OEM of Packaging Solutions for the Pharmaceutical Industry Turnaround its US Business to Restore Value Creation
An in-depth financial, operational and organizational review allowed a leading global OEM of packaging solutions for the pharmaceutical industry to formulate a turnaround strategy to change the trajectory and performance of its US business
A leading global manufacturer and distributor of packaging solutions for pharmaceutical products headquartered in Germany, faced eroding profitability in its US subsidiary that represented more than 30% of its international business. The top management team partnered with Argo to determine root causes of underperformance and develop a Turnaround Plan to restore profitability, growth and value creation.
The U.S. subsidiary was established more than 30 years ago to act as an agent of the corporate parent in sales and service and to serve the dynamic US Pharmaceutical market. However, during the last four years and despite a revenue growth of 11% CAGR, profitability declined from 14% EBIT margin to near break-even point as shown in Exhibit 1 below:
In addition, current levels of Revenues and Profits were well below the company targets of $50 million (vs actual of $31 million) and 10% of EBIT margin (vs actual of 0%), making the improvement of this unit a priority for the parent company.
Argo conducted a comprehensive financial, operational and organizational review of the US Business Unit to identify areas of underperformance and determine the respective root causes of poor performance. Our assessment included consolidated and divisional profitability analysis, value driver analysis for each functional area and identification of operational activities impeding optimal performance. In addition, we evaluated the organizational structure, key business processes and potential synergies between the different business units operating in the US market. Exhibit 2 below summarizes our project approach:
Fundamental Change in the Production of Pharma Products in the US: The US pharma market is experiencing two major shifts that affect packaging equipment manufacturers. First the “patent cliff” for blockbuster drugs (Lipitor, Advair etc.), where co-packers and generic manufacturers replaced large pharma companies as major buyers of packaging equipment is changing the emphasis from “brand, performance, quality, and reliability” to “cost, flexibility and fast delivery”. The second transformation in the pharmaceutical market involves the shift from “small molecules”, typically delivered in pill form, to large molecules or biologic drugs often packaged as injectables which requires different packaging equipment solutions. The change in market conditions and the customer base was confirmed by our analysis on revenue by customer segment shown in Exhibit 3:
Several Activities were Operating at a Loss: Adding to the market changes, our profitability analysis by division uncovered several activities with negative or rapidly declining margins. From the 9 divisions of the subsidiary, 4 were operating at a combined loss of $3.2 million in 2020 and Divisions 6 (Tooling), 7 (Service) and 8 (Refurbished Equipment) exhibited rapid declining in profitability with a combined drop on EBIT of $3 million between 2017 and 2020. Exhibit 4 below summarizes our profitability analysis by division and consolidated for 2017 and 2020. This analysis helped us determine the key focus areas for improvement.
Once unprofitable areas were identified, the Argo team focused on determining root causes of underperformance for each critical area by evaluating key value and operational drivers, conducting workshops with key personnel and surveying key customers on value delivered and product performance. The results of such analyses are presented below:
Division 6 – Tooling – Cost disadvantage and subpar operational processes:
Division 6 was a tooling operation that projected a loss of $1.2M in 2020. Operational performance was poor with average lead times of 14 weeks, well in excess of customer expected lead times of between 6 and 8 weeks. Long lead times were the consequence of efficiency leakages across the value chain including Engineering, Programming, Machining and Assembly. In addition, the Argo team identified the following factors eroding competitiveness and profitability:
- High labor costs and limited labor availability in current location
- Weak functioning of key processes including planning and scheduling, performance management and lean practices
- Lack of a modern digital technology interface between the key components of the value chain (e.g. drafting and CNC machining)
- Dysfunctional supply chain performance of both internal and external sources
- Old equipment, lacking technology and reliability, resulting in long wait times, unplanned maintenance and excessive downtime
Division 7 – Service – Loss of Talent, Reputation and Lack of a Robust Growth Model:
Service operated at a loss of 1M (-31% EBIT Margin) in 2020 completing 4 years in a row of unprofitable performance. Customer interviews revealed poor service levels which were affecting not only service revenues but also sales of new equipment and overall company reputation. In terms of root causes, our organizational assessment identified a significant loss of talent since 2017 in an area where experience is the essential qualification for high performance personnel. The existing organization was understaffed, lacked customer service focus and a robust performance management and incentive system. Adding to these challenges, we found opportunities to revamp training, capability development and a growth model to support the client’s installed base in the US market.
Division 8 – Refurbished Equipment – A Complex, Non-Core and Difficult to Scale Business:
The refurbished equipment division was operating at a loss of $0.8M with several commercial and operational challenges that raised questions regarding its viability. On the operational side our analysis uncovered several root causes of underperformance including:
- Long lead times of 31 weeks, in excess of customer expected lead times of ~20 weeks
- Poor communication between the parent company and the US business in several key processes including parts quoting, parts availability, pricing and lead times
- High labor costs, limited labor availability and access to key know-how in the US location
On the commercial side, the following issues were identified:
- Unclear definition of priority markets to commercialize refurbished products and lack of strategy, incentives, guidance and training of sales representatives to drive sales in this category
- Fragile go-to-market approach with challenges to identify the optimal list of target products, geographies, price targets, value proposition communication and sales execution
Our Recommendations, Strategic Alternatives and Profit Impact
Based on these analysis efforts, insights and sessions with the client’s customers, Argo and the client team put forward a number of actions and strategic alternatives to turnaround the US division and maximize value creation with great success. For each division root causes of underperformance were confirmed and actions to eliminate those causes were systematically developed and agreed with the client. Additionally, our team formulated different strategic alternatives to close existing gaps in each area which were then evaluated in detail to define the new strategy of the organization in the US market. Exhibit 5 summarizes the actions, strategic options and profitability impact by business unit:
The pharmaceutical industry is going under a profound transformation of its business model. Today, Pharma companies are highly focused on innovation, advancing their R&D capabilities and developing new biological products using technologies that were previously unthinkable. This transformation has also impacted Pharma manufacturing strategies, networks and their supply chains. Generic Manufacturers and Contract Manufacturing Organizations have become far more relevant and capable to handle significant volume of the total production of pharmaceutical products worldwide with improved levels of efficiency.
This transformation of the Pharma industry had a direct impact on our client’s competitive position. To start, the transformation brought significant change in our client’s customer base once dominated almost exclusively by big pharmaceutical companies and now having Generic Manufacturers and CMO’s as the key customer segments of the business comprising no less than 50% of sales.
To win in this new environment, our client had to rethink its business strategy in the US to offer the right product to the right segments, produce equipment and parts quicker and more cost effectively and improve the organization’s overall service, flexibility and responsiveness.
Achieving this degree of transformation is not easy, but keeping the status quo was not an option. The Argo team partnered with our client to understand the root cause of the problem, define the optimal set of structural changes needed to turnaround the situation and formulate the strategic alternatives to implement those changes and achieve a profitability improvement of between 15% and 22% of 2020 revenues.
About the Authors:
Fernando Assens is Argo’s Managing Partner and a co-leader of its Private Equity Practice. He focuses in Industrial and Distribution companies. [email protected]
Fabian Rodriguez is a Vice President at Argo’s Private Equity, M&A and Restructuring Practice. Prior to joining Argo, Fabian was a Senior Vice President at Stern Stewart & Co. and a Senior Associate at A.T. Kearney. [email protected]
Tony Barone runs Argo’s M&A and Restructuring practice. Before joining Argo, he was an Operating Partner for two Private Equity firms, a CFO of three public companies, and a CPA. [email protected]