Big pharma has potential to free up US$35 billion in working capital

A new Ernst & Young analysis of the 16 largest (by sales) US and European pharmaceutical companies, “Pharmaceutical companies and working capital management”, finds that the majority of big pharma players have a significant opportunity to release cash from working capital – between US$17 billion and US$35 billion, the equivalent of 3% to 7% of sales. This opportunity is distributed across the various components of working capital, with 40% from payables and 30% each from receivables and inventories.

With the rate of sales growth and pipeline productivity for the big pharma companies slowing and pricing pressures intensifying from generic competition, customer consolidation and government health authorities’ cost-containment policies, the big pharma business model and stock prices are under siege. In this environment, the pharmaceutical industry’s increasing attention on working capital has taken on new urgency. The analysis notes that the industry has made progress in reducing levels of working capital since 2000, but in the last two years 70% of the achievement gains in the previous five years have reversed.

Although a lot of focus has been on big pharma’s cost cutting measures, increasing the return on investment on existing assets is the value that keeps on giving. “In the past, pharmaceutical companies have not focused as rigorously on working capital management as other industries,” explained Jeffrey Greene, transactions leader for Ernst & Young’s pharmaceutical sector. “With high operating margins, strong balance sheets, and fears of running out of critical patient medication, a cash culture never fully developed.”

The full cash and cost benefits could be realized within 12 to 24 months from the launch of an intense working capital program, according to the report. The analysis finds that the best opportunities for improved working capital management include:

* Incentivizing cash performance
* Tightening management of payment terms for customers and suppliers
* Improving credit, billing and collections processes
* Establishing leading demand forecasting processes
* Building greater linkage and closer coordination across the entire supply chain

The study notes that there is a wide range of performance across the industry in the areas of cash-to-cash cycle, receivables, inventory and payables, indicating significant potential for improvement. Aligning performance of each pharma company with the industry average and with the upper quartile indicates potential cash opportunities of between US$11 billion and US$16 billion, respectively, for cash-to-cash performance; between US$5 billion and US$11 billion for receivables performance; between US$5 billion and US$10 billion for inventory performance; and between US$7 billion and US$14 billion for payables performance.

“Looking ahead, a number of trends will increasingly put pressure on companies to achieve higher levels of excellence across the entire working capital value chain,” said Greene.

Author: Lee Sibbald, October 1, 2008
Filed under: Ernst & Young