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Hidden Costs Across the Pharmaceutical Supply Chain

Updated: 4 days ago

The rising costs of U.S. healthcare affect all participants in the supply chain, from manufacturers to patients. While inflation is often mentioned as the leading cause of price increases over the last couple of years, other factors across the manufacturing cycle can lead to sticker shock at the pharmacy counter. This article briefly describes these concealed expenses and suggests solutions to reduce costs for suppliers and consumers.

How Hidden Costs Affect Pharmaceutical Production

Calculating the cost of a drug involves considering all aspects of its manufacturing. The price of active ingredients is often the starting point for estimating production costs, and it is essential to consider the total amount of time that the company is willing to invest in manufacturing a particular formulation. The reason for this is that the price of ingredients changes over time due to several factors, such as:

  • The number of manufacturers that sell the ingredient.

  • Availability of raw materials.

  • Rebates and other price agreements which depend on the volume purchased by the supplier during a certain period.

One option to decrease costs is to offshore certain parts or even the entire production process. While some suppliers in China and India may offer low manufacturing prices,  factors such as import tariffs, port charges, clearance fees, shipment inspections, and importation taxes can inflate costs. Therefore, when evaluating bids, one must consider both the quote sent by the potential partner and all the associated expenses that come with it. 

Other less-known factors that increase the manufacturing process of a pharmaceutical product are banking fees (for example, currency exchange or letters of credit), pharmacy board fees, and value-added tax (VAT). Thus, allocating a percentage of the overall cost estimate for contingency expenses is advisable. The contingency percentage depends on the supply chain's overall reliability, averaging between 1% to 4%, but representing up to 10% in additional costs in some Sub-Saharan countries.

How in-house activities affect costs

Calculating the price of a pharmaceutical product should also consider other activities unrelated to its manufacturing. For example, the product selection process may require the company to test and submit several formulations, of which not all will reach the market. Inventory, shipping, and storage often require substantial investments. Sourcing new suppliers can be expensive, and it is crucial also to consider internal overhead costs. While all these non-manufacturing expenses may represent up to just 1% of the total costs, it is vital to consider the impact this can have, considering that producing and commercializing a single formulation requires hundreds of thousands of dollars.

Pharmaceutical executives can reduce the impact these internal activities have on costs by:

  • Building a more streamlined supply chain, as faster delivery times reduce carrying costs.

  • Digitalizing manufacturing and inventory, to detect bottlenecks and low source levels and identify areas of improvement.

  • Restricting sourcing to a limited number of prequalified suppliers, thus reducing the number of bids that are evaluated.

  • Delegating supplier sourcing to an expert partner, which can reduce the time and staffing costs of doing it internally.

It is essential to mention that many pharmaceutical organizations do not leverage the benefits of delegating manufacturing processes. By partnering and delegating some activities, in-house resources can be allocated more effectively and increase internal efficiency.

Other internal and external manufacturing costs

The hidden factory is a process improvement concept that refers to all the additional activities and expenses caused by poor quality, including batch rejection, warranty costs, inspection, scrap, and rework. Other examples are:

  • Multiple versions of product specifications can increase the chance of teams across the supply chain using an outdated version and losing time while updating to the latest versions.

  • Know-how owned by a few technicians, which causes delays when they are not available or they leave the organization.

  • Supervisors speeding up turnaround times or having crunch sessions, which often increase overhead costs and make room for more mistakes.

  • Low-quality suppliers, who require more testing and quality reviews.

  • Lag time in reporting, which can allow problems to grow before they are detected.

  • Hierarchical or non-flexible organizational structures to reduce the chance for people to collaborate or share ideas.

  • Lack of preventative maintenance on equipment, which can lead to part damage or even machine failure.

According to the American Productivity & Quality Center (APQC), the hidden factory can raise the total cost of production up to 2.2% more

An image of an iceberg with hidden costs described

Regarding external factors that affect manufacturing, it is necessary to mention some systemic issues from the healthcare industry. The case of Teva, a pharmaceutical company facing criminal price-fixing charges, exemplifies the impact of monopolies over a product's market pricing, which forces competitors to either accept a specific price point or stop offering the product altogether. The involvement of intermediaries in drug pricing negotiations between manufacturers and hospitals often fails to translate into savings for either suppliers or patients. Instead, it introduces an additional layer of complexity,  inflating the overall expenses within the supply chain.

How patients are affected by hidden costs

From the patient's side, some hidden costs can influence the price of healthcare. A routine checkup may lead to additional charges for patients who ask questions, inadvertently turning a routine appointment (often covered by insurance companies) into a diagnostic session, which incurs extra fees. 

Paradoxically, patient engagement can contribute both to increase and decrease medical costs. Generic drugs, which have the same active ingredients as their brand-name counterparts, cost significantly 80-85% less according to the Food and Drug Administration (FDA). Therefore, patients must be proactive and clearly request generic options, which can result in huge savings.

In addition, many pharmaceutical companies offer free or low-cost drugs for patients who do not have prescription drug coverage, cannot afford the expense out of pocket, or have reached their insurance’s annual allowance limit. These discounts depend both on the cost of drugs and the patient’s income, with information available from healthcare professionals, government institutions, and websites such as the Medicine Assistance Tool (MAT).

As mentioned before, pushing towards transparency and digitalization can combat and eliminate hidden costs at all supply chain points. By embracing technology and digital solutions, patients, suppliers, and healthcare systems can collectively address hidden expenses to ensure that drug prices remain accessible and affordable for all.

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