In medicine, researchers often study people who don’t get sick after getting exposed to an otherwise deadly virus to understand what enables their immunity, which can accelerate the development of a successful vaccine.  Similarly, when it comes to logistics outsourcing, it’s sometimes useful to study the outliers to get a different perspective on what’s happening in the industry.

I use the medicine analogy because the “outlier” I’m focusing on is the healthcare industry.  Now, before you stop reading this commentary because you’re not from this industry, let me just say that what I see happening in healthcare is applicable across most industries, so please read on.

Why is healthcare an outlier?  Simply put, according to a market study we conducted a few years ago on the logistics service provider (3PL) market, the healthcare industry (which includes pharmaceuticals and medical devices) accounted for only 4 percent of service provider revenues.  In contrast, automotive, consumer goods, high tech, and retail each accounted for 20 percent or more of revenues. 

There are several reasons why healthcare companies haven’t outsourced their logistics operations in greater numbers historically, including their logistics costs as a percent of sales are relatively low and very few logistics service providers have the expertise, especially with regards to regulatory compliance, to serve the industry.

The healthcare industry, however, is undergoing some significant changes.  In addition to increased regulation, pharmaceutical companies face significant cost pressures, as many of their “blockbuster drugs” come off patent and generic alternatives gain market share.  To me, these challenges are very similar to the ones CPG manufacturers face with private-label brands.  Also, competition in the healthcare industry is much more global today, and emerging markets like China, India, and Eastern Europe provide greater growth opportunities than North America and Western Europe.  Distribution models are also changing, as in-pharmacy clinics and direct-to-patient shipments become more common.

The bottom line: many healthcare companies are reaching that fork in the road that other companies reached years ago.  As their supply chains become more cost sensitive, global, and dynamic, will healthcare companies invest internally to transform their supply chain and logistics operations or will they outsource?  Based on some recent developments, it seems that they’re opting for the road less travelled.

Last month, for example, UPS announced that it will manage a significant portion of Merck’s U.S. distribution of pharmaceuticals and vaccines.  According to the press release, UPS Supply Chain Solutions has assumed control of two key Merck distribution centers (in Atlanta and Reno) and will provide Merck with temperature-sensitive storage, packaging, and transportation services.  I haven’t had a chance to speak with anyone at Merck, but I did interview Bill Hook, UPS vice president of global strategy for healthcare logistics.  I asked him what drove Merck’s decision to work with UPS, and more generally, what factors are causing (or will cause) other healthcare companies to take a similar path.  Bill highlighted many of the factors I mentioned earlier, including increased cost pressures and globalization.  But he also said something that resonated with me: healthcare companies are seeking more “supply chain flexibility” in order to respond more effectively to dynamic market changes.

Is the quest for greater “supply chain flexibility” what differentiates the newcomers to logistics outsourcing (the outliers) from the early-adopters, companies that may have outsourced solely for cost reduction or service improvement reasons?  What defines “supply chain flexibility” and how do you determine if a logistics service provider can provide it?  What are the tradeoffs between flexibility and cost?  Will supply chain flexibility become a critical component of performance-based outsourcing contracts?

As in medicine, sometimes the initial research doesn’t lead to answers, just more questions.  I’ll be exploring these questions in the weeks ahead, and as always, I welcome your viewpoints on the topic.