We ended last year’s benchmark report with the question, would 2023 be the year that the seemingly inexorable upward rise in big pharma inventory levels abates? The answer, emphatically, is no.
Once one-off effects (1) are taken out, in DIO terms median inventory grew a further 6.1% year on year, with mean inventory growing 5.1%. Total inventory grew from $160bn to $175bn, in a year where revenues and cost of sales were down 4%.
Overall inventory write offs, as far as can be estimated (2), held steady at about 4% of cost of sales, although there were significant write offs of Covid-19-related vaccines and treatments, most notably Pfizer’s eye-watering $6.2bn write off of Paxlovid and Comirnaty.
Days Inventory Outstanding (DIO) = inventory value/(cost of sales/365). See also the technical notes at the end of this article.
A mixed year
Overall, despite a good crop of new medicines coming to market, financially 2023 wasn’t a great year for the industry. There were notable blockbuster successes, such as MSD’s Keytruda, and growth in demand for weight-loss treatments carried on apace, although with greater competition as more medicines enter the market, but the overall lacklustre sales saw many companies forced to cut costs, with layoffs across the sector. The full impact of the Inflation Reduction Act on medicine pricing in the US still remains to be seen but is also driving an increased focus on cost.
We refresh the list of companies included in the benchmark from time to time, so you can’t compare the numbers from one year’s report to another, but in the seven years we have been producing this report, inventories expressed as DIO have increased every year but 2, with DIO remaining roughly flat one year and showing a small decrease the other. The other five years have shown increases. Looking at it another way, in 2017, median DIO was around 180 days, equivalent to approximately 6 months of demand. In 2023 median for those companies who were in the benchmark in 2017 was over 220 days, comfortably more than 7 months in demand.
In short, the industry’s inventory binge does not appear to be over. As we write every year, there are good reasons why pharmaceutical companies carry a lot of inventory (security of supply for products that are critical to patients, long lead times, regulatory restrictions) as well as bad ones (high gross margins, a lack of focus on inventory optimization).
One reason for the increase in inventories in 2023 was the playing out of a classic bullwhip, as concerns of shortages throughout the value chain in previous years had led many to increase inventories, leading to overstocking. Producers of API’s noted a slow-down in sales, as many pharmaceutical manufacturers had swollen their raw material supplies in recent years to ensure supply. For the companies in our benchmark, on average raw materials inventories are almost double what they were before the pandemic. Meanwhile the pharmaceutical manufacturers themselves reported overstocking at their customers as a reason for suppressed demand.
A cost of doing business?
Of course, given the importance and utility of their products, no one would want the pharmaceutical manufacturers to run short of essential medicines, and this consideration features very highly in their approach to inventory. If the current levels of excess and obsolescence are simply a necessary evil to achieve such high availability, surely it is a price worth paying?
However, while a certain amount of waste is necessary to maintain very high service levels for products with very short shelf lives, most medicines have a shelf life sufficiently long for this not to be a significant factor on its own. When a product has a shelf life that can be measured in months, this is certainly the case.
Another way of looking at it is from a purely financial perspective. There are a variety of companies in the benchmark: generics manufacturers, research-driven pharmaceutical manufacturers, diversified groups, contract manufacturers, but the average gross margin in 2023 was 65%. The gross margin is so large because R&D accounts for such a large proportion of the true cost of doing business for a lot of the firms, but EBITDA is also very healthy in the sector. In this context, scrapping 4% of your inventory each year equates to little more than 1% of revenue. This is a very small consideration compared to the rewards for, say, successfully bringing a new blockbuster to market.
The true cost of inventory imbalances
Inventory is not a cost to be minimized. It is a strategic asset to be optimized. Medicine shortages continue to be a global problem (3). As we highlighted in last year’s report, contrary to what intuition might tell you, shortages and overstocks are not inversely linked. Yes, if you only have one product then having too much of it means you can’t simultaneously not have enough. But once you consider the huge number of different medicines and dosage forms, it is obviously possible to have too much of some and not enough of others and this is the case in practice. Manufacturing capacity, raw materials and cash are all finite resources and overproduction in one area can and does cause shortages in others.
So when we hear people say “we don’t want to reduce inventories because we don’t want to risk shortages”, this is the wrong way of thinking about it. You should reduce unneeded inventories so that shortages can be better avoided. This is not to say that pharma supply chain teams are not already exerting themselves to better achieve this balance – of course they are, this is the very essence of supply chain. But as we look at another year’s inexorable rise in big pharma inventory levels, we have to conclude that there is still much room for improvement.
If you have any questions about this report, or would like help improving your organisation’s inventory levels (whether you feature in the benchmark or not), please contact us.
Technical Notes
1. “One-off effects” include the change of companies in the benchmark as well as major acquisitions or divestitures. When we compare DIO numbers from one year to the next, we exclude companies with this type of one-off effect so that they do not distort the underlying trend. Of course, a lot of these companies are making acquisitions or divestitures on a fairly regular basis, so we only exclude those where a significant impact on inventory levels is observable in either of the two years compared. The major one-off effects in 2023 are as follows:
- Bausch Health recorded a fair value step up on $162m of XIIDRA inventory acquired from Novartis. This should be amortized over 2 years, of which $20 was amortized through Cost of Sales in 2023.
- Biogen recorded a fair value step up on $1.3bn of inventory acquired through the purchase of Reata. This should be amortized over 3 years, with 31.5m amortized in 2023. Biogen have finished writing off Aduhelm.
- Pfizer recorded a fair value step up on $4.1bn of inventory acquired through the purchase of Seagen , $672m of inventory acquired through the purchase of GBT and $817m of inventory acquired through the purchase of Biohaven. Pfizer wrote off $6.2bn of unmarketable Paxlovid and Comirnaty (which also affected the DIO numbers by swelling Cost of Sales). In addition, Pfizer lost $209m of inventory from the tornado which hit its Rocky Mount facility.
- Amgen recorded a fair value step up on $5.025bn of inventory acquired through the purchase of Horizon Therapeutics.
- AstraZeneca recorded a $114m impact on Cost of Sales from the unwinding of fair value from the acquisition of Alexion.
At the time of publishing, Boehringer Ingelheim had not released their Finance Report for 2023, so we have replicated the 2022 figures as a placeholder and will update the benchmark once it becomes available. Boehringer Ingelheim do not report Cost of Sales so we have used an estimate as with previous years.
2. For estimates of inventory write offs, see our article “Inventory write offs in pharmaceutical manufacturing”.
3. See, for instance, the European Association of Hospital Pharmacists report, this summary from C&EN on shortages in the US, or this research briefing from the UK parliament. Of course, there are multiple reasons why medicines run short, but a lack of free capacity to react quickly to shortages is one.
Big Pharma’s inventory position was buffeted by a number of macro-trends in 2022. The direct impact of the Coronavirus receded, as vaccination programs did their job and everyday life began to return to normal over the course of the year. Demand for the vaccine and antivirals dropped from its peak, leading to a certain level of write offs of inventory produced in excess of eventual demand, although the world at large no doubt considers this a price worth paying for the speed with which effective vaccines and medicines were developed and produced.
As demand for Covid medicines and vaccines waned, however, the affect of the lockdown on people’s immune systems led to an unusually high incidence of seasonal illnesses and the latter part of the year saw shortages of many medicines, particularly generics and antibiotics. The widely-reported shortages no doubt also led to stockpiling, exacerbating the situation. So acute was the shortage of liquid ibuprofen, for instance, that the US FDA took the unusual step of allowing medicine manufacturers to compound ibuprofen to distribute in hospitals.
The numbers
And yet you would struggle to find evidence of an increase in shortages if you just looked at the balance sheets of the major pharmaceutical manufactures. Inventories grew by 10% year on year in aggregate for the companies included in our benchmark, to a combined total of $150bn, while sales grew by just 7%, to $994bn and cost of sales by only 4%, to $311bn.
Inflation drove price increases in raw materials, and this was a contributing factor in the increase in inventory by value, although this increase should ultimately be reflected in cost of sales. Ongoing supply concerns also led many firms to deliberately increase inventories, with the biggest increase (28%) visible in raw materials. The fact that it takes time for an increase in raw materials cost to filter through to cost of sales may indicate that a year-on-year increase in DIO will in part be temporary.
At an individual company level, 20 of the 28 companies saw their DIO increase in 2022, with the mean DIO increasing 5% to 202 and the median up to 197. Thus the increase in shortages cannot be attributed to a lack of inventory. Inventories seem to grow almost every year and yet this does not appear to help protect us from shortages. What is going on?
The main challenge is structural: many manufacturers make to forecast and in large batches, with long lead times and little spare capacity reserved. This makes it extremely difficult to respond quickly to sudden changes in demand. This means that on the one hand they systematically overproduce, with an estimated average ~4% of inventory being written off each year, but still run short of specific medicines from time to time.
Inventory optimization is about having enough of the right inventory. It can seem counter-intuitive, but excesses and shortages often go together.
Inventory waste
As we have written before, companies do not have a standard reporting framework for inventory write offs, so one needs to sort through the various accounting standards to derive an estimate, but inventory write offs continued to be in the range of 4% in 2022, with 12 of our 28 benchmarked companies making no disclosure at all, and the rest ranging from less than 1% up to an eye-watering 15% for Biogen, mostly related to Aduhelm.
That 4% would equate to about $12.5bn of medicines written off at cost in 2022 across the 28 companies considered. While some waste is inevitable in most supply chains and medicine manufacturers need to ensure very high availability, this figure still represents a large waste of capacity and resources. nVentic is working with the Sustainable Medicines Partnership to help create better visibility of this issue and to help address it.
Outlook
While inventory plays a vital role in assuring supply, cheap cash and high margins also encourage companies to let their inventories grow more than they otherwise should. Those preconditions appear to be at risk heading into 2023. Interest rates are on the rise, with the cost of capital growing from historic lows over the last 10-20 years. And the passing of the Inflation Reduction Act in the US in 2022 is part of an ongoing trend putting pressure on medicine pricing.
When one also considers that inventories in 2022 were consciously increased to mitigate supply issues over the previous 36 months, only some of which are still ongoing, one might expect to see reductions in inventory during 2023.
On the other hand, new medicines for weight loss and Alzheimer’s, as well as RSV vaccines, amongst other new treatments, are creating new demand, with manufacturers ramping up production. Novo Nordisk, for instance, announced in early May 2023 that it needs to restrict access to Wegovy. Holding over 300 days of inventory overall does not help them with the additional capacity required, especially since the same medication, semaglutide, is used by its type-2 diabetes drug Ozempic, which has also been experiencing shortages.
Large-scale bets on new blockbusters are typical of the industry. Once a new treatment is available, we rightly want patients to have access to it. And patent protection also incentivizes manufacturers to maximise sales post-approval. The cost of producing too much inventory can be significant, but with double-digit sales increases a realistic prospect for companies with a new blockbuster, this is usually a risk manufacturers are willing to take.
And yet one feels that at some point something has to give. Excessive inventories are not only environmentally irresponsible and a poor use of capital, but ultimately they also drive up the cost of medicines. Will the tide start to turn in 2023?
Technical Notes
Benchmark reports for 2018, 2019, 2020, 2021 and 2022 can be found on our website.
For a fuller discussion of DIO as a metric, see our Ultimate guide to DIO. All figures from published corporate reports/filings.
Like last year, we have used figures for calendar years for all firms, including those whose financial years are not the calendar years, i.e. Daiichi Sankyo, Takeda and Astellas, by putting together their quarterly reports.
Like in previous years, we have used an estimate of Boehringer Ingelheim’s cost of sales, which they do not publish.
Two major outliers are visible in the charts in 2022:
Pfizer continue to benefit from the impact of Covid-related products on their numbers. In 2022 they wrote off $1.7bn in unused doses of Paxlovid and Comirnaty. However, with annual sales having soared from $42bn in 2020 to over $100bn in 2022, they easily absorbed this loss and the ratio of inventories to cost of sales expressed in DIO continued on a different level to the pre-pandemic years.
AstraZeneca unwound nearly $3.5bn of fair value mark up on acquired Alexion inventories through cost of sales in 2022 and while this has returned their inventories to pre-acquisition levels in the $4-5bn range, the impact on cost of sales has had a significant impact on DIO for 2022.
On the widespread shortages of medicines at the end of 2022, see for instance this article from the World Economic Forum.
Public health and the environment are areas of high concern. These two topics overlap in the waste generated by the pharmaceutical industry. In this article we want to consider one particular type of waste, which is excess and obsolete (E&O) inventory: the medicines destroyed because surplus to requirements or out of date.
And while waste of this kind is generated at different points in the supply chain, from raw material production to unused medicines discarded by patients, we are going to focus on the pharmaceutical manufacturers themselves.
How big an issue is this, what causes it and can it be avoided?
How much is scrapped each year?
While sustainability reports are becoming ever-more common and comprehensive, waste in the sense of surplus products does not yet seem to be on the radar. Companies report on important metrics like energy and water consumption, plus CO2 emissions and waste (in the sense of by-products from the manufacturing process), but not yet how much of those relate to products that end up being scrapped.
Financial reports can sometimes give an indication of the scale of the issue, but not necessarily entirely transparently. Some companies report on inventories written off for obsolescence, excess or unmarketability, which is probably as close as we can get to the number that interests us, although even in this case any scrap due to excess is bundled with quality excursions.
Frequently, instead of write offs (where the full value of inventory is permanently removed from the balance sheet), companies report write downs. A write down could be due to a need to discount medicines, to the extent the net realizable value becomes less than the production cost. Or it could be a temporary measure to reflect the risk of inventory becoming worthless. This is particularly relevant to pharmaceuticals, where new medicines are often produced in large quantities before regulatory approval is achieved. In this case a write down might subsequently be reversed.
A survey of annual reports also turns up provisions for inventory impairment, which is where companies estimate in advance how much inventory will be written down or written off and make allowance for it in their balance sheets. All such decisions also have implications for tax, as both tax assets and liabilities can be deferred.
And finally, you also frequently find no mention of inventory impairment at all. Nearly half of the 28 big pharma companies in nVentic’s 2023 big pharma inventory benchmark report make no mention of inventory write offs, although one can be sure that they too destroy unused inventory each year.
Where inventory is scrapped, the cost normally passes through cost of sales (and inventory write downs treated as an expense is one variant of the numbers reported) but this is not the only possible treatment. Where inventory is built up and destroyed before product launch the expense can be charged to R&D rather than cost of sales.
In summary, therefore, it is very hard to ascertain with any degree of accuracy how much medicine is scrapped by the big pharma manufacturers each year from their annual reports and since the ones who do report at least some figures use different variations (impairment vs write off vs write down vs provisions, treated as an expense for cost of sales or not), we cannot meaningfully compare the companies amongst themselves in this respect either.
Looking at the numbers that are reported, however, which range from under 0.5% to over 10% of inventory sold each year, and admitting all of the uncertainty concerning inclusions and exclusions outlined above, it would appear that on average ~4% (based on 2022 figures) of all inventory produced is written off. Discussions with a number of companies on this list suggest a figure in this ballpark.
While 4% may not sound like much as a percentage, certainly not compared to something like waste in the food industry, it represents over $11bn (production cost) of medicines destroyed each year just for these 28 companies.
One can assume that any company would rather not have to destroy a product it has put so much time, effort and money into producing, so what are the root causes of this waste and (how) can we tell if 4% is good or bad?
The causes of scrap
A certain amount of obsolescence is inevitable in almost all supply chains, since forecasts are never perfect and most products reach a point where no one wants to buy them anymore. The problem is particularly acute for perishable products like medicines which have a definite shelf life beyond which they cannot be used and which demand high availability because they are essential for the preservation of life or quality of life.
Some of the main root causes for E&O inventory in pharmaceuticals are:
- Perishability. Products reach the end of their shelf life before they can be used
- A very low risk approach to shelf life. Expiry dates represent the date up to which a pharmaceutical manufacturer will guarantee the safety and efficacy of a medicine. Various studies have shown that, depending of course on type of ingredients, forms and how medicines are stored, many medicines remain safe and even efficacious, although slowly declining from the date of manufacture, for many years past the expiry date, but regulations encourage the manufacturers to take minimal risks with reduced efficacy
- Patent protection. The limited time window during which a new medicine has patent protection puts commercial pressure on manufacturers to maximise sales, building sizeable inventories before actual sales begin
- Historically high profit margins have encouraged pharmaceutical manufacturers to be sales-led organisations with E&O inventory seen as just a cost of doing business. Avoidance of shortages at any cost tends to take precedence over efficiency in many cases
- Long lead times and large batch sizes reduce supply chain agility and make it hard for pharmaceutical companies to be responsive to changing market conditions
Different medicines will be affected by these different root causes to different extents, and this no doubt explains the range of inventory write offs, at least in part.
For items with a short shelf life, targeting very high service levels will actively generate waste. Average shelf time can be calculated from the target service level and where this is greater than the shelf life of the product, waste will consistently be generated (and can be calculated in advance):
However, this is only likely to be the main driver of waste in items with very short shelf life, such as certain types of fresh produce where items perish within days. Even blood products last several weeks, while most drugs will last months or years.
Even given the very high service levels targeted for medicines, inventory write offs from pharmaceutical manufacturers are much more likely to indicate that volumes way in excess of demand have been produced. This means that of the 5 root causes listed above, the first two are unlikely to be the main drivers of waste at pharma manufacturers, so the other 3 should be the area of focus for improvement efforts. Let us concentrate on them as we consider whether a good proportion of the existing write offs can be avoided.
Can inventory write offs be avoided?
It bears repeating that pharmaceutical manufacturers are already naturally commercially motivated to avoid destroying inventory. No one is deliberately generating waste. But more could be done to reduce this type of waste. Let us look at the three main root causes in turn.
New product launches are surely one of the biggest headaches for pharmaceutical supply chains. Patent protection lasts 20 years from when the new molecular entity (NME) is filed. Of those 20, over 10 are taken up by research and development (1), meaning fewer than 10 remain for patent-protected sales. Since patent protection presents the opportunity for the highest margins in most drugs’ lifecycle, pressure is high to maximise sales during those remaining years.
Since lead times to source raw materials, commit capacity and build up the process are long, and since the regulatory process, which itself takes months, requires manufacturers to demonstrate they can produce at scale, production starts well before regulatory approval is assured. Where regulatory approval is denied, delayed, or dependent on changes, waste is very likely to be generated.
The thinking behind the patent protection regime makes sense. When a medical breakthrough is achieved, regulators want it to be available to patients as soon as possible. By putting a limit – 20 years – on patent protection, regulators ensure manufacturers are motivated to move quickly. Similarly, regulators want medicines to be affordable, so limiting the time a patent lasts allows cheaper alternatives to come onto the market relatively soon.
However, this time pressure has some undesirable side effects, of which E&O inventory is an obvious one. And this E&O inventory itself brings up the total cost of R&D, given the write offs of inventory prior to regulatory approval are usually charged to R&D.
One might validly ask whether a different regime could achieve the same ends while reducing the waste. For instance, giving manufacturers a fixed period of time, such as 8-10 years, post-approval to market new medicines before the patent expires and discouraging them from producing at scale (beyond what is required for the regulatory approval process itself) before the regulatory approval is formalised, might reduce some of the worst excesses in this area (although it must be said that the classic challenge of all new product launches – forecasting demand – is still likely to generate some E&O inventory).
Incentives for efficiency are another area worth exploring as this seems a persistent issue in pharmaceuticals. A McKinsey report from 2010 considered inventory optimization to be one of the biggest opportunities for pharma supply chains, estimating a minimum 25% reduction to be achievable. In fact, since then, in DIO terms those inventories have increased by over 10% instead!
While there is an obvious commercial incentive not to produce inventory that will not sell, the truth seems to be that overall margins are still adequate to allow manufacturers to remain nicely profitable while regularly scrapping a proportion of their inventories. Inventory optimization, for various reasons, is a technically challenging supply chain goal. However, if money itself is not sufficient reason to push much harder to reduce inventory write offs, perhaps the ever-greater imperative to reduce our collective environmental footprint could be. If pharmaceutical manufacturers had to start reporting, in a transparent and standard way, how much inventory they destroy each year – and the emissions related to it, then maybe efforts to find a better balance between high service levels and lean inventories would be increased.
In many cases, and pharmaceuticals is far from being alone in this, supply chain professionals already know they need less inventory, but they find it hard to prevail against sales voices in strategic planning processes such as Sales and Operations Planning (S&OP). A strong counterweight from a sustainability perspective might be beneficial in this situation.
Structural supply chain challenges, such as long lead times and large batch sizes, also represent potential for improvement, but are longer-term opportunities. Continuous and semi-continuous manufacturing present opportunities to move away from often large fixed batch sizes and finding or developing alternative raw material suppliers in-region also offers advantages.
Conclusions
There certainly appears to be an opportunity for pharmaceutical manufacturers to reduce the amount of E&O inventory they scrap each year and the environmental benefits of doing so are not insignificant. Perhaps a nudge in this direction can help these companies make a concerted effort to reduce it.
While society does have an expectation of very high availability of key medicines, we also have to keep in mind that there is a not insignificant opportunity cost in each medicine destroyed. That is money, time, effort and manufacturing capacity that could better have been employed in other directions.
And while we need to avoid the dangers of drawing too many conclusions of what could have been done with the wonderful benefits of hindsight, it is valid to question whether everything possible is being done to reduce this waste.
In order to help reduce the amount of inventory destroyed through obsolescence each year, nVentic has joined the Sustainable Medicines Partnership, a not-for-profit private-public collaboration executing projects to make the use of medicines more sustainable and less wasteful. nVentic is leveraging its deep analytical expertise to help the SMP develop frameworks and approaches to help reduce excesses and improve availability of medicines.
For more information on the SMP, see www.yewmaker.com/smp
To discuss your challenges with excess and obsolete inventories, contact us.
Notes
- Various estimates of average development times from first registering a new molecular entity to regulatory approval can be found, mostly in the range of 10 to 15 years, for example: http://phrma-docs.phrma.org/sites/default/files/pdf/rd_brochure_022307.pdf