive to

deliver year-over-year improvements in both cost and inventory management.

Our research on pattern recognition has uncovered a rich relationship between

operating margin and inventory turns. For most supply chain leaders, these are

some of the most important measures of their performance. Not only are they

important, they are more directly influenced by day-to-day supply chain

decisions than other, and more broadly used, corporate metrics. It is for this reason they are the two

components of our strength factor in the Supply Chain Index.

The strength measure in the Supply Chain Index is a mathematical calculation of the vector trajectory

of the pattern between inventory turns and operating margin for the periods of 2006-2015 and 2010-

2015. Like the balance factor calculation, the work starts with understanding the orbit chart pattern.

To understand the calculation, imagine a plot—an orbit chart—of inventory turns and operating

margin. In this report, performance is graphed on an annual basis from an origination point

representing performance on the two metrics at Year 0 (2006). The overall trajectory of this vector

from Year 0 (2006) to Year 9 (2015) is simplified into a single value which represents strength.

Improvement on both metrics simultaneously is graphically shown as movement to the upper-right

quadrant with increasing values for both inventory turns and operating margin over the period.

For example, let’s compare Eli Lilly and Novo Nordisk. These two companies compete in the diabetic

care sector. Note in Figure 5 that Novo Nordisk is driving a slow rate of improvement on the two

metrics, while Eli Lilly is struggling to drive improvement and going backwards during the period of

2011-2015.

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Figure 5. Orbit Chart: Operating Margin vs. Inventory Turn Comparison of Eli Lilly and Novo Nordisk A/S

As a result of this pattern, and driving higher and more sustainable results, Novo Nordisk’s ranking on

strength in the Supply Chain Index is higher. The companies are then stacked-ranked based on

performance and assigned a strength factor. The strength ranking is 1/3 of the Supply Chain Index.

Resiliency Resiliency is an adjective easily tossed around as one of the important qualities

of a successful supply chain in today’s volatile world. However, the concept of

resiliency is difficult to define, and there is rarely clarity among stakeholders as

to what resiliency is or should be.

As we plotted orbit chart after orbit chart, we could see that some supply chains

had very tight patterns at the intersection of operating margin and inventory

turns, and that other companies had wild swings. We wanted to find a way to measure the variation.

So, we turned to the experts at ASU. After evaluating several methods to determine the pattern in the

orbit chart, we settled upon the Euclidean Mean Distance between the points.

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These results were published in our March 2014 report, Supply Chain Metrics That Matter: Improving

Supply Chain Resiliency, where we define resiliency as the tightness of the pattern at the intersection

of inventory turns and operating margin. (The calculation is outlined in the Appendix of this report.)

These metrics, both critical for any supply chain, are components of both the strength and resiliency

metrics in our Supply Chain Index model.

The tightness of the pattern (mathematically speaking, the Euclidean Mean Distance) indicates the

ability of a supply chain to maintain a tight, consistent pattern across these two metrics as the

business environment shifts and changes over a nine year period (2006-2015). As shown in Table 4,

supply chain resiliency varies considerably by industry. The pharmaceutical industry is more resilient

than contract manufacturing and consumer electronics, but more volatile than consumer packaged

goods.

Table 4. Supply Chain Resiliency by Industry

The resiliency metric is similar to the cash-to-cash cycle in that a smaller number is better. A lower

number for resiliency is an indicator of a tighter pattern and greater reliability in results over the time

period.

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Evaluating Supply Chain Excellence: Putting It All Together In the overall analysis each company is judged by their own potential to make progress. While the

average values of a company’s performance may be higher,

in the Supply Chain Index we are evaluating companies on

their ability to drive year-over-year improvement and reliable

progress on the metrics that we believe matter.

The Supply Chain Index is a measurement of supply chain improvement. Each of the factors—

balance, strength and resiliency—as defined above, comprises 1/3 of the total score.

𝑆𝑢𝑝𝑝𝑙𝑦 𝐶ℎ𝑎𝑖𝑛 𝐼𝑛𝑑𝑒𝑥™ = 13𝐵𝑎𝑙𝑎𝑛𝑐𝑒 𝐹𝑎𝑐𝑡𝑜𝑟 + 1

3𝑆𝑡𝑟𝑒𝑛𝑔𝑡ℎ 𝐹𝑎𝑐𝑡𝑜𝑟 + 1

3𝑅𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑐𝑦 𝐹𝑎𝑐𝑡𝑜𝑟

The Supply Chain Index results for Pharmaceutical companies are shown in Table 5.

Table 5. Supply Chain Index for Pharmaceutical Companies for the Years of 2006-2009, 2010-2015 and 2006-2015

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The companies making the most improvement are Amgen, Bayer Group, Biogen Inc., Novo Nordisk

A/S, and Roche Holding AG. Three of these companies also outperform their peer group on Price to

Tangible Book Value.

Companies that are underperforming their peer group can drive supply chain improvement faster than

higher-performing companies. As a result, when evaluating supply chain excellence, it is important to

look at improvement and performance together. We use this analysis to determine the best

performing supply chains through our Supply Chains to Admire methodology.

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Executive Overview Globalization. Serialization. Clinical trials. Cold chain operations. Custom drug protocols. Compliance.

Risk Management. Corporate Social Responsibility (CSR). First pass yield. Over the last decade, the

number and variety of supply chain initiatives exploded for the pharmaceutical leader. As a result, the

supply chain group, and the business imperatives, grew in importance.

Overall, the pharmaceutical supply chain fared better through the decade than that of consumer

products or food/beverage. The reason? The pharmaceutical supply chain entered the decade as a

supply chain laggard. They were able to focus and catch up to the level of other industries.

As shown in Table 6, when the industry averages of 2016 are compared to 2015, the pharmaceutical

supply chain grew revenue while driving improvements in operating margin, inventories, cash-to-cash

and Return on Invested Capital (ROIC).

Table 6. Industry Snapshot of Performance

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However, when we look at the balance sheets and income statements, and compare company

performance, there is not clear supply chain winner. While Biogen and Novo Nordisk are clearly

driving improvement, and Price to Tangible Book Value, neither company outperforms on inventory.

As a result, no pharmaceutical company will make the Supply Chains to Admire list for 2016. To

make the list, a company had to deliver performance (above average results for the period of 2009-

2015 than their peer group on a portfolio of metrics including Price to Tangible Book Value, growth,

operating margin, inventory turns and Return on Invested Capital) and drive supply chain

improvement (based on the Supply Chain Index) faster than their peer group. We believe both

performance and improvement matter. We hope this report can be a guide to help companies

understand what is possible, and how supply chain metrics drive value.

In the pharmaceutical industry we find most companies to be stuck. They have either regressed in

supply chain performance or they are at the same point as they were a decade ago. For many supply

chain leaders that attend conferences, this may seem unfathomable. There is an industry belief that

companies have implemented new technologies and evolved processes and driven improved balance

sheet results. The goal of this report is to enable benchmarking and to spark a new conversation on

the definition of supply chain excellence.

The Race for Growth Growth rates for the pharmaceutical companies were faster early in the decade than the last part of

the decade. The overall growth for the period of 2006-2015 is 6%. As shown in Table 7, note that four

companies in the peer group posted growth rates greater than the industry average and are in the top

half of the Supply Chain Index (measurement of supply chain improvement) for the periods of 2006-

2015 and 2010-2015. These companies are Amgen, Biogen, Novo Nordisk and Shire. Conversely,

Merck beat the growth rates for the period of 2006-2015, but struggled to drive supply chain

improvement. Companies with the highest growth rates also did the best on driving supply chain

improvement.

Many supply chain leaders don’t believe it is possible to grow and manage the Supply Chain Metrics

That Matter simultaneously. In the analysis, we see that as growth slowed in the pharmaceutical

industry that it was harder to drive improvement on the Supply Chain Metrics That Matter.

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Table 7. Industry Growth Rates Over the Last Decade with a Comparison to the Supply Chain Index

What Is Value? As noted in Table 8, companies outperforming in market capitalization may not outperform in Price to

Book, or Price to Tangible Book Value. Also note the trend between PTBV and the Supply Chain

Index. While a company like AstraZeneca PLC is outperforming on many metrics, the supply chain

performance is declining with a falling Price to Tangible Book valuation.

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Table 8. Comparison of Market Capitalization, Market-To-Book Value and Market-To-Tangible Book Value

Judging Supply Chain Performance When it comes to overall supply chain performance, Biogen and Novo Nordisk are posting results

better than the peer group while still driving improvement. However, neither company is pushing

above the industry average on all of the metrics to meet the Supply Chains to Admire definition. As

shown in Table 9, both Biogen and Novo Nordisk are outperforming in growth, operating margin and

ROIC, but underperforming on inventory turns. Shire is showing improvement in the later part of the

decade, but is a late bloomer.

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Table 9. Comparison of Performance and Improvement for the Periods of 2006-2009, 2010-2005 and 2006-2015

Managing Cycles When comes to managing cash-to-cash cycles, a small number is better. The question in the

boardroom is “How small can supply chain cycles be managed before we put the supply chain at

risk?” To understand the management of cycles in the pharmaceutical industry we evaluated them in

three time periods: pre-recession, during the recession and post-recession. We wanted to understand

how the components of cash-to-cash cycles had changed across competitors over time.

Cash-to-cash is a composite metric of receivables, inventory and payables. As can be seen through

the charts, the greatest improvement in supply chains in the last decade has been made in

payables—i.e. lengthening payment terms to supplies—while inventory levels and receivables have

been more constant. However, with the exception of AstraZeneca, the pharmaceutical companies

have not been as aggressive as other industries on the elongation of payables.

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Table 10. Comparison of Cash-to-Cash Components: Pharmaceutical Industry During 2006-2009 and 2010-2015

While it looks like AstraZeneca has made the most progress in managing cash-to-cash cycles, a

closer examination of the payables in Figures 6 and 7 tells a different story. The improvement is

primarily coming from lengthening payables. The movement from 300 to over 500 days by

AstraZeneca is dangerous. This is especially true in the pharmaceutical industry where there is a

critical dependence on suppliers and contract manufacturers.

Figure 6. Cash-To-Cash Cycles for Major Pharmaceutical Companies for the Period 2006-2009

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Figure 7. Cash-To-Cash Cycles for Major Pharmaceutical Companies for the Period of 2010-20015

We find that the supply chain leaders who are making the most progress on the Effective Frontier,

and have the tightest resiliency on orbit charts (at the intersection of inventory turns and operating

margins), usually have lower payables in the 30- to 120-day range.

A Closer Look at Generic Pharma While the first part of this report focuses on branded pharmaceuticals, a new industry for generic

drugs has evolved. These companies operate at a lower margin, where supply chain performance

should be paramount. However, note that the generic pharma leaders Teva and Mylan have not been

able to drive higher levels of supply chain performance or improvement. As shown in Figure 8, both

companies lack resiliency at the intersection of operating margin and inventory turns. There is an

opportunity in generic pharma to use supply chain as a competitive advantage which has not

happened yet.

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Figure 8. A Study of Teva and Mylan at the Intersection of Operating Margin and Inventory Turns

Industry Focus To grow, the industry was rife with acquisitions. During 2010-2015 the supply chain focus was Lean

Six Sigma, the prevention of counterfeit products/protection of intellectual property, and globalization.

Pharmaceutical companies are more mature on Risk Management and Supplier Development

programs than consumer products or food/beverage. In this section we share significant supply chain

related quotes from the corporate reports for this period.

Abbot Laboratories 2010: in recent years. Just as our Guidant acquisition in 2006 capped a long-

term strategy that gave us critical mass in an attractive new business, our more recent strategic

actions have taken Abbott to a new level in emerging markets. In 2010, we:

• Acquired Solvay Pharmaceuticals, bringing us approximately $2 billion in stable, branded generic sales;

• Acquired Piramal’s Healthcare Solutions business, making Abbott the largest pharmaceutical company in

India, an $8 billion market expected to double in the next five years;

• Completed an agreement with Zydus Cadila for 24 branded generic pharmaceutical products in 15 emerging

markets;

Created a new Established Products Division (EPD) to maximize the strong commercial opportunities

for branded generics outside the United States. EPD launched at the beginning of 2011 with

approximately $5 billion in annual sales. All these actions give us the right commercial footprint to

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become one of the largest pharmaceutical companies in emerging markets.

We expect that roughly one-third of our global pharmaceutical sales will come from high-growth

emerging markets within five years.1

In the domestic pharmaceutical business, the most significant charges against gross sales are for

Medicaid and Medicare Rebates, Pharmacy Benefit Manager Rebates and Wholesaler Chargebacks.

In order to evaluate the adequacy of the ending accrual balances, management uses both internal

and external data to estimate the level of inventory in the distribution channel and the rebate claims

processing lag time. External data sources used to estimate the inventory in the distribution channel

include inventory levels periodically reported by wholesalers and third party market data purchased

by Abbott. Management estimates the processing lag time based on periodic sampling of claims data.

To estimate the price rebate percentage, systems and calculations are used to track sales by product

by customer and to estimate the contractual or statutory price. Abbott’s systems and calculations

have developed over time as rebates have become more significant, and Abbott believes they are

reliable.2

Astrazeneca 2010: We seek to maximize the efficiency of our supply chain through a culture of

continuous improvement. We focus on what adds value for our customers and patients, and what

eliminates waste. This program has delivered significant benefits in recent years, including reduced

manufacturing lead times and lower stock levels, both of which improve our ability to respond to

customer needs and reduce inventory costs. Changes have also been achieved without

compromising customer service and quality. We have been applying Lean business improvement

tools and ways of working to improve the efficiency of our manufacturing plants for a number of years,

and are now applying them to the whole of our supply chain. In 2010, we reinforced our commitment

to creating a Lean supply and manufacturing organization with a global campaign to recruit more

Lean experts into our manufacturing sites and supply chain functions. This has included the creation

of a new global centre of excellence comprising Lean experts from a broad range of industrial

backgrounds to provide support and co-ordination to the accelerated development of our Lean supply

system. This enables us to learn from other industries how to operate our supply chains at a much

higher performance level than is generally found in the pharmaceutical sector. The inauguration of a

new regional packing centre in Wuxi, China in 2010 was a key milestone. We operate this centre to

1Abbot Laboratories, 2010 Annual Report, March 3, 2011, p.3, http://www.abbott-laboratories.si/uploads/datoteke/Global%20citizenshi p%20report%202010.pdf, accessed April 1, 2016. 2 Abbot Laboratories, 2010 Annual Report, March 3, 2011, p.65, http://www.abbott-laboratories.si/uploads/datoteke/Global%20citizenshi p%20report%202010.pdf, accessed April 1, 2016.

Page 27

our global standards and apply a broad range of Lean techniques and principles. We believe it will

improve our competitiveness in Asian markets.3

At the end of 2010, approximately 9,300 people at 23 sites in 16 countries were working on the

manufacturing and supply of our products. Approximately 8,350 people work in formulation and

packaging and 350 people work in active pharmaceutical ingredient (API) supply. Our principal small

molecule manufacturing facilities are in: the UK (Avlon and Macclesfield); Sweden (Snäckviken and

Gärtuna, Södertälje); the US (Newark, Delaware and Westborough, Massachusetts); France (Reims);

Japan (Maihara); Australia (North Ryde); China (Wuxi); Puerto Rico (Canovanas); Germany (Wedel);

Mexico (Lomas Verdes); Brazil (Cotia); and Argentina (Buenos

We continue to work to make sure that our purchasing is directed only to those organizations which

embrace ethical standards consistent with our own. This is particularly important given the strategic

changes to our geographic footprint and our increased outsourcing activity to support improved

efficiency and effectiveness across the organization. Our Global Responsible Procurement Standard

defines the process for integrating our ethical standards into our procurement activity and decision

making worldwide. The process is based on an escalating set of risk-based due diligence activities,

applied in a pragmatic way. The same initial assessment process is used for all suppliers and more

detailed, specific assessments are then made as required, proportionate to the level of risk a supplier

presents. The Standard includes detailed expectations of suppliers which suppliers sign up to as part

of the contracting process. We will work with suppliers to help them improve their standards, rather

than automatically excluding them from our supply chain but we will not use suppliers who are unable

or unwilling to meet our expectations in a timely way.

Implementing our approach across the many thousands of suppliers we work with around the world

will take time. We started with our largest suppliers, whose contracts with AstraZeneca are managed

centrally by our Procurement team. In 2009, we completed Responsible Procurement assessments of

over 800 suppliers accounting for around 65% of our third party spend. In 2010, we extended the

program to other companies in our supply chain, including smaller suppliers and those whose

contracts are managed locally. Since the program began, we have completed over 1,950

assessments which account for around 75% of our third party spend. The ongoing program will

continue throughout 2011 and beyond.

3 Astrazeneca, 2010 Annual Report, March 2011, p.34, https://www.astrazeneca.com/content/dam/az/our-company/investor-relations/presentations-and-webcast/Annual-Reports/2010-Annual-Report.pdf, accused April 1, 2016.

Page 28

In late 2010, we introduced a requirement that our key suppliers provide independent audit

verification that their ethical standards are being applied in practice. Together with our suppliers, we

are partnering with experienced third party providers in this work and using an assessment program

that reflects best practice from other industry sectors, as well as the principles of the Pharmaceutical

Supply Chain Initiative (a group of major pharmaceutical companies working to support suppliers in

operating in line with industry expectations). We are in the early stages of engaging with suppliers on

the introduction of this requirement and it will take time to embed the practice. However, we believe

that this move significantly strengthens the framework for working together with our suppliers to drive

continuous improvement. We continued our Integrated Supplier Evaluation Protocol audit program

during the year and have now supplemented this with the introduction of focused Responsible

Procurement assessments. In 2010, the program covered 48 audits at 42 different suppliers (2009:

51 audits at 45 suppliers).4

Roches Holdings AG 2010: In the Pharmaceuticals Division the operating profit increased by $2.2

billion to $5.9 billion, driven primarily by synergies from the Genentech integration in all functions,

higher positive effects of cost-sharing agreements with related parties and resource prioritization,

notably in marketing and distribution, despite the initial costs for the

Operational Excellence program of $0.4 billion. Cost of sales decreased in comparison to 2009, as a

result of lower royalty expenses and lower expenses for collaboration and profit-sharing agreements

in 2010, further to an amended agreement with GlaxoSmithKline in the U.S. for Bonviva/Boniva. 2010

also includes the impacts of productivity improvements in technical operations, offset by unfavorable

product mix effects. The comparative period includes the one-time impact of the inventory write-off for

the voluntary withdrawal of Raptiva. Research and development costs, excluding intangible assets

impairments, decreased by 4% mainly due to the positive impact of cost sharing agreements with

related parties, resource prioritization and synergies. Research and development expenses also

included the immediate recognition of the remaining costs of $53 million necessary to cover the

termination of the ocrelizumab rheumatoid arthritis development program and the payment received

from Novartis for opting in the Lucentis study on the treatment of macular edema following retina/vein

occlusion.The majority of the costs that were recorded as part of the Operational Excellence program

4 Astrazeneca, 2010 Annual Report, March 2011, p.44, https://www.astrazeneca.com/content/dam/az/our-company/investor-relations/presentations-and-webcast/Annual-Reports/2010-Annual-Report.pdf, accused April 1, 2016.

Page 29

relate to research and development.5

Astrazeneca 2011: In October, we launched an online Supply Chain Academy, providing ongoing

internal training to drive further improvements across our end-to-end supply chain. Alongside this we

ran an internal leadership program to reinforce the cultural aspects of more efficient supply chain

processes. In October, we announced an investment of $200 million to build a manufacturing facility

in China Medical City in Taizhou, Jiangsu province, China to meet growing local demand for our

products and expand availability of our products to people in urban and rural communities. This will

be our first manufacturing site to be built using Lean principles from the outset. These principles are

being applied from the planning stage to the whole facility, including operators, products, components

and equipment. We are designing equipment to meet varying demand, enabling fast, reliable

changeover. We also seek to identify where processes could fail, designing systems to minimize

these risks.6

Capital expenditure on supply and manufacturing facilities totalled approximately $388 million in 2011

(2010: $333 million; 2009: $360 million). As part of our overall risk management, we carefully

consider the timing of investment to ensure that secure supply chains are in place for our products.

We also have a program in place to provide appropriate supply capabilities for our new products. At

the end of 2011, approximately 9,600 people at 23 sites in 16 countries were working on the

manufacturing and supply of our products.

GlaxoSmithKline 2011: In 2011 the FDA approved the highest number of new molecular entities

since 2004, and nearly a third of these approvals were for therapies to treat rare diseases. This is in

line with the FDA’s priority to address the public health needs of special populations. Enforcement

and compliance activity increased in the manufacturing and global supply chain, as well as in drug

advertising and promotion. The FDA developed its goals for the renewal in 2012 of the Prescription

Drug User Fee Act (PDUFA) with a focus on enhancing the science of drug development, improving

the quality of evidence in applications, providing a more efficient and predictable review process, and

maintaining public confidence.7

Our record demonstrates the success of this approach. Although reported turnover fell 3% in 2011,

we have delivered underlying sales growth of 4% in each of the past two years. We anticipate that 5 Roche Holdings AG, 2010 Annual Report, March 2011, p. 3, http://www.roche.com/rhi_ar_2010.pdf, accessed April 1, 2016. 6 Astrazeneca, 2011 Annual Report, March 2012, p.38, https://www.astrazeneca.com/content/dam/az/our-company/investor-relations/presentations-and-webcast/Annual-Reports/2011-Annual-report.pdf, accessed April 4, 2016. 7 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.14, https://www.GlaxoSmithKline.com/media/325141/annual-report-2011.pdf, accessed April 4, 2016.

Page 30

underlying sales growth will translate into reported sales growth in 2012. (For details of underlying

growth see page 27). In addition, 38% of Group turnover is now generated outside the USA and

Europe.

The shift in sales away from a reliance on ‘white pills in Western markets’ to a broader base including

Emerging Markets, Vaccines and Consumer Healthcare is clear.8

Despite a 5% fall in reported sales, our US operating profit increased by 1% as our efforts to simplify

and standardize work processes produced efficiencies that helped control costs and offset the decline

in sales of certain products combined with higher asset disposal income. In our Pharmaceuticals

business, reported turnover declined by 6% and underlying turnover declined by 1%. Sales of our

largest product, Advair, declined 1%. This follows the drop in the US market for ICS/ LABA

combination products following the revised class labeling implemented by the Food and Drug

Administration (FDA) in 2010. Hycamtin sales declined 92% due to generic competition and Zovirax

sales declined 79% following the divestment of the brand in January 2011.9

The first implementation of GSK’s new global standard Enterprise Resource Planning system,

designed to standardize and improve financial and commercial processes, was completed

successfully in Germany, and the deployment of our new European supply chain continues.10

Reported turnover growth in the year was 6%, but underlying growth of 15% outpaced growth in the

market for the third consecutive year. The underlying growth was driven by relatively consistent

pharmaceuticals growth during the year, of 14%. Operating profit fell 3%, reflecting the loss of sales

of pandemic products, Avandia and Valtrex.11

In 2011, we announced our intention to build a new manufacturing facility in the UK for the supply of

biopharmaceutical products. Subject to the introduction of ‘patent box’ legislation by the UK

Government in 2012, this facility could be built at one of four existing GSK sites – Barnard Castle or

Ulverston in the north of England, or Irvine or Montrose in Scotland – representing an investment of

several hundred million pounds.

Standardization should increase productivity, as our businesses will have more time to focus on their

8 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.16, https://www.GlaxoSmithKline.com/media/325141/annual-report-2011.pdf, accessed April 4, 2016. 9 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.18, https://www.GlaxoSmithKline.com/media/325141/annual-report-2011.pdf, accessed April 4, 2016. 10 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.20, https://www.GlaxoSmithKline.com/media/325141/annual-report-2011.pdf, accessed April 4, 2016. 11 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.21, https://www.GlaxoSmithKline.com/media/325141/annual-report-2011.pdf, accessed April 4, 2016.

Page 31

operations and performance rather than coordinating internal processes. Standardization of data and

systems should provide better decision-making information. A key enabler for the delivery of benefits

from CBS will be the enterprise-wide Enterprise Resource Planning (ERP) system.

The significant investment we are making in the Global ERP program over the next five years will

enable CBS to

• create standard business processes, systems and data to support the growth and

• change agenda across multiple businesses. As part of the ERP programd we are

• converting country-based commercial IT systems to a single SAP IT system and

• replacing numerous fragmented and non-standardized applications. In 2011 the system went

live in Germany, marking the start of ERP deployment across the whole of GSK.

In 2011, we implemented changes to our supply chain processes. To help supply chain efficiency we

have significantly simplified our product portfolio by reducing the number of packs or ‘SKUs’ by 25%

in Europe, 15% in Japan and up to 24% in Emerging Markets. We are now focused on standardizing

the remaining pack formats to improve packaging efficiency and costs. In addition, our manufacturing

organization is actively seeking to improve procurement processes and in particular our purchasing of

active ingredients, chemical intermediates, packaging components and part-finished and finished

products. This is releasing further cost efficiencies and allowing us to reduce working capital.

In our Consumer Healthcare business, we are redesigning our supply chain to form an integrated,

end-to-end process that is more aligned with our customers and the commercial operations of the

business. This process is also being configured to support the high-growth regions of emerging

markets. These changes are expected to reduce cost and free-up working capital. Our European

pharmaceuticals and vaccines supply chain has also been redesigned to simplify operations and

consolidate distribution locations to reduce inventory, increase service levels and cut operating

costs.12

Our long-term vision is for our entire value chain to be carbon neutral by 2050. Around 40% of our

carbon footprint results from our supply chain and a further 40% from propellants released from our

inhalers. Less than a fifth of our total impact comes directly from our operations, so while we continue

to increase energy efficiency and the use of renewable energy at our sites, we are also focusing on

our supply chain and the use of products, especially inhalers.

In 2011 we began foot-printing key products to identify the priorities, and have developed site-based

12 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.41, https://www.GlaxoSmithKline.com/media/325141/annual-report-2011.pdf, accessed April 4, 2016.

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events to analyze local carbon reduction potential and act on the opportunities. In 2011 we reduced

energy consumption from our operations by 5.2%. Greenhouse gas emissions from the use of

inhalers rose by 2.9%.13

Inventory of £3,873 million has increased by £36 million during the year. The increase reflects higher

Vaccine stocks, principally Cervarix for the national HPV program in Japan, partly offset by initiatives

to reduce manufacturing cycle times and reduce stockholding days through more efficient use of

inventory throughout the supply chain.14

Roches Holdings AG 2011: The manufacturing organization’s primary objectives in 2011 were to

support Roche’s growing R&D pipeline and improve our manufacturing network and processes, while

maintaining a strong focus on supply chain reliability and product quality. We continued to foster a

culture of continuous improvement and share best practices across sites. Improvements introduced in

2011 include additional common standards for producing small molecules, which will help make site

performance more transparent, and establishing best practices for materials flows and productive

maintenance. In biologics production, we improved scrap-handling practices, resulting in lower

manufacturing costs, Manufacturing sites higher yields and improved manufacturing processes for

products such as Pulmozyme and Nutropin.15

The agility and resilience of our global supply chain was tested in March, when the disastrous

earthquake in Japan interrupted Chugai’s Utsunomiya operations, and again in September, when a

fire damaged our site in Segrate. In response, Roche and Chugai immediately set up supply chain

taskforces that worked in close cooperation with health authorities to ensure continued product supply

and regulatory compliance. Both sites have fully recovered from these incidents and resumed

production.

As part of the Operational Excellence program, announced in late 2010, and the ongoing evaluation

of our manufacturing network, we divested technical development and small molecule manufacturing

operations located in Boulder, USA, to Corden Pharma. Corden will continue to supply us with

commercial-scale peptides and chemical active ingredients for important medicines. We also sold our

clinical plant in Oceanside, USA, to Gilead Sciences in our ongoing program to consolidate clinical

and process development operations. These divestments, along with other measures, lowered the

13 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.49, https://www.GlaxoSmithKline.com/media/325141/annual-report-2011.pdf, accessed April 4, 2016. 14 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.61, https://www.GlaxoSmithKline.com/media/325141/annual-report-2011.pdf, accessed April 4, 2016. 15 Roche Holdings AG, 2011 Annual Report, March 2012, p.55, http://www.roche.com/gb11e.pdf, accessed April 4, 2016.

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number of people employed in pharmaceutical operations in the US by 15%.

We reorganized operations across the Diagnostics Division in 2010 to establish a single, integrated

function for driving excellence in manufacturing, supply chain management and procurement. Since

then, we have pursued an agenda of delivering cost savings while building capabilities for sustainable

high performance in quality, cost and supply reliability. In 2011 we again realized an aggressive cost-

saving target, which contributed to the division’s overall improvement in profitability. We also

advanced three performance initiatives:

Asset management: We invested in facilities to expand capacity, alleviate bottlenecks and mitigate

supply risks, and we transferred product manufacturing to consolidate capacity, increase utilization

and reduce costs. We also consolidated our supplier base to ensure optimal alignment between

external suppliers and internal capacities.

Right-first-time manufacturing: We introduced a system-wide program to improve performance by

systematically eliminating errors, driving improvements in right-first-time rates, quality and cost at all

sites. The program also served as a forum for sharing best practices across the network.

Design for quality and manufacturability: We developed tools and methodologies to ensure the

establishment of robust production processes and applied them to product development projects

across the division. We expect these changes to pay dividends in the form of improved quality and

manufacturability as new products are brought to market.16

Abbot Laboratories 2012: Geographically, we are now one of the most truly globalized of healthcare

companies, with only 30 percent of our revenue coming from the United States, a remarkable reversal

from just 10 years ago. Another 30 percent of our sales come from established international markets,

while 40 percent now come from the world’s fastest-growing international markets, including India, in

which we are the largest pharmaceutical company. We expect this to grow to 50 percent over the

next several years.17

Astrazeneca 2012: Since 2007, we have undertaken significant efforts to restructure and reshape

our business to improve long-term competitiveness. The first phase was completed in 2009. The

second phase, which featured a significant change program in R&D, began in 2010. The restructuring

actions for this phase of the program were completed in 2011, at a total program cost of $2.1 billion.

16 Roche Holdings AG, 2011 Annual Report, March 2012, p.57, http://www.roche.com/gb11e.pdf, accessed April 4, 2016. 17 Abbot Laboratories, Annual Report, March 2013, p.2, file:///Users/howardking/Downloads/2012%20Annual%20Report.pdf, accessed April 5, 2016

Page 34

Headcount changes associated with this phase, involving an estimated 9,000 positions, were also

completed. Total annual benefits of $1.9 billion were to be delivered by the end of 2014 in connection

with this phase of the program, of which $1.5 billion had been achieved by the end of 2012.

We are committed to delivering product quality that underpins the safety and efficacy of our

medicines. We have a comprehensive quality management system in place designed to assure the

quality of our products in compliance with relevant regulations. Notwithstanding our efforts, during

2012 we experienced disruptions to our supply chain resulting from the implementation in February

2012 of an enterprise resource planning IT system in our facilities in Sweden (Södertälje and

Gärtuna). This change was necessary, due to the legacy systems reaching the end of their life-cycle.

At launch the implementation encountered some unexpected difficulties and we put in place a team

with representatives from different parts of the organization to manage the situation so that impact on

patients would be minimized and markets were kept informed. The underlying problems have now

been resolved and production levels returned to normal in September. We estimate that the negative

revenue impact for the year resulting from this disruption was approximately 1%. Supply from our site

in India (Bangalore) was also disrupted for a period of time following a voluntary recall of products

that we determined did not meet our global quality standards. Remediation actions have been

implemented.

Lessons learned from the supply chain disruptions in 2012 have been shared across the Group as

part of our continuous improvement program. This program allows us to improve our systems and

minimize the impact of our activities on the environment. We focus on what adds value to our

customers and patients, as well as waste elimination. The program has delivered significant benefits

in recent years, including reduced manufacturing lead times and lower average stock levels, both of

which improve our ability to respond to customer needs and reduce inventory costs. All improvements

are designed to ensure we maintain product quality, safety and customer service.18

We have applied Lean production business improvement tools and ways of working to improve the

efficiency of our manufacturing plants for a number of years and, in recent years, have applied them

to the whole of our supply chain. This has led to improvements in quality, lead times and overall

equipment effectiveness. In 2012, we continued to establish more efficient processes, with experts

from our global supply chain organization providing cross-functional support throughout the

18 Astrazeneca, 2012 Annual Report, March 2013, p.40, https://www.astrazeneca.com/content/dam/az/our-company/investor-relations/presentations-and-webcast/Annual-Reports/2012-Annual-report.pdf, accessed April 5, 2016.

Page 35

business.19

We categorize suppliers as high, medium or low risk. We focus our auditing efforts on high and

medium risk rated suppliers but we also audit some suppliers that we consider to be lower risk, to

confirm our performance expectations across all suppliers we do business with. In 2012, we

continued our audit activity with 482 audits across 52 countries (751 audits in 2011) as set out in the

table on the previous page. Forty-three percent of suppliers audited demonstrated standards that met

our expectations, with a further 53% implementing improvements to address minor noncompliance.

We monitor progress across all corrective actions and 4% of suppliers audited this year will require

significant follow up to confirm they will make the improvements we require. We will not use suppliers

who are unable or unwilling to meet our expectations in a timely way. During 2012, we removed eight

suppliers from our supply chain.20

GlaxoSmithKline 2012: We continue to make changes to simplify our operating model. Our

Operational Excellence program has now delivered annual savings of £2.5 billion and remains on

track to hit the target we set of £2.8 billion of annual savings by 2014. In February 2013 we

announced a new major change program, which we expect to produce incremental annual cost

savings of at least £1 billion by 2016. This program will include a series of echnological advances and

opportunities to eliminate complexity, which we believe can transform our long-term cost

competitiveness in both manufacturing and R&D. The program will help us simplify our supply chain

processes, shorten cycle times, lower inventory levels and reduce our carbon footprint.21

Despite reducing our carbon footprint from energy use by 15% since 2010, our total carbon footprint

(excluding that from raw materials) increased by 7% compared to 2010 driven by higher inhaler sales.

However, current carbon reduction projects should enable us to reach our interim target to cut our

value chain carbon footprint by 10% to 13.5 million tons of CO2 equivalent by 2015.22

The transformation of our operating model and processes has been a key business strategy, enabling

us to standardize and streamline important aspects of our business, including our supply chain. We

have been implementing a restructuring program to deliver significant savings to support investment

19 Astrazeneca, 2012 Annual Report, March 2013, p.41, https://www.astrazeneca.com/content/dam/az/our-company/investor-relations/presentations-and-webcast/Annual-Reports/2012-Annual-report.pdf, accessed April 5, 2016. 20 Astrazeneca, 2012 Annual Report, March 2013, p.42, https://www.astrazeneca.com/content/dam/az/our-company/investor-relations/presentations-and-webcast/Annual-Reports/2012-Annual-report.pdf, accessed April 5, 2016 21 GLAXOSMITHKLINE, 2012 Annual Report, March 2013, p.3, https://www.GlaxoSmithKline.com/media/279963/annual-report-2012.pdf, accessed April 5, 2016. 22 GLAXOSMITHKLINE, 2012 Annual Report, March 2013, p.43, https://www.GlaxoSmithKline.com/media/279963/annual-report-2012.pdf, accessed April 5, 2016.

Page 36

in our priority growth businesses as well as offset pressures on the Group’s margin resulting from

changes in the shape and mix of our business.

The existing Operational Excellence program is coming to a close and will be superseded by a new

major change program. This will focus on opportunities to simplify our supply chain processes, as

previously announced in 2012 and on building the Group’s capabilities in manufacturing and R&D, as

well as restructuring our European business. 2012 also saw £165 million of restructuring charges

relating to the acquisition of Human Genome Sciences (HGS). Total restructuring charges related to

HGS are expected to be approximately £204 million, of which most is expected to be a cash cost. The

majority of the remaining HGS restructuring charges will be booked in 2013.23

Roche Holdings AG 2012: Manufacturing, procurement and supply functions bring innovative

medicines and diagnostics from the R&D pipeline to patients and healthcare professionals worldwide.

At all stages of our global supply chain, from suppliers to manufacturers, warehousing and

transportation, we require and apply rigorous safety, quality, ethics, labor, health and environmental

standards. State-of-the-art processes and facilities ensure that these standards are fully met and that

products are made available reliably.24

Pharmaceutical manufacturing played a decisive role in the rapid launch in the US of breast cancer

medicine Perjeta — available to patients one day following FDA approval — and skin cancer

medicine Erivedge — in distribution three days after approval. In collaboration with R&D, we

supported 108 development projects for new medicines, including manufacturing investigational

products for approximately 600 global clinical trials that involved tens of thousands of patients. During

the year we took active steps to safeguard operational reliability. Throughout the organization, we

increased inventory ‘safety stock’ levels, to ensure continuity of product supply in response to

unforeseen increases in demand, especially for new product launches. This contributed to a total

inventory increase of 18% in the division. We also increased oversight across the supply chain

including suppliers and CMOs. To ensure an effective response in case of unexpected events, a new

business continuity process for our manufacturing operations was put into effect.25

Throughout 2012 we continued to pursue several long-term initiatives aimed at sustainable high

performance:

23 GLAXOSMITHKLINE, 2012 Annual Report, March 2013, p.44, https://www.GlaxoSmithKline.com/media/279963/annual-report-2012.pdf, accessed April 5, 2016. 24 Roche Holdings, 2012 Annual Report, March 2013, p.62, http://www.roche.com/gb12e.pdf, accessed April 5, 2016. 25 Roche Holdings, 2012 Annual Report, March 2013, p.64, http://www.roche.com/gb12e.pdf, accessed April 5, 2016.

Page 37

We established a continuous improvement culture and metrics in manufacturing quality performance

(‘right first time’) and put methodologies and tools in place to ensure more robust production

processes (‘design for quality and manufacturability’), with first positive trends.

We continued to optimize manufacturing capacity (‘asset management’), and initiated a major capital

investment project at our site in Penzberg, Germany.

We started two new initiatives that are expected to generate significant savings over the next years: a

supply chain excellence initiative to enhance the reliable and cost-effective supply of our products

and to optimize inventory levels, and a procurement excellence initiative to ensure more strategic

sourcing and improved supplier management, including a new supplier performance measurement

tool.26

Abbot Laboratories 2014: In a highly innovative move, we also agreed to co-develop a dairy-farm

hub in China, which will deepen our roots in the country and strengthen our supply chain. These

investments are a reflection of the strong underlying demand for high-quality adult and pediatric

nutrition products. Our intent is to design and manufacture products around the world to ensure that

they’re geared to local needs and preferences, that we can produce them efficiently, and that we build

our presence and strengthen our relationships with key stakeholders in every country in which we do

business.27

In Abbott’s worldwide diagnostics business, margin improvement continued to be a key focus in 2014.

Operating margins increased from 19.2 percent of sales in 2012 to 22.9 percent in 2014 as the

business continued to execute on efficiency initiatives in the manufacturing and supply chain

functions. In addition to continued margin improvement, unit growth across geographical regions

positively impacted worldwide diagnostic sales. Worldwide sales for this business increased 6.4

percent in 2014 and 8.3 percent in 2013, excluding foreign exchange. In the Established

Pharmaceutical Products segment, Abbott announced in July 2014 that it will sell its developed

markets branded generics pharmaceuticals business to Mylan Inc. As a result, the current and prior

year operating results of the developed markets branded generics business are reported as part of

discontinued operations. Following the close of this transaction, the Established Pharmaceuticals

business will operate entirely in emerging markets. On September 26, 2014, Abbott completed its

acquisition of a controlling interest in CFR Pharmaceuticals S.A. (CFR). The acquisition of CFR more

26 Roche Holdings, 2012 Annual Report, March 2013, p.66, http://www.roche.com/gb12e.pdf, accessed April 5, 2016. 27 Abbott Laboratories, 2014 Annual Report, March 2015, p. 2, http://www.abbottinvestor.com/phoenix.zhtml?c=94004&p=irol-proxy, accessed April 11, 2016.

Page 38

than doubles Abbott’s branded generics pharmaceutical presence in Latin America and further

expands its presence in emerging markets. On December 12, 2014, Abbott acquired control of

Veropharm, a leading Russian pharmaceutical company. Through this acquisition, Abbott establishes

a manufacturing footprint in Russia and obtains a portfolio of medicines that is well aligned with

Abbott’s current pharmaceutical therapeutic areas of focus.28

A supplier’s recall of product in August 2013 in certain international markets negatively impacted

International Pediatric Nutritional sales in the third and fourth quarters of 2013, as well as the first two

quarters of 2014. While there were no health issues associated with this supplier recall and the

supplier subsequently determined that the product had been safe for consumption, this event created

significant disruption in these markets. The decline in 2014 U.S. Pediatric Nutritional sales primarily

reflects lower infant formula revenue. U.S. Pediatric sales were flat in 2013 due to lower formula

share, partially offset by higher sales of toddler products.29

In 2014, Abbott management approved plans to streamline operations in order to reduce costs and

improve efficiencies in various Abbott businesses including nutritional and established

pharmaceuticals businesses. Abbott recorded employee related severance and other charges of

approximately $164 million in 2014. Approximately $20 million is recognized in Cost of products sold,

$53 million is recognized in Research and development and approximately $91 million is recognized

in Selling, general and administrative expense. Additional charges of approximately $39 million in

2014 were also recorded primarily for accelerated depreciation. In 2014 and 2013, Abbott

management approved plans to reduce costs and improve efficiencies across various functional

areas as well as a plan to streamline certain manufacturing operations in order to reduce costs and

improve efficiencies in Abbott’s established pharmaceuticals business.30

Astrazeneca 2012: We are committed to high product quality, which underpins the safety and

efficacy of our medicines. To help assure compliance and quality, we maintain a comprehensive

quality management system. Our continuous improvement program allows us to upgrade our systems

and minimize environmental impact. By focusing on increasing efficiency and cutting waste, we have

reduced manufacturing lead times, average stock levels and inventory costs. We have also improved

customer responsiveness. We apply Lean production business improvement tools and methods to

28 Abbott Laboratories, 2014 Annual Report, March 2015, p. 61, http://www.abbottinvestor.com/phoenix.zhtml?c=94004&p=irol-proxy, accessed April 11, 2016. 29 Abbott Laboratories, 2014 Annual Report, March 2015, p. 63, http://www.abbottinvestor.com/phoenix.zhtml?c=94004&p=irol-proxy, accessed April 11, 2016. 30 Abbott Laboratories, 2014 Annual Report, March 2015, p. 66, http://www.abbottinvestor.com/phoenix.zhtml?c=94004&p=irol-proxy, accessed April 11, 2016.

Page 39

our manufacturing plants and entire supply chain to improve efficiency, quality, lead times and overall

equipment compliance responsibility and supported by dedicated compliance teams. Our Internal

Audit Services (IA) function provides independent assurance.

Due to our strategy to outsource most API manufacturing, we need an uninterrupted supply of high

quality raw materials. As such, we place great importance on our global procurement policies and

integrated risk management processes. We purchase materials from a wide range of suppliers and

work to mitigate supply risks, such as disasters that disrupt supply chains or the unavailability of raw

materials. Contingency plans include using dual or multiple suppliers where appropriate, maintaining

adequate stock levels and working to mitigate the effect of pricing fluctuations in raw materials.

In 2014, we implemented a new process for third party risk management. This process, which

consists of four steps and applies to all our suppliers, downstream supply chain partners and local

business development partners, assesses risk based upon defined criteria, including that related to

anti-bribery and anti-corruption, data privacy, the environment and wages. Each step of the process

provides an additional level of assessment, and we conduct more detailed assessments on those

relationships identified as higher risk. Through this process we seek to better understand the

partner’s risk approach, ensure the partner understands and can meet our standards and mitigate

risk.

To help secure our future, we are identifying and recruiting emerging talent and investing in

internships and recruitment opportunities globally. For example, we conduct a global program to hire

recent graduates for our procurement, quality, engineering, IT and supply chain functions. We also

have a graduate program for IMED, which complements our established IMED Post Doctorate

Program for researcher recruitment.

GlaxoSmithKline 2012: Our end-to-end supply chain program, which began in 2013, is designed to

reform and simplify our supply chain. In 2014, we introduced processes to improve coordination

across each stage of production from sourcing and manufacturing to more efficient delivery of our

products to patients and consumers

In 2014, we introduced the GSK Production System (GPS) across our Pharmaceutical manufacturing

sites. The GPS is a standard way of working to identify and eliminate the root causes of accidents,

defects and waste. This standardized way of working will improve our processes and performance.

For example, at our site in Cairo, Egypt, deployment of the program has resulted in a 26% increase in

production with a decrease in manufacturing interruptions of more than 40%.

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Consolidation of our supply base also helps to simplify our Pharmaceutical manufacturing and supply

chain operations and during 2014 we reduced the number of third-party suppliers who manufacture

medicines on behalf of GSK, by a further 8%, compared with 2013. We have also continued to reduce

complexity in our supply base by standardizing specifications for goods and materials that we buy

and pursuing integrated sourcing processes.

We continued our initiative to reduce the complexity of our Pharmaceutical product portfolio, which

allows us to simplify both supply chain and commercial operations and reduce risk and complexity

while increasing service levels. In 2014, we achieved a 19% reduction (against our 2012 baseline)

which equates to more than 4,000 discontinued packs.31

We have faced challenges during the year with several of our Consumer Healthcare manufacturing

sites primarily in North America. However, affected supply lines are now fully operational and we

expect to see increasing benefit from resumption

in supply during 2015. We have undertaken a comprehensive operational review of our supply

network and are investing heavily in a multi-year program to ensure future sustainable supply

including improvements in systems and capacity, more training for our people and addition of new

roles, particularly in key areas such as quality and engineering. We are also working to reduce our

exposure to single source supply. In 2014, we continued to roll-out GSK’s commercial Enterprise

Resource Planning (ERP) system across the Consumer Healthcare business. This new platform

allows us to make better commercial decisions and drive financial efficiencies as we standardize and

consolidate data, forecast and plan on the same system, save time and money on system

maintenance and upgrades, and become more efficient in how we do business with our customers.

With 11 Consumer Healthcare markets added in 2014, 26% of global consumer healthcare revenue is

now on the system and we expect to fully complete the roll-out by 2020.32

In 2014, we introduced Fingerprint, an end-to-end supply chain serialization program that will apply

unique serial fingerprints’ on many of our products. The unique identifiers will be recorded in a

database so the product can then be scanned and verified against the database at any point in the

supply chain. By the end of 2014, 48 packaging lines at 14 of our sites had serialization capability.33

31 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.30, https://www.gsk.com/media/603031/annual-report-2014.pdf, accessed April 11, 2016. 32 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.35, https://www.gsk.com/media/603031/annual-report-2014.pdf, accessed April 11, 2016. 33 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.42, https://www.gsk.com/media/603031/annual-report-2014.pdf, accessed April 11, 2016.

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We have been establishing Core Business Services (CBS) to bring together our support functions in

order to streamline and standardize functional support to the business. Six CBS regional business

centers already support 93 markets, representing 65% of GSK sales. Further, the enterprise resource

planning (ERP) platform that we are implementing is replacing a large number of separate outdated

IT systems across the company, giving us common databases and standard business processes that

will help us simplify our operations, drive efficiencies and give us detailed analytics to improve our

day-to-day operations and decision making.34

Inventory of £4,231 million increased by £331 million during the year. The increase primarily reflected

the impact of stock building for new product launches and remediation of the Consumer Healthcare

supply chain, partly offset by a favorable exchange impact.35

Roche Holdings AG 2014: In order to manage our supply chain more effectively on an end-to-end

basis, an enhanced technical product management approach was implemented and significant

progress was made in 2014. This includes clearer governance for sourcing decisions and better

defined strategic supply plans over the product lifecycle.

Roche has established a dedicated Supplier Relationship Centre (SRC) in order to work more closely

with key suppliers on innovation. In 2014, Roche increased the scope of the SRC to form an

Innovation Centre of Excellence to include more external partners and drive innovative strategies. We

introduced a new fast-track process to deliver more ideas and value in shorter time. To date, 45

innovative business cases have been approved and 32 are in progress or have been implemented.36

Through partnerships with governments and other stakeholders, we aim to build disease solutions

which support infrastructure development, support training and education and improve supply chain.

We also plan to work with private insurers to create policies that cover treatment for cancer and that

have regional, rather than a local risk pool. We also have plans to develop centers of excellence, as

well as create a pan-African platform for healthcare professional education to train specialists. There

is enormous scope to make a difference to patients in this part of the world.37

Counterfeiting of medical products is a serious and growing global problem. The World Health

Organization (WHO) defines a counterfeit medicine as ‘one which is deliberately and fraudulently

mislabeled with respect to identity and/or source.’ It estimates that counterfeiting, substandard 34 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.51, https://www.gsk.com/media/603031/annual-report-2014.pdf, accessed April 11, 2016. 35 GLAXOSMITHKLINE, 2011 Annual Report, March 2012, p.66, https://www.gsk.com/media/603031/annual-report-2014.pdf, accessed April 11, 2016. 36 Roche Holdings AG, 2014 Annual Report, March 2015, p. 69, http://www.roche.com/gb14e.pdf, accessed April 11, 2016. 37 Roche Holdings AG, 2014 Annual Report, March 2015, p. 86, http://www.roche.com/gb14e.pdf, accessed April 11, 2016.

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formulation, contamination, fakery, and active ingredient substitution constitute a 431 billion US dollar

market.1 Illegally imported medicines may also not have been stored or handled properly and could

be contaminated, damaged or degraded. Patients are the ultimate victims of this criminal activity. In

answer to increasing global supply chain challenges and international criminal activities, in 2010,

Roche initiated a ten-year program to increase security in our supply chain. We are implementing a

number of new technologies including overt and covert anti-counterfeiting features, 2D barcoding,

mass serialization techniques, tamper-evident packaging as well as tracking and tracing systems.

In 2014, we increased supply of serialized products significantly, particularly those for China and the

US. On completion of the program, which is anticipated by 2018, every Roche product, folding box,

case and pallet will have a unique identification. With the cooperation of health authorities and other

trading partners, this will ultimately enable tracking and tracing from our manufacturing facilities,

through all global distribution channels and, then, to the patient.

We are also working with international trade organizations in support of industry-wide efforts to

improve the safety and security of the pharmaceutical supply chain. In addition, we collaborate with

health authorities, law enforcement bodies and other government agencies in the countries where our

products are sold on traceability guidelines and regulations.

Roche is committed to conserving eco-system services and biodiversity. In order to provide us with

an overarching metric which assesses and compares our risks and opportunities across operations,

products and supply chains we are exploring the idea of natural capital evaluation. This is a means of

placing a monetary value on environmental impacts along the entire supply chain of our business.

Roche is, however, faced with a number of challenges associated with natural capital evaluation such

as the lack of a harmonized framework and difficulties to gain access to data if the impact analysed

lies beyond the company premises. In general, putting the impacts into a regional context and to find

data with adequate quality are also great challenges. We are now investigating the best way

forward.38

One focus in 2014 was the launch of the Global Logistics Security Program in the Pharmaceuticals

Division. The goal is to improve, systematically, the protection of our products from theft or

manipulation during transportation or storage in own or third-party warehouses. A small team led by

Global Pharma Supply Chain and comprising security and logistics experts from different regions,

performed training sessions and delivered guidance on risk assessment and auditing for the local

38 Roche Holdings AG, 2014 Annual Report, March 2015, p. 126, http://www.roche.com/gb14e.pdf, accessed April 11, 2016.

Page 43

logistics security officers.39

Abbot Laboratories 2015: In recent years, we’ve built our presence in the region through targeted

investments in manufacturing, supply chain and research-and-development facilities. In 2015, we

opened a new research-and-development pilot plant in Singapore that will allow us to more rapidly

pair nutrition science innovation with local taste and texture preferences.40

In 2015 and 2014, Abbott management approved plans to stream‑line operations in order to reduce

costs and improve efficiencies in various Abbott businesses including the nutritional, established

pharmaceuticals and vascular businesses. Abbott recorded employee-related severance and other

charges of approximately $95 million in 2015 and $164 million in 2014. Approximately $18 million in

2015 and $20 million in 2014 are recorded in Cost of products sold, approximately $34 million in 2015

and $53 million in 2014 are recorded in Research and development and approximately $43 million in

2015 and $91 million in 2014 are recorded in Selling, general and administrative expense. Additional

charges of approximately $45 million in 2015 and $39 million in 2014 were recorded primarily for

accelerated depreciation. From 2013 to 2015, Abbott management approved various plans to reduce

costs and improve efficiencies across various functional areas. In 2013, Abbott management also

approved plans to stream‑ line certain manufacturing operations in order to reduce costs and improve

efficiencies in Abbott’s established pharmaceuticals business.41

Astrazeneca 2015: Following the successful introduction of our Taizhou facility in China at the end of

2014, regulatory validation work continues at our Vorsino facility in Russia, which opened in 2015.

This marks the largest foreign investment in the construction of a new pharmaceutical plant in Russia.

First commercial production is scheduled to commence in early 2016, improving our ability to supply

local markets. Also during 2015, we announced major investment plans to develop our capability in

biologics, including the acquisition of Amgen’s facility in Boulder, Colorado in the US, as well as a

$285 million investment in a new manufacturing facility in Södertälje, Sweden. These projects, in

addition to a previously announced expansion plan at Frederick, Maryland US, will increase

production capacity to support the growing demand for biologics, which represents half of our

development pipeline.42

39 Roche Holdings AG, 2014 Annual Report, March 2015, p. 132, http://www.roche.com/gb14e.pdf, accessed April 11, 2016. 40 Abbott Laboratories, 2015 Annual Report, March 2016, p.17, http://www.abbottinvestor.com/phoenix.zhtml?c=94004&p=irol-proxy, accessed April 11, 2016. 41 Abbott Laboratories, 2015 Annual Report, March 2016, p.67, http://www.abbottinvestor.com/phoenix.zhtml?c=94004&p=irol-proxy, accessed April 11, 2016. 42 Astrazeneca, 2015 Annual Report, March 2016, p. 46, https://www.astrazeneca.com/content/dam/az/our-company/investor-relations/presentations-and-webcast/Annual-Reports/AZ_Annual_Report_2015.pdf, accessed April 11, 2016.

Page 44

Our continuous improvement program allows us to upgrade our systems and minimize environmental

impact. By applying Lean methodology to our manufacturing plants and supply chain, we have been

successful in reducing waste and inventory costs. We have also improved efficiency, quality, lead

times, equipment effectiveness and overall customer responsiveness.

We are continuing to establish more efficient processes, with global supply chain experts providing

support throughout the organization.

With most of our API manufacturing outsourced, we need an uninterrupted supply of high-quality raw

materials. We therefore place great importance on our global procurement policies and integrated risk

management processes. We purchase materials from a wide range of suppliers and work to mitigate

supply risks, such as natural or man made disasters that disrupt supply chains or the unavailability of

raw materials. Contingency plans include using dual or multiple suppliers where appropriate,

maintaining adequate stock levels and working to mitigate the effect of pricing fluctuations in raw

materials.43

GlaxoSmithKline 2015: In 2015, we significantly reshaped our Pharmaceuticals business, and

continued to reduce supply chain complexity, while retaining our commitment to quality. We have

rescaled the commercial operations, global support functions, R&D and manufacturing that support

this business. Our supply chain improvement programme aims to deliver industry-leading levels of

performance. Since 2012, this programme has delivered significant savings through procurement

excellence (how and what we buy), logistics (distribution), portfolio optimization – reducing the

number of pharmaceutical pack variants by 27% (against the 2012 baseline), and streamlining our

external supply network by 35%. We have strengthened our logistics operations by establishing five

regional supply and demand hubs, enabling more efficient use of our warehouses and transport

reducing ‘cost to serve’ by £136 million. The ongoing roll-out of our Enterprise Resource Planning

(ERP) system across our commercial markets and manufacturing sites is a critical part of our

transformation. Coupled with new planning capabilities, this increases end-to-end visibility and

control, helping ensure supply and demand are robust and aligned. These changes will help improve

service to our patients and consumers. Cost savings generated from Pharmaceuticals restructuring

will support delivery of £3 billion annual savings for the Group by the end of 2017.44

43 Astrazeneca, 2015 Annual Report, March 2016, p. 47, https://www.astrazeneca.com/content/dam/az/our-company/investor-relations/presentations-and-webcast/Annual-Reports/AZ_Annual_Report_2015.pdf, accessed April 11, 2016. 44 GlaxoSmithKline, 2015 Annual Report, March 2016, p.25, http://annualreport.gsk.com/downloads/GSK_Annual_Report_2015.pdf,

Page 45

We strive to minimize the risk of counterfeit medicines. In 2015, we extended our end-to-end supply

chain serialization program, Fingerprint, across 86 packaging lines in more than 18 manufacturing

sites. The program applies unique serial ‘fingerprints’ on products and logs them into a government-

managed database, which they can be verified against at any point in the supply chain.45

Cost of sales as a percentage of turnover was 31.4%, 3.0 percentage points higher than in 2014. On

a pro-forma basis, the cost of sales percentage increased 0.8 percentage points and 1.0 percentage

points on a CER basis. This reflected adverse price movements, particularly in US Pharmaceuticals,

and increased investments in Vaccines to improve the reliability and capacity of the supply chain.

This was partly offset by an improved product mix, particularly as a result of the growth in HIV sales,

and the benefits of our ongoing cost reduction programs.46

In addition, the Committee has continued to monitor the Group’s key ongoing transformation and

simplification programs including, in particular, those in our Global Support Functions where we are

continuing to simplify our operating model through programs such as Finance Transformation as well

as undertaking major upgrades to the Group’s systems and global processes, including core ERP,

HR and supply chain platforms. The Committee has also regularly reviewed the Group’s cyber

security and the progress of our Infoprotect program which is designed to address this risk

specifically.47

The Committee has continued to review regularly the multi-year programs underway to simplify our

support functions and standardize our operating model around new and upgraded platforms. These

programs are now well established but are at a peak of activity currently as the new platforms and

processes are rolled out across the Group, compounded by the additional requirements to integrate

the former Novartis businesses into the Group’s operating and reporting infrastructure. Significant

progress has been reported with the completion of new global HR and supply chain forecasting

systems and multiple cut overs of local operating companies onto the new ERP platform delivered

during the year with targeted control levels maintained throughout. The Committee has also paid

particular attention to the parallel transformation programs underway in a number of the support

functions, especially the Finance Transformation initiative, to ensure that controls and reporting

accessed April 11, 2016. 45 GlaxoSmithKline, 2015 Annual Report, March 2016, p.44, http://annualreport.gsk.com/downloads/GSK_Annual_Report_2015.pdf, accessed April 11, 2016. 46 GlaxoSmithKline, 2015 Annual Report, March 2016, p.63, http://annualreport.gsk.com/downloads/GSK_Annual_Report_2015.pdf, accessed April 11, 2016. 47 GlaxoSmithKline, 2015 Annual Report, March 2016, p.88, http://annualreport.gsk.com/downloads/GSK_Annual_Report_2015.pdf, accessed April 11, 2016.

Page 46

requirements are not affected.48

Roche Holdings AG 2015: e also launched the VENTANA HE 600 system globally. A fully

automated hematoxylin and eosin (H&E) tissue staining system, it enhances patient safety by

avoiding cross-contamination, and produces exceptional staining quality. This system improves

workflow by eliminating the need to manually mix reagents. In a global test Doubling the already

market-leading throughput of our current instrument from 200 to 400 results per hour is a key feature

of the cobas c 513. This new instrument is used in laboratories for the analysis of HbA1c levels in

blood samples from people with diabetes. The cobas c 513 is an essential tool for healthcare

providers coping with the ever-increasing number of people with this condition. Another key milestone

in 2015, the FDA approved the cobas 6800 and cobas 8800 systems and the cobas HBV, cobas HCV

and cobas HIV viral load tests. The fully automated systems offer the fastest time to results, the

highest throughput and the longest walkaway time available among automated molecular platforms,

providing laboratories both improved operating efficiency and flexibility to adapt to changing testing

needs. The new tests are the next generation of our viral load tests, which clinicians use to manage

the treatment of people with hepatitis B or hepatitis C virus as well as HIV. The US approval follows

the 2014 launch of these systems and tests in countries accepting the CE mark.** conducted in 2015,

more than 4,000 slides from laboratories in 12 countries were stained on the VENTANA HE 600

system and reviewed by 67 pathologists, with excellent results.49

The African continent is developing quickly, with the GDP expected to increase by 5% in 2016.6

Significant strides have been made in improving health outcomes in many countries. However, major

challenges remain, particularly in sub-Saharan Africa. Poor outcomes persist in sub-Saharan Africa

for a multitude of reasons, including low disease awareness, late presentation of patients with

disease, limited quantity and poor quality of healthcare institutions, lack of medical specialists,

uncertain supply chain quality, low government priority, little to no local prevalence data and limited

funding.50

In 2010, we initiated a program at Roche to increase security in our supply chain. We are

implementing a number of new technologies, including overt and covert anti-counterfeiting features,

2D barcoding, mass serialization techniques and tamper-evident packaging. On completion of the

program, slated for 2018, every Roche product, folding box, case and pallet will have a unique 48 GlaxoSmithKline, 2015 Annual Report, March 2016, p.89, http://annualreport.gsk.com/downloads/GSK_Annual_Report_2015.pdf, accessed April 11, 2016. 49 Roche Holdings AG, 2015 Annual Report, March 2016, p.35, http://www.roche.com/gb15e.pdf, accessed April 11, 2016. 50 Roche Holdings AG, 2015 Annual Report, March 2016, p.84, http://www.roche.com/gb15e.pdf, accessed April 11, 2016.

Page 47

identification.51

Another initiative to reduce GHG emissions is reducing our use of halogenated substances that are

used for refrigeration and/or fire suppression and can remain in the atmosphere for a long period of

time. We planned to reduce halogenated substances by 90% (from 2002 baseline) at all Roche

legacy sites by 2015. This excludes acquisitions (including Genentech and Ventana), which are

working towards their own timelines (2018/2022). With great efforts we managed to achieve a 89.8%

reduction and we have now set a new goal to further reduce halogenated substances by 20% at

Roche legacy sites over the next five years. We continue to examine alternatives and work with

refrigeration and fire suppression suppliers to achieve these reductions.52

51 Roche Holdings AG, 2015 Annual Report, March 2016, p.102, http://www.roche.com/gb15e.pdf, accessed April 11, 2016. 52 Roche Holdings AG, 2015 Annual Report, March 2016, p.127, http://www.roche.com/gb15e.pdf, accessed April 11, 2016.

Page 48

Recommendations In supply chain benchmarking it is important to look at performance and improvement of peer

companies over time. The orbit charts are useful to see these patterns. As companies study supply

chain excellence and corporate performance, we recommend that they:

1) Build a Guiding Coalition to Drive Improvement Based on Industry-Specific Data. Organizations should benchmark companies within an industry. Each industry has unique rhythms and

cycles. As a result, supply chain excellence analysis needs to be within an industry. No company within

the pharmaceutical supply chain has exercised power to improve the value chain. The industry has

largely been a follower of supply chain practices and a late adopter of technology.

2) Understand Supply Chain Potential and Orchestrate Trade-offs on the Effective Frontier. Supply chain leadership teams should analyze the total portfolio of metrics and study progress at the

intersections of the Effective Frontier. Companies with higher performance are using more advanced

analytics to plan outcomes and design the supply chain.

3) Apply Systems Theory. Teams should evaluate performance over time to understand improvement while realizing they are

managing a complex system. The functions should be aligned to a balanced portfolio of metrics

representing the Effective Frontier, while functional metrics should be focused on improving reliability

(first-pass yield, OEE, hands-free orders, etc.).

4) Focus on Building Value Networks. No pharmaceutical company is driving improvements in value chain effectiveness. While many of these

companies could be a powerbroker in the industry to redefine outside-in processes, all companies are

accepting the limitations of the inside-out supply chain. To drive the necessary change, the

pharmaceutical company needs to take charge of the supply chain in the channel and translate and

orchestrate demand.

5) Learn from Other Industries and Use a Steady Hand to Drive Improvement. Companies within the pharmaceutical industry are late adopters of supply chain analytics and Supply

Chain Operating Network technologies. To make the necessary improvements, they must move past

their “ERP-centric view” and build outside-in processes.

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Conclusion The supply chain within the pharmaceutical industry is increasing in importance to deliver on the

objectives of quality, drug efficacy and reliability. Risk mitigation, and counterfeiting are important

cornerstones for the end-to-end supply chain vision.

To understand who performed best within the peer group, we systemically analyzed pharmaceutical

company performance on the Effective Frontier. While Nova Nordisk and Biogen are driving

significant improvement, no pharmaceutical company meets the criteria of performance better than

their peer group on the Supply Chain Metrics That Matter while driving improvement.

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Prior Reports in This Series Over the course of the last four years our methodology has changed and matured. You can track our

progress and find industry-specific information here:

Supply Chain Metrics That Matter: A Focus on Retail Published by Supply Chain Insights in August 2012. Supply Chain Metrics That Matter: A Focus on Automotive Published by Supply Chain Insights in September 2012. Supply Chain Metrics That Matter: A Focus on Automotive Published by Supply Chain Insights in August 2015 Supply Chain Metrics That Matter: The Cash-to-Cash Cycle Published by Supply Chain Insights in November 2012. Supply Chain Metrics That Matter: A Focus on the Food and Beverage Industry Published by Supply Chain Insights in December 2012. Supply Chain Metrics That Matter: Driving Reliability in Margins Published by Supply Chain Insights in January 2013. Supply Chain Metrics That Matter: A Focus on Hospitals Published by Supply Chain Insights in January 2013. Supply Chain Metrics That Matter: A Focus on Brick & Mortar Retail Published by Supply Chain Insights in February 2013. Supply Chain Metrics That Matter: A Focus on Medical Device Manufacturers Published by Supply Chain Insights in February 2013. Supply Chain Metrics That Matter: A Focus on Consumer Electronics Published by Supply Chain Insights in April 2013. Supply Chain Metrics That Matter: A Focus on Apparel Published by Supply Chain Insights in May 2013 Supply Chain Metrics That Matter: A Focus on Contract Manufacturing Published by Supply Chain Insights in August 2013 Supply Chain Metrics That Matter: A Focus on the Automotive Industry Published by Supply Chain Insights in October 2013

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Supply Chain Metrics That Matter: A Closer Look at the Cash-To-Cash Cycle (2000-2012) Published by Supply Chain Insights in November 2013 Supply Chain Metrics That Matter: Third Party Logistics Providers Published by Supply Chain Insights in December 2013 Supply Chain Metrics That Matter: A Critical Look at Operating Margin Published by Supply Chain Insights in December 2013 Supply Chain Metrics That Matter: A Closer Look at Pharmaceutical Companies Published by Supply Chain Insights in April 2014 Supply Chain Metrics That Matter: A Closer Look at Chemical Companies Published by Supply Chain Insights in May 2014 Supply Chain Metrics That Matter: A Closer Look at Food and Beverage Companies Published by Supply Chain Insights in June 2014 Supply Chain Metrics That Matter – A Focus on Pharmaceutical Companies Published by Supply Chain Insights in April 2015 Supply Chain Metrics That Matter – A Focus on Chemical Companies – 2015 Published by Supply Chain Insights in May 2015 Supply Chain Metrics That Matter: A Focus on Food and Beverage Companies-2015 Published by Supply Chain Insights in June 2015 Supply Chain Metrics That Matter: A Focus on Consumer Products – 2015 Published by Supply Chain Insights in August 2015 Supply Chain Metrics That Matter: A Focus on the High-Tech Industry – 2015 Published by Supply Chain Insights in January 2016 These reports, and additional information on the Supply Chain Metrics That Matter methodology, are available at our Supply Chain Insights website and in the Beet Fusion community.

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Appendix

Here we share more data to help the reader understand the math behind this report.

Methodology: Understanding the Math and Ratios Throughout this report we reference a number of commonly used financial ratios. Each company has

a unique potential. The potential is based on the size of the company and the drivers within the

industry. As shown in Figure A, each has a major impact on the company’s potential on the Effective

Frontier.

Here is a summary of the definitions of the ratios used in this report.

Figure A. Measurement Definitions

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Supply Chain Index Methodology: Formulas and Calculations

Supply chain leaders are competitive. Each wants to drive performance improvement faster than the

peer group. To gauge improvement, companies need to compare and benchmark. To make this

easier, we developed the Supply Chain Index. In the building of the Index, we used financial ratios

versus absolute numbers. The use of ratios allowed us to compare companies regardless of size, and

also compare companies across currencies.

The Index has three factors: balance, strength and resiliency. In this report, the three factors were

calculated for the periods of 2006-2009, 2010-2015 and 2006-2015. Our goal was to understand pre-

recession and post-recession trends while also looking at progress over the longer-term view. The

companies within the industry are stack ranked based on performance within each factor and given a

ranking. The rankings are then built into an index based on overall performance of the three factors.

The math behind the Index is defined below. This methodology was built in cooperation with the

Operations Research faculty at Arizona State University (ASU) in the spring of 2014.

Balance To develop the balance factor used in the Index, we evaluated a scatter plot of revenue growth and

Return on Invested Capital (ROIC) for a specific company. The balance factor (B) is the proportional

difference of points on an orbit chart for the period of 2006-2012 at the intersection of revenue growth

and Return on Invested Capital. To calculate the balance factor, let iREV denote the revenue growth

of the ith time period, iROIC denote the return on invested capital of the ith time period and n denote

the total number of periods under consideration. Thus the balance factor is defined as:

−+

−−

=1

1

1

1

11

ROICROICROIC

REVREVREV

nB nn

.

Strength Strength factor is a similar calculation to balance factor, but with a focus on the intersection of

operating margin and inventory turns. For this analysis, we used a scatter plot of operating margin

and inventory turns on an orbit chart for a specific company. Let iOM denote the operating margin of

Page 54

the ith time period (e.g. ith year), iIT denote the inventory turns of the ith time period and n denote the

total number of periods under consideration. The strength measure (S) is defined as:

−+

−−

=1

1

1

1

11

ITITIT

OMOMOM

nS nn

The denominator reflects that there are n-1 differences between n time periods. Figure B depicts the

intersection of operating margin and inventory turns for an example company. The difference in

operating margin and inventory turns between the first and last time period is shown.

Figure B. Inventory Turns and Operating Margin Intersection for an Example Company

Resiliency The resiliency factor is a measurement of the tightness of the pattern at the intersection of operating

margin and inventory turns for a given company. For companies that did well, and had a tight pattern,

the value will be lower than companies that lacked reliablity for the period. To develop the value, we

considered a scatter plot of operating margin and inventory turns for a specific company. Let dij

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denote the Euclidean distance between a pair of points i and j and let m denote the total number of

pairs. The resiliency measure (R) is defined as the mean distance of all possible pairs of points at the

intesection.

That is,

∑∑>

=i ij

ijdm

R 1

Figure B shows an example of the opertaing margin and inventory turns intersection for an example

company. Table A shows the distances between every possible pair of points at the intersection. The

resiliency is calculated from the mean of the distance values and is equal to 0.7335.

A Closer Look at Inventory Turns: An Important Measurement In an ideal world, companies want to turn inventory faster. The faster the turns, the faster the cash

turnover, and the greater contribution to market valuation.

There are two primary measurements for inventory turns. Both are used in the industry. Often they

are used with clarity of the underlying definition. The results are very different.

One ratio is based on inventory turnover as a ratio based on revenue, and the other measures the

inventory turnover ratio based on cost of goods sold. In the period of 2013-2014, at Supply Chain

Insights, when calculating the Supply Chain Index rankings, we used financial information from

YCharts. The methodology used by YCharts is to calculate inventory turns as Inventory Turnover =

Revenue / Average Inventory where Average Inventory is equal to the average of the last two

reported inventory levels of the specified frequency. However, in this report, and the subsequent

series of industry-specific reports, we will be using the cost of goods sold formula:

Inventory Turnover = Cost of Goods Sold/Inventory.

As can be seen in Tables A and B, the two calculations yield very different results. The larger the

margin in the industry, the greater the difference. With operating margins of 22%, the difference in the

measurement is especially relevant for pharmaceutical companies. Consider the differences between

Table A and Table B. When turns are viewed as a ratio based on revenue, the inventory turns value

for the industry for the period of 2006-2015 is 8.44 versus 2.43 for the same period when measured

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based on cost of goods sold.

It is for this reason that in the calculation of the Supply Chain Index methodology in this, and

subsequent reports in this series, we are using the cost of goods sold method in the calculation of

inventory turns.

Table A. Inventory Turns Analysis for All Industries Using Revenue/Average Inventory

.

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Table B. Inventory Turns Analysis for All Industries Using Cost of Goods/Inventory Analysis

Looking at Trends We use orbit charts to track and depict changes in year-over-year results at the intersection of certain

metrics that we measure. Here are two orbit charts which compare Operating Margin to Inventory

Turns. The first chart is a reflection of the calculation as Inventory Turnover = Revenue /Average

Inventory and the second depicts Inventory Turnover = Cost of Goods Sold/Inventory.

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Figure C. Inventory Turns (Revenue/Average Inventory) and Operating Margin for the Period of 2006-2015

Figure D. Inventory Turns (Cost of Goods/Average Inventory) and Operating Margin for the Period of 2006-2015

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As you can see, the difference in the number of inventory turns during the observed timeframe (2006-

2015) were 7.60 turns according to the original method, while average inventory turns were 6.27

using the new method.

Pharmaceuticals is a unique industry, in that compared to other industries, margins are extremely

high. So when the methodology for calculating industry turns was adjusted, we found the inventory

turns were overstated when using YCharts data. This drastic change can be explained by the

difference in using revenue versus using cost of goods sold in calculating inventory turns. Because of

the large revenue margins that pharmaceutical companies have, it is possible to skew the ratios when

cost is not taken into account.

In our countdown for the Supply Chain Insights Global Summit, we will be publishing a series of

reports on the Supply Chain Metrics That Matter by industry. In this series we will use the cost of

goods definition for inventory turns.

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Corporate Overview Data In looking at the data, it is useful to understand the size and scope of the company. To help the

reader, here we share some overarching corporate data.

Table C. Pharmaceutical Companies Overview

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About Supply Chain Insights LLC Founded in February, 2012 by Lora Cecere, Supply Chain Insights LLC is beginning its fifth year of

operation. The Company’s mission is to deliver independent, actionable, and objective advice for supply chain leaders. If you need to know which practices and technologies make the biggest

difference to corporate performance, we want you to turn to us. We are a company dedicated to this

research. Our goal is to help leaders understand supply chain trends, evolving technologies and

which metrics matter.

About Lora Cecere Lora Cecere (twitter ID @lcecere) is the Founder of Supply Chain Insights LLC and

the author of popular enterprise software blog Supply Chain Shaman currently read

by 5,000 supply chain professionals. She also writes as a Linkedin Influencer and

is a a contributor for Forbes. She has written four books. The first book, Bricks

Matter, (co-authored with Charlie Chase) published in 2012. The second book, The

Shaman’s Journal 2014, published in September 2014; the third book, Supply

Chain Metrics That Matter, published in December 2014; and the fourth book, The

Shaman’s Journal 2015, published in September 2015.

With over 12 years as a research analyst with AMR Research, Altimeter Group, and Gartner Group and now as the Founder of Supply Chain Insights, Lora understands supply chain. She has

worked with over 600 companies on their supply chain strategy and speaks at over 50 conferences a

year on the evolution of supply chain processes and technologies. Her research is designed for the

early adopter seeking first mover advantage.