The Strategic Role Of Cost Modeling In Pharmaceutical Procurement

By Brian James, Outsourced Pharma Advisory Board Member

Pharmaceutical procurement shares consistencies across companies, and the decision to contract with other parties can depend on price, geography, expertise, and other variables. However, while price is often a key motivation for the decision, it’s production cost that should be carefully considered.

As part of that consideration, an independent production cost analysis can aid in the decision-making process. The following scenarios demonstrate how to effectively leverage this deep dive into your production.

Licensing And Acquiring Inventory

Let’s begin with when an innovator company discusses acquiring a new asset. Numerous considerations go into the potential purchase and negotiations.

The company selling the assets may include the cost of the tech transfer, any work in progress, and existing materials. They may offer to sell the inventory separately if it is not explicitly addressed during the acquisition. In either case, knowing the value of that inventory is essential.

Of course both sides are pursuing the best deal. For example, the innovator may benefit from having the materials available immediately, but will also need to consider any ongoing supply agreement with a CDMO, or a potential technology transfer to a new provider.

Is it better to start with a new supply and later retest for expiry dates, or is time-to-clinic the driving force? Can inventory be resupplied before exhaustion? Answers to questions like these are important. It is also important to keep in mind that for the seller, the materials are a sunk cost; they should in fact be included in the valuation of the overall licensing deal.

In one example, an asset acquiring client of ours was offered 1,000 kg of existing drug substance at a purchase price of $2,600/kg. We ran a detailed cost model (based on a best-case scenario) that informed us the cost of producing the material was estimated to be closer to $600/kg.

With this information in hand, a deal was struck with the seller at $1,000/kg, saving the client $1.6 million.

Establishing A New Relationship

Another scenario arises when an innovator approaches a CDMO to prepare a starting material, intermediate, drug substance, or drug product.

Early in the development process, an innovator may send out multiple RFPs and receive multiple proposals. Having a solid understanding of what it “should cost” to manufacture material at a given scale and in a geographic region will quickly identify outliers, for example “low ball” offers that will require endless change orders and other cost adjustments.

As well as experience, creating and working from a cost model with relevant data can help you understand that “should cost” range, and can save drug sponsors future challenges.

Accepting the lowest price offered is enticing, but saving on the front end can end up costing more in the long run. Here are some questions to consider.

• Why would a CDMO offer a price that obviously provides them low-profit potential?
• Are they “cutting corners” on quality or other areas?
• Are they desperate to fill capacity and thus doing all they can to get you in the door?

Let’s then move to when the selection of a CDMO has been made, a relationship established.

For example, both the innovator and the CDMO should be highly confident in the process to start to pursue PPQ (validation) batches.

Again, it is important to revisit cost models as part of your PPQ process, as well as look at multiple manufacturing circumstances. Having the ability to discover where price breaks might occur is critical:

Does six batches at 50kg make better sense than three batches at 100kg? At what scale is process revalidation in new equipment or a new facility required? Supplemental validation is expensive; it can be avoided with careful planning.

We should note the timing for long-term manufacturing agreements. It may not be beneficial for the innovator to consider entering an agreement until closer to the assurance of a product launch, while the manufacturer will prefer to schedule capacity as far ahead of time as possible, and lock in the (potential) demand.

In any case, having valid production-cost models will benefit both provider and supplier.

Evolution Of Cost Modeling

The art and science of cost modeling continually evolves. There are many approaches and perspectives in generation, but to summarize, the “cost” is the combination of two categories: raw materials and processing.

The raw material component is readily understood as the cost of starting materials, reagents, solvents, and catalysts used in production. Material prices can be impacted by the quality/quantity purchased, suppliers, shipping costs, taxes, and tariffs. Maintaining a ready data source of prices, especially common materials, can boost efficiency and avoid the headache of constantly changing conditions.

Processing costs are much less transparent and difficult to estimate. Nonetheless, long-term industry professionals can rely on experience to provide some high-level estimates of, for example, yearly plant costs. “Variable costs” will include such items as labor and waste disposal.

A caution here is that some costs may not be refined in a high-level estimate. If project-specific considerations are significant, they will correspondingly affect the price. Variable costs such utilities, maintenance, and depreciation may be tailored for project-specific considerations.

The “best” way to build a cost model depends on the goal. A simple estimate can be to:

• build up a stepwise bill of materials using the known information on quantities and prices and dividing the sum by the kilo output of the product.
• add an arbitrary figure for processing, such as $100-$200/kg based on complexity, and use that as the input price date for the next step.

I know that this simple method has been applied to billion-dollar deals as a reality check.

A more complex but similar approach employees spreadsheet applications to link processes so costs at individual manufacturing stages can be updated automatically through the model.

These models may also consider a cycle time for each step, and multiply by an hourly/daily/weekly rate to better refine the processing cost estimate. This method is less crude, but each estimator will have their own biases and will potentially make varying assumptions.

Finally, there are cloud-based applications that are in fact built upon decades of experience. These tools come with libraries of raw materials and facility costs. The user can build in as much granularity as required for their purpose, and better still, they can standardize the process and assumptions across the team for a reliable comparison of scenarios.

With this more advanced application, the user can also benefit from reporting options to present and interpret data, and perform error-checking activities that would be hard to identify and implement in linked spreadsheets.

A cost model can be a powerful negotiating tool. It allows decisions to be made with more confidence. And a final point: The cost of developing a model is insignificant compared to the savings in time, money, and heartache of not having one.

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Brian James is Chief Operating Officer, Rondaxe Pharma LLC