Prior to the 1970s, virtually all U.S. pharmaceutical companies manufactured their products domestically. The move to offshore was initially driven by tax incentives realized by relocating manufacturing operations to places like Puerto Rico and Europe in the 70’s and 80’s. During the 80’s and 90’s, we saw manufactures move operations to developing nations like India and China primarily to realize greater cost savings. The cost savings were mainly achieved through lower labor rates and less stringent environmental regulations. Additionally, most of the raw materials used in pharmaceutical products were being produced in China. To facilitate process efficiency, ingredient supply was subsequently relocated to be in close proximity to the manufacturing plants. By August 2019, 72% of manufacturing facilities making active pharmaceutical ingredients (APIs) were located overseas, with 13% located in China, and that trend has been accelerating since 2000 as illustrated in the accompanying chart.
Today, more than 80% of APIs used to manufacture pharmaceuticals come from China or India. The U.S. is heavily dependent on China for generic drugs including more than 30% of our antibiotics. We have recently seen this reliance on foreign drug manufacturers for antibiotics being used to treat infections associated with COVID-19 (i.e. azithromycin, ciprofloxacin, and piperacillin/tazobactam) and the use of anti-malarial drugs being used as potential therapies to lessen the severity of COVID-19. The demand for these drugs has increased to the point where several manufactures are reporting drug shortages to the FDA. U.S. outsourcing of pharmaceutical manufacturing processes is not limited to the use of pharmaceutical ingredients. Of all pharmaceutical products that enter the U.S. each year, 67% come from European countries. Ireland has the largest share of import value due to a low corporate tax rate, good access to labor and large manufacturing plants.
Is it time for On-Shoring?
The COVID-19 pandemic has highlighted the risks of the offshore model for the US.
- Crises like this pandemic, as well as previous natural disasters such as hurricane Maria in Puerto Rico, disrupt the current decentralized supply chain, making it difficult for the US to access drugs when they are most needed.
- Major dependency on China for APIs creates significant risks in the event of disruption, whether from the current pandemic, a natural disaster, cyberattacks or other events.
- Quality may be an issue. While the FDA inspects more than half of foreign facilities, foreign manufacturers of certain OTC drugs can legally ship to the US without inspection.
Repatriating pharmaceutical manufacturing to the US would not only help mitigate these risks, but would also present some real opportunities, including:
- Repositioning the US as a major global pharmaceutical manufacturer, including an increased use of contract manufacturing organizations (CMOs)
- Increasing US GDP by balancing pharmaceutical trade
- Improving product safety, as US-based facilities are inspected by the FDA more frequently than offshore facilities
Of course, there would also be significant challenges to on-shoring. These include:
- A three- to four-year timeline to set up new manufacturing facilities in the US, as well as physical capacity issues, especially for APIs
- It can take up to two years to transfer a single product to a new manufacturing site (process transfer and scale-up, validation, regulatory filings, etc.).
- The impact of US tax and labor regulations on revenue for manufacturers
- Power buyers, like CVS Health and Cardinal Health, are driving prices down, putting pressure on margins
The CARES Act and other proposed legislation will also influence on-shoring and other supply chain decisions for pharmaceutical companies. Let’s start with what has already been enacted.
Several provisions of the CARES Act directly impact supply chain considerations for pharmaceutical manufacturers.
- Manufacturers now must notify the FDA of drug or medical device shortages, and may be required to include additional information about API supply issues as a reason for drug shortages. Risk management plans must be developed and maintained (Sec 3112 and 3121)
- HHS will engage with the National Academies to analyze the drug and device supply chains in order to develop recommendations on how to improve the resiliency (Sec 3101)
- Permanent liability protection will be provided for manufacturers of personal respiratory protective equipment to incentivize production and distribution (Sec 3102)
- Steps will be taken to accelerate development of drugs to treat zoonotic diseases to prevent animal-to-human transmission of disease (Sec 3302)
What effect will these provisions have on pharmaceutical companies? They push for increased domestic manufacturing and create opportunities to expand facilities or shift lines for critical products. But that could mean increased costs and reduced margins. The CARES Act also creates new reporting requirements and establishes rules to develop, implement and maintain robust risk management programs.
Two proposed pieces of legislation, the Protecting our Pharmaceutical Supply Chain from China Act and the Securing America's Medicine Cabinet Act of 2020, also could significantly impact supply chain considerations for pharmaceutical companies. The first aims to completely move production of US pharmaceuticals out of China while the second would take a variety of steps to encourage US production of APIs. In addition, infrastructure elements under discussion as part of continuing the next wave of stimulus legislation would focus, in part, on repatriating supply chains for US companies. It is too early to predict the prospects for these legislative efforts, but they do indicate a Congressional inclination to encourage repatriation of pharmaceutical manufacturing, so these and other legislative activities bear watching as you consider your supply chain efforts.
Balancing cost, control and the future of your supply chain
Rising supply chain costs is the number one supply chain challenge facing most organizations. Pharmaceutical companies are no exception. Given the risks and disruptions that pharmaceutical companies have experience during the COVID-19 crisis, whether and how to reconsider their supply chains, including related tax planning issues, takes on new urgency.
This four-part process helps realize the true value of risk-informed, tax-effective supply chain design by effectively addressing the four key drivers of shareholder value--revenue growth, operating margin, asset efficiency and tax management. Those drivers hinge on 14 critical value levers:
- Customer Segmentation
- True Cost-To-Serve
- Product Lifecycle Management
- Raw Materials Cost
- Distribution Network Costing
- Tax Margin Enhancement
- Inventory Turns
- Network Service Levels
- Days Payable Outstanding
- Days Sales Outstanding
- Asset Utilization
- Transfer Pricing
- Tax-Location Nexus
Effective consideration of those levers then translates into six strategies that supply chain leaders must execute:
- Calibrate the supply chain with customer segmentation logic and product strategy
- Align inventory investments and service level commitments accordingly
- Build comprehensive models to capture total supply chain cost to serve
- Take advantage of tax changes to build tax advantageous supply chains
- Digitize the supply chain to create sustainable competitive advantage
- Develop supply chain risk mitigation strategies to ensure resiliency
Effective supply chain design is a four-part process, including supply chain design, tax planning, operating model, and cash management considerations, as illustrated below:
Supply chain tax considerations
Effective supply chain design must consider a broad range of international, US, state and even local tax issues. Any location changes have to be viewed through a variety of filters and many of those considerations are exacerbated by current economic conditions, especially issues like treatment of NOLs, and global loss utilization and related transfer pricing issues. The CARES Act included a variety of tax changes companies should consider—especially the five-year NOL carryback provision, which companies may be able to take advantage of to generate refunds and help with current cash flow needs. The CARES Act also moves April 15 filing and payment dates to July 15, allowing companies to conserve cash at a time when cash needs are critical. Read a detailed analysis of tax changes in the CARES Act here
Changes in the Tax Cuts and Jobs Act, the major tax reform legislation enacted in 2017, also bear consideration as you consider supply chain options and in light of the current economic situation. While TCJA was overwhelmingly favorable to most businesses, there are elements of the law that have a detrimental impact on businesses especially in a recession
. Companies considering supply chain changes need to consider the new 21% corporate rate in comparison to other jurisdictions’ rates, the 13.25% foreign derived intangible income deduction, the 10.5% global intangible low-taxed income (GILTI) rate, the base erosion and anti-abuse (BEAT) rate of 10% and how all of those will interact to affect their eventual global effective tax rate.
For pharmaceutical companies considering repatriating operations as part of a supply chain redesign, state and local tax considerations also need consideration. Watch for federal developments, as there seems to be considerable Congressional appetite to encourage onshoring. Be careful in choosing ground-up construction versus fitting out an existing space as 100% expensing options may be available. And, while most life sciences companies effectively capture R&D credit options, R&D pilot model expenses may present even larger opportunities. State and local tax credits and incentives also can be very valuable, but need to be investigated prior to announcing any site selection.
The Grant Thornton Pandemic Risk Model
Grant Thornton’s Pandemic Risk Assessment
addresses a rapidly evolving need in the pharmaceutical industry and beyond. This online, interactive tool, asks nine key questions across four impact zones and eight key risk factors to help organizations better understand and respond to the risks and business impacts of the COVID-19 crisis including areas like disruption in logistical processes, cost of credit, regulatory fines, loss of market share and reduced workforce.
This free assessment presents the organization with a resiliency scorecard. After submission, Grant Thornton will schedule a call and discuss the outcomes and recommendations with the organization. We have a specific version of this tool specifically developed for the life sciences industry.
Listen to our recent webcast, Pharmaceutical supply chain: Balancing cost vs. control amid COVID-19
for a more detailed discussion of these issues.
Life Sciences Sector Leader
Regulatory and Compliance Solutions
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