Essays on pharmaceutical capacity planning and outsourcing

This thesis explores the challenges facing pharmaceutical manufacturers in capacity planning, with a special focus on outsourcing decisions. Pharmaceutical capacity planning is challenging because of the several conflicting factors involved: (1) long lead time for constructing capacity but high uncertainty in product launch due to clinical trial and FDA approval, and (2) high demand uncertainty but high service level requirement right after product is approved.;Motivated by the growing practice of outsourcing in the pharmaceutical industry to deal with the above challenges, Chapter 2 studies the dual capacity sourcing problem where a manufacturer uses two capacity sources to meet demand: in-house capacity with a longer construction lead time, but once built, can be used throughout the planning horizon, and short-term outsourcing with a shorter reservation lead time but can only be used for one reservation period. Current practices treat such problems as one-time decisions, ignoring the fact that the finite planning horizon defined by the drug patent periods has important implications on the dynamics in such decisions. Our analysis shows that indeed, the optimal decisions are dynamically changing in the planning horizon. Specifically, the optimal total (in-house plus outsourcing) capacity is characterized by state dependent base-capacity levels. Given the complexity of the problem, the optimal in-house capacity policy is analyzed using two well-behaved heuristic approaches and an extensive numerical analysis. Based on the analysis, we obtain the following guiding principles for effective dual capacity sourcing policies: (1) postpone most of the long-term in-house capacity investment until after product launch and rely primarily on short-term outsourcing to meet demand right after products are approved; (2) quickly expand to a moderate level of excess in-house capacity right after product launch and rely primarily on in-house capacity to meet demand in the middle of the planning horizon; and (3) use both the already built in-house capacity and outsourcing to meet demand in the late years.;Chapter 3 extends the dual capacity sourcing model to multiple drugs since many manufacturers with multiple drugs in their pipelines consider building flexible capacity for multiple drugs for risk pooling, in addition to using outsourcing to reduce risks as analyzed in Chapter 2. Specifically, we investigate whether outsourcing and flexible capacity can be used as substitution or complements and how the optimal decisions change along the planning horizon. Given the many dimensions involved in the manufacturers decisions, based on the results from Chapter 2, we devote our analysis to a two-stage capacity planning problem where in-house flexible capacity is only built during the first three periods (referred to as the capacity expansion stage). Demand in the expansion stage can be met by either in-house flexible capacity or outsourcing. In the rest of the periods (referred to as the capacity allocation stage), demand can be met by allocation of the flexible capacity between the two drugs (capacity switching) as well as outsourcing. We find that outsourcing and flexible capacity are complementary as long as both drugs have uncertain demands. The optimal policy in the expansion stage is to prioritize in-house capacity investment on one of the drugs (betting one) in period 1 even if both drugs have similar risks and use capacity switching to meet the demand of the other if needed after product launching risks for both drugs have resolved. During the allocation periods, excess capacity is switched if strong demand is expected for one drug and relatively stable demand for the other in order to minimize capacity idleness costs and capacity switching costs. Any capacity requirement that cannot be met from switching of the in-house flexible capacity will be fulfilled by outsourcing.;While Chapters 2 and 3 are motivated more specifically by the pharmaceutical industry, in Chapter 4, we turn our attention to outsourcing contract design in a general setting. Reflecting on the growing bargaining power of some of the contract manufacturers, we examine the outsourcing contract selection problem with a price-setting vendor (contract manufacturer) under cost uncertainties. Applying a real options approach, we develop profit ratio functions for the vendor and client (OEM) under fixed price (FP) and cost-plus (CP) contracts to analyze their contract selection decisions. Supply chain coordination is also investigated. Our analysis shows that when the vendor has a big cost advantage, contract selection becomes independent of operating costs. In addition, contracts selected by the vendor and client always conflict with each other, with no supply chain coordination available. When the vendor has no or a small cost advantage, however, contract selections may or may not conflict. In addition, even if there is no conflict, a coordinated contract can generate higher profits for both players. Also, since the client has a timing flexibility to exercise a contract, the vendor cannot always induce a positive profit even if he controls outsourcing prices.