Wednesday, July 09, 2008

The Politics of Cost-Cutting: Pfizer Downplays Outsourcing in Letter to Congress

Investors urging Pfizer to make more aggressive moves in cost-cutting take note: Pfizer says it has not yet realized any savings at all from manufacturing outsourcing.

The company recently told Congress that “we have realized little, if any savings to date” from outsourcing of production. In a letter to Sen. Sherrod Brown (D-Ohio) Pfizer Vice President-Quality Gerald Migliaccio explained, “Pfizer has been very cautious in sourcing from emerging markets that provide lower cost.”

Investors have been complaining that the firm is not serious about cutting costs as its blockbuster revenue base erodes, and the fact Pfizer has off-loaded 17 percent of its production operations without saving a dime may be seen as confirmation of that critique.

Of course, there is more to the story. In this case, context is everything. Brown's interest in outsourcing is driven by the heparin contamination debacle, and he (along with plenty of his colleagues in Congress) is quite eager to make that into an anti-globalization argument. So this would not be a good time for Pfizer to brag about efficiency.

The correspondence followed Migliaccio’s appearance at a Senate hearing where he touted the rigorous auditing Pfizer conducts of its contractors (Subscribers to "The Pink Sheet" can read Pfizer’s argument about the limited utility of inspections).

Brown had asked Pfizer about the risks of outsourcing, and the company emphasized that when conducted well, there aren’t any safety issues. But the exchange, as well as the grilling Baxter has faced over heparin, should serve as notice to firms that any savings they hope to achieve by moving operations oversees needs to be balanced against the increased spending they will likely take on in order to demonstrate that those activities remain in regulatory compliance.

And this is also a case where timing is everything. Pfizer notes in the letter to Brown that it only now received its first approval of a facility to supply raw material to the US from China--and that it has not yet used that facility as a source for finished products. But it will--and, we suspect, it will do so at a meaningfully lower cost to Pfizer.

Still, although Pfizer’s policies may reflect the full oversight costs of outsourcing, they may not be bowing to the financial realities of the company’s current circumstances, where all eyes are focused on the looming Lipitor patent expiration.

We are not adherents to numerology, but we do think it’s worth noting that Pfizer has also made another 17 percent change to its operations that may not save it any money. The company announced last week that it would stop providing grants to for-profit companies as part of changes to its policies for continuing medical education. ("The Pink Sheet" delineates how the move reduces the firm’s flexibility but improves its relations with academics.)

The 17 percent of Pfizer’s CME funds that are now spent with for-profit firms will likely go elsewhere (did we mention the improved relations with academics?), so don't expect that change to improve the bottom line.

Speaking of the number 17, Lipitor was approved on Dec. 17, 1996, and accounts for about 34 percent of Pfizer’s U.S. pharmaceutical revenue. When it goes generic in three years, Pfizer will need a lot more than the two 17-percent solutions it’s already implemented.

M. Nielsen Hobbs

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