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Evaluating outsourcing partners capability: A case study from the

pharmaceutical supply chain

Article  in  Journal of Manufacturing Technology Management · October 2013

DOI: 10.1108/JMTM-02-2012-0023

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 Evaluating outsourcing partners’ capability: A case study from
the pharmaceutical supply chain
Abstract

Purpose Many pharmaceutical companies outsource their research and development and
manufacturing operations to value chain partners. Effective evaluation of outsourcees’
capabilities and relationship management are often central for outsourcers to secure
sustainable competitive advantage. This study investigates how to evaluate outsourcees and
manage outsourcing relationships in the pharmaceutical industry based on the theory of
dynamic capability.

Design/methodology/approach The investigation used an exploratory multiple case study

approach. The data collection, spanning a period of twelve months, entailed a multinational
pharmaceutical company (PharmCo) with its headquarters in Europe, and four contract
research and manufacturing organizations (CRMOs) from China and India.

Findings The results show that PharmCo evaluates its outsourcing partners based on their
dynamic capabilities, which include processes (project deliverables, communication, and
accuracy of costs), positions (financial assets, number of scientists, spectrum of services, and
geographical presence), and paths (past experiences). Our findings indicate that a
pharmaceutical company outsources to partners with high operational capabilities, whereas it
builds fully integrated outsourcing relationships only with those that have high dynamic
capabilities.

Practical implications Findings from this study provide guidelines for practitioners in
manufacturing industries to efficiently and effectively evaluate and manage outsourcees to
deal with the challenges and risks associated with strategic outsourcing.

Originality/value We contribute to the literature by providing empirical evidence on the role

of dynamic capability in outsourcee evaluation and outsourcing relationship management in
the pharmaceutical industry. Moreover, we illustrate how to conceptualize and measure the
dynamic capability as a multi-dimensional construct. Our analysis also indicates that
partners’ dynamic and operational capabilities play different roles in outsourcing relationship
management.

Keywords Outsourcing, Supplier evaluation, Dynamic capability, Pharmaceutical industry

Paper type Case study

1
 Evaluating outsourcing partners’ capability: A case study from the pharmaceutical
supply chain

1. Introduction
Research and development (R&D) and manufacturing in the pharmaceutical industry
are knowledge-intensive, complex and risky processes, and have been traditionally contained
in-house (Gupta et al., 2007; PricewaterhouseCoopers, 2008; Chen and Hung, 2010).
Pharmaceutical companies often need to build new R&D and production facilities designed
for special molecules or drugs, which is costly and time consuming (Chambers et al., 2009).
The pharmaceutical industry used to rely on a vertically integrated model, in which
companies would do everything themselves, from R&D through manufacturing to
commercialization. In this model, success hinges on the firm’s internal abilities to identify
promising new molecules, test them in large clinical trials, and promote them with an
extensive marketing and sales presence (PricewaterhouseCoopers, 2009). This model has
been challenged by declining R&D productivity, increasing competition from brand generic
medicines, continual price pressure from governments and healthcare institutions, and rising
applications of biotechnology (PricewaterhouseCoopers, 2009; Rossetti et al., 2011).
Pharmaceutical companies have realized that relying only on internal resources for R&D and
manufacturing has become ineffective for competition, and have started to collaborate with
external organizations (outsourcees) to restructure their global value chains (Boulaksil and
Fransoo, 2010; Liao et al., 2010; Nepal et al., 2011; PricewaterhouseCoopers, 2011). The use
of contract research and manufacturing organizations (CRMOs) in emerging economies for
drug discovery and development, clinical trials, drug manufacturing and distribution has
provided pharmaceutical companies with a way to reduce cost, improve speed, quality and
flexibility, and adjust their organizational boundaries in response to external economic
pressures (Rothaermel et al., 2006; Gupta et al., 2007; Chen and Hung, 2010; Handley, 2012).
After decades of development, CRMOs in emerging economies (e.g. China and India)
are able to offer complex pharmaceutical outsourcing services (Sinha and Kohnke, 2009).
This enables pharmaceutical companies to pursue strategic objectives beyond cost saving,
such as focusing on core activities, exploring advanced technologies and new markets, and
accessing new resources and knowledge bases, through outsourcing (Holcomb and Hitt,
2007; Kumar and Arbi, 2008; Boulaksil and Fransoo, 2010; Li et al., 2010). Pharmaceutical
companies’ success becomes more and more dependent on the long-term cooperative
relationships they have established with critical CRMOs (Prahinski and Benton, 2004; Gupta
2
et al., 2007). Meanwhile, outsourcing might also bring risks and potential negative
consequences, such as decrease in labour productivity (Broedner et al., 2009), operational
capability loss (Handley, 2012), and appropriation of valuable technological knowledge (Li et
al., 2008). Partner evaluation and relationship management are important ways to deal with
the “dark side” of outsourcing (Pawar et al., 2009; Chen and Hung, 2010). However, there is
limited empirical evidence on how pharmaceutical companies evaluate CRMOs and manage
their outsourcing relationships (Boulaksil and Fransoo, 2010; Rossetti et al., 2011).
As outsourcing in the pharmaceutical industry is moving from tactical operations to
strategic decisions, CRMOs are becoming involved in the outsourcers’ entire value chains
(Gupta et al., 2007; Pawar et al., 2009). A CRMO can offer unique expertise and
technologies that are not available internally. Pharmaceutical companies can hence gain
access to a larger talent pool and leverage partners’ core competences and resources to
expand or improve their capabilities over time (Li et al., 2010; Liao et al., 2011). Moreover, a
pharmaceutical company also relies on outsourcing to improve flexibility in production and
develop capabilities to tackle the rapid changes in external business environments in terms of
regulation, technology and market (Chambers et al., 2009). Strategic outsourcing is
associated with high interdependence among partners, which increases the uncertainties and
dynamics of outsourcers’ operations (De Vries and Huijsman, 2011, Rossetti et al., 2011).
Dynamic capability (DC) describes a firm’s ability to adapt and update capabilities so as to
achieve congruence with the changing business environment (Eisenhardt and Martin, 2000).
Hence, partners’ DC, which deals with uncertainties and leverages resources in a dynamically
competitive environment, becomes critical in outsourcing (Barreto, 2010). However, research
on outsourcing has given limited attention to the roles of partners’ DC in supplier evaluation
and relationship management. The objective of this paper is to explore how to evaluate
outsourcees and manage outsourcing relationships in the pharmaceutical industry based on
the theory of DC. It aims to address the following three research questions: 1) How does a
pharmaceutical company manage its CRMOs? 2) What criteria are used by a pharmaceutical
company to evaluate its outsourcing partners? 3) How does partners’ DC influence
outsourcing relationships in the pharmaceutical industry?
The remainder of the paper is organized as follows. Section 2 reviews the literature on
supplier evaluation and DC. The method used for the case study is presented in Section 3,
followed by the description of the cases in Section 4. The case materials are analysed in
Section 5. The key findings, theoretical contributions, and their managerial implications are
discussed in Section 6. Finally, Section 7 summarizes the study and highlights future research
3
directions.

2. Literature review
2.1 Supplier evaluation
Today’s hypercompetitive business environment requires organizations to make
effective use of not only internal capabilities, but also supplier network resources in order to
remain competitive (Modi and Mabert, 2007). Through externally obtaining goods and
services previously provided by the firm itself, outsourcing moves a firm’s internal activities
and decision making responsibilities to external partners (Chase et al., 2004; Kakabadse and
Kakabadse, 2005). Supplier capability hence becomes an important contributor to companies’
competitive advantage (Humphreys et al., 2011). When companies outsource a significant
part of their business, the processes of supplier evaluation become strategic (Pawar et al.,
2009). A company must determine appropriate criteria and methods for evaluating
outsourcing partners to ensure that their resources and capabilities meet its current and future
needs (Chen and Hung, 2010; Humphreys et al., 2011; Kumar et al., 2011).
Supplier evaluation refers to the processes of assessing suppliers’ capabilities and
resources, benchmarking their performance, and detecting development opportunities
(Prahinski and Benton, 2004; Modi and Mabert, 2007). Pharmaceutical companies tend to
outsource to a selected number of partners via a pre-qualification process (Chen and Hung,
2010). However, not all selected outsourcees are qualified for long-term integrated
relationships (Modi and Mabert, 2007). Supplier evaluation helps a company to categorize its
partners based on assessment criteria (Li et al., 2008; Humphreys et al., 2011). When a
company is making strategic outsourcing decisions, evaluation activities enable it to monitor
the on-going outsourcing relationship and to manage the competitiveness of the supply chain
in supporting companies’ strategies, hence preventing risks and negative consequences
associated with outsourcing (Carr and Pearson, 1999; Ounnar et al., 2007; Handley, 2012).
Supplier evaluation is a multi-criteria decision process. In empirical surveys,
researchers conceptualize supplier evaluation as various practices and routines. For example,
Carr and Pearson (1999) assessed the supplier evaluation system as comprising a certification
programme, formal performance management, and a formal supplier recognizing programme.
Prahinski and Benton (2004) tested a model in which supplier evaluation was conceptualized
as four communication strategies (indirect influence strategy, formality, feedback, and
collaborative communication). Modi and Mabert (2007) operationalized it as a formal
procedure with guidelines, feedback, and a certification programme. Humphreys et al. (2011)
4
measured it in terms of a certification programme for quality, a rating system, and a
relationship with supplier development programme. Quantitative modelling, such as weighted
average method, analytic hierarchy process, data envelopment analysis, categorical method,
total cost of ownership, neural networks, and fuzzy logic, is another commonly used method
for supplier evaluation studies (e.g. Ross and Buffa, 2009; Ordoobadi, 2009; Wu and
Blackhurst, 2009). Multi-criteria models have been developed to evaluate suppliers’ various
attributes. For example, Shore and Venkatachalam (2003) proposed a method for evaluating
the information sharing potential of suppliers based on collaboration capability and
infrastructure capability; Ohdar and Ray’s (2004) model measured four supplier attributes:
quality, delivery, service, and price; Ounnar et al. (2007) developed a supplier evaluation
process comprising five criteria: lead time, cost, quality, reliability, and strategy; Ross and
Buffa (2009) considered three attributes (the use of information and communication
technology, quality and delivery execution, and monetary incentives) when evaluating
suppliers; Wu and Blackhurst (2009) used the evaluation criteria of price, proprietary design
partnerships, and quality and delivery performance; Ordoobadi (2009) focused on the
attributes of delivery, service, product, quality, and cost; Chen and Hung (2010) built a
framework to evaluate outsourcing manufacturing partners in the pharmaceutical industry
using the criteria of financial consideration, quality, service performance, compliance, and
culture.
Existing supplier evaluation frameworks mainly focus on financial measures and
other tangible operating factors, such as information technology, communication, delivery,
quality, and cost (Ross and Buffa, 2009). Such models emphasize suppliers’ performance
outcomes and internal operational capabilities that are important for evaluating partners for
transactional outsourcing and arm-length relationships (Wu and Blackhurst, 2009). Strategic
outsourcing aims at leveraging suppliers’ specialist skills, investments, innovations and
knowledge. Hence, manufacturers are dependent on suppliers’ capabilities and resources.
Moreover, suppliers’ skills and competences required for strategic outsourcing are different
from those needed for transactional outsourcing (Ordoobadi, 2009). To build strategic, long-
term partnerships, manufacturers need to search for external capabilities through resource
analysis rather than efficiency and cost reduction (Holcomb and Hitt, 2007; McIvor, 2009).
Therefore, manufacturers need to evaluate suppliers’ DC, which indicates suppliers’
capabilities and resources to match the requirements of a changing environment, rather than
tactical operations’ performance. However, the existing models provide little insight into

5
partners’ DC, and thus cannot offer a holistic view of the strategic outsourcee evaluation
(Drnevich and Kriauciunas, 2011; Helfat and Winter, 2011; Liao et al., 2011).

2.2 Dynamic capability

DC is defined as “the firm’s ability to integrate, build, and reconfigure internal and
external competences to address rapidly changing environments” (Teece et al., 1997:516).
The key attributes of DC include the capacity “(1) to sense and shape opportunities and
threats, (2) to seize opportunities, and (3) to maintain competitiveness through enhancing,
combining, protecting, and, when necessary, reconfiguring the business enterprise’s
intangible and tangible assets” (Teece, 2007:1319). Eisenhardt and Martin (2000) further
argued that DC is embedded in strategic processes, exhibits commonalities across effective
firms, and is influenced by the market dynamics and guided by learning mechanisms. DC
emphasizes the integration and reconfiguration of resources and capabilities, operating
routines, and learning mechanisms, and typically involves long-term commitments (Winter,
2003). According to Teece et al. (1997), DC consists of a set of specific and identifiable
managerial and organizational processes and routines which are shaped by the firm’s asset
positions and evolution paths. Hence, processes, positions, and paths are DC’s key
parameters. “Processes” refer to the way things are done in organizations, such as routines
and practices. They have three roles: coordination/integration, learning, and reconfiguration
(Teece et al, 1997). “Positions” refer to the firm’s current specific endowments and assets,
such as market power, human capital, and financial resources. Internal position refers to the
specific set of resources available in a firm, and external position refers to the specific market
assets of the focal firm (Teece et al., 1997). “Paths” refer to the firm’s relevant past
experiences, which relate to the history of the organization (Teece et al., 1997).
DC has been viewed as a higher-order capability or meta-capability (Blyler and Coff,
2003). Through adjusting routines and resources according to the environment, DC enables a
firm to extend, enhance, modify or create “zero-order” operational capabilities (Winter, 2003;
Pavlou and El Sawy, 2011). Winter (2000: 983) defined an operational capability as “a high-
level routine (or collection of routines) that, together with its implementing input flows,
confers upon an organization’s management a set of decision options for producing
significant outputs of a particular type”. Operational capability generally involves using a
collection of routines to execute and coordinate a variety of tasks required to perform an
activity, such as R&D, manufacturing, marketing and distribution (Winter, 2003). Dynamic
and operational capabilities differ in their purposes and intended outcomes. In particular, DC

6
would enable a firm to explore new opportunities, whereas operational capabilities would
correspond to the efficient exploitation of existing resources (Pavlou and El Sawy, 2011).
Operational capability focuses on current techniques and practices to support existing
products and services for the same customer population, while DC reveals how a firm alters
and fine-tunes operational capability and governs the rate of change (Helfat and Winter,
2011). Hence, a firm relies on its operational capability to make its living in the short term,
and on DC to alter how it makes its living (Winter, 2003). Moreover, Drnevich and
Kriauciunas (2011) discovered that environmental dynamism negatively affects the impact of
operational capability on performance, but positively influences the contribution of DC to
performance.
DC has already become an important framework for understanding the strategic
operations of organizations and has been used to analyse sustainable competitive advantage
(Barreto, 2010). Empirically, DC has been conceptualized as a multi-dimensional construct
(Barreto, 2010). For example, based on a survey in the automotive industry, Ettlie and Pavlou
(2006) found that partners’ DC, which is conceptualized as absorptive capacity, coordination
capability, and collective mind, positively influences both new product success rate and
product commercialization. Doving and Gooderham (2008) analysed 254 Norwegian small
accountancy firms and found that DC, measured by the heterogeneity of human capital,
internal development routines and alliances with complementary service providers, has a
distinct effect on the scope of services. Agarwal and Selen (2009) argued that DC has five
sub-dimensions (customer engagement, collaborative agility, entrepreneurial alertness,
collaborative organizational learning, and collaborative innovative capacity); using empirical
data from a large telecommunication company they found that it positively influences the
service innovation outcome.

3. Methodology
We employed an exploratory multiple case study approach in this research
(Eisenhardt, 1989; Yin, 2009). This choice was motivated by the fact that supplier evaluation
and outsourcing relationship management are not yet well documented in the pharmaceutical
industry (Boulaksil and Fransoo, 2010).
3.1 Case selection
The cases were selected from China and India. The main reasons for choosing these
countries are their importance in the global CRMO market and their leading roles as
recipients of pharmaceutical outsourcing (PricewaterhouseCoopers, 2007,
7
PricewaterhouseCoopers, 2011). The selection methodology suggested by Miles and
Huberman (1994:16-39) was used. The research team, comprising researchers from Europe,
China and India, brainstormed the possible factors and established the boundaries of the study
to ensure that the selection criteria were fully aligned to the research questions. Eight
CRMOs were selected for the initial case studies. Using the information gathered from the
pilot studies, the research team developed a summary of the basic constructs underlying
supplier evaluation, DC and outsourcing relationship management (Miles and Huberman,
1994). We then applied this framework to the initial eight CRMOs to select ideal-case
candidates. This process was guided by replication logic (Yin, 2009). Three CRMOs were
selected because the pharmaceutical company had adopted either integrated or partial
integrated outsourcing relationships with them. These CRMOs are the literal replications that
predict similar results. A further CRMO was selected because the pharmaceutical company
had a transactional outsourcing relationship with it and it had different DC compared with the
other CRMOs. This CRMO represents a theoretical replication that predicts contrasting
results but for anticipatable reasons. Hence, a total of four CRMOs in China and India,
exhibiting polar types of DC and outsourcing relationships and sharing a reasonable number
of commonalities to permit systematic and paired comparisons, were selected (Figure 1)
(Eisenhardt, 1989). Representatives from all these companies agreed to cooperate with this
study, and we arranged follow-up interviews with the desired participants.
---------------------------------------
Figure 1 about here
---------------------------------------
3.2 Data collection
The data sources for this study included semi-structured interviews, quantitative and
qualitative data from the Internet, personal observations and companies’ internal reports. The
multiple sources of evidence strengthened the analysis by allowing triangulation on important
issues to cross-verify insights and findings (Yin, 2009).
Owing to the collaborative relationships with these companies, the face-to-face
interview strategy was selected as the main method for data collection (Yin, 2009). In total,
the fieldwork for this study spanned a period of twelve months during 2010-11. A member of
the research team was based in the pharmaceutical company’s office and was able to visit the
CRMOs’ sites in China and India regularly to collect the required data until theoretical
saturation was reached. The research team had a good understanding of the companies’
organisational structures, thereby making it easier to identify the best employees to target for
data collection. The key individuals interviewed included the pharmaceutical company’s
8
global sourcing managers, project managers and the head of the research centre, and the
general managers and marketing executives of each CRMO. A semi-structured interview
protocol with open-end questions, developed based on existing literature and adapted
according to the pharmaceutical supply chain context and our research questions, was used in
each round of the interview (Appendix I). This protocol included three sets of questions
regarding the pharmaceutical company’s outsourcing practices (Pawar et al., 2004; Gupta et
al., 2007; Holcomb and Hitt, 2007; Rossetti et al., 2011), supplier evaluation processes (Modi
and Mabert, 2007; Ross and Buffa, 2009; Chen and Hung, 2010), and its suppliers’ DC
(Teece et al., 1997; Winter, 2003; Teece, 2007). Before each interview, a briefing meeting
was conducted to share information and experiences from previous interviews among team
members, on the basis of which the research team modified the semi-structured protocol.
Each interview lasted approximately one hour, was tape-recorded, transcribed to textual data,
and checked by other research team members to ensure accuracy prior to data analysis. The
research team was given plant tours in the participating companies. We also collected
approximately 30 archival records from both the company and the CRMOs (e.g., internal
meeting notes, PowerPoint presentations and research reports). The data collected from the
fieldwork were presented using a standardised template in a consistent, logical and coherent
manner, which allowed the research team to undertake a detailed and systematic analysis.

4. Case description
4.1 The pharmaceutical company
The pharmaceutical company (PharmCo) is a global, innovation-driven and integrated
biopharmaceutical corporation with its headquarters in Europe. It is active in over 100
countries, with a growing presence in emerging markets including Russia, China and India.
By partnering with major hospitals, research institutions, universities and CRMOs, PharmCo
aims not only to reduce R&D and manufacturing costs but also to acquire new market
information and capabilities. It is actively collecting local pharmaceutical market intelligence
and CRMO knowledge to assist its global stakeholders to design low cost sourcing strategies;
this also enables PharmCo to discover drugs for the treatment of diseases prevalent in China
and India rather than targeting global or western consumers. In particular, a global
externalization team (GET) works as an interface between CRMOs and internal departments.
GET focuses on sourcing raw materials, intermediates and R&D services globally, and
provides project management and quality assurance for outsourcing activities. Outsourcing
managers liaise with project managers and CRMOs to match their expertise to internal
9
requirements. When there is a request to outsource, GET prepares the invitation for proposal
(a tender), which is sent to CRMOs. The submitted proposals or bids are then compared and
evaluated, and CRMOs are selected.

4.2 The contract research and manufacturing organizations

All the CRMOs in this study have had previous dealings or collaboration track
records with PharmCo. They are system integrators, offering a wide range of R&D services
(e.g. clinical trials, clinical management, clinical data management, and regulatory affairs
advice), manufacturing services, and commercial manufacturing. Furthermore, the majority
of these CRMOs have world-class facilities and highly qualified and competent scientists and
other technical staff at their disposal.
AppTech Ltd (CRMO #1) has a good brand value and is considered as a tier 1
supplier. It offers a broad portfolio for drug development support, from molecule creation to
first-in-human testing, and provides a flexible approach to accommodate customer
requirements. It has over 80 small molecule customers and over 600 large molecule
(biopharmaceuticals) and medical device customers. AppTech Ltd provides fully integrated
“basket offerings”, thereby reducing overall timelines. It is good at on-time delivery and
communication, and can ensure the accuracy of actual costs against budget, but is often
uncompetitive on price. PharmCo has developed an integrated outsourcing relationship with
AppTech Ltd, which is characterized by direct communications (e.g. information sharing and
problem solving) among a range of business functions (e.g. design, finance, IT, operations,
and logistics). All internal departments involved in the transaction interact with each other
and share specific information to build multiple information sharing channels. PharmCo and
AppTech Ltd make joint decisions on R&D, manufacturing and delivery. Such a relationship
imposes significant demands on resources from both PharmCo and AppTech Ltd’s senior
managers, and requires time to develop sustainable and workable collaborations. For example,
meetings between the top management of both parties take place on a monthly basis to
demonstrate a high level of commitment to the relationship. Visits by the personnel of each
company to the partner’s sites create a mutual understanding of each party’s resources and
capabilities. Face-to-face interactions are also frequently used to understand the company and
AppTech Ltd’s needs and requirements.
Chem Ltd (CRMO #2) was originally established in America and has a good brand
value in overseas markets. It has expanded its business rapidly by acquiring new sites and
building significant production capacities. Chem Ltd has quick decision making processes but
10
lacks flexibility in customization. It provides high quality professional services, ensuring
timely delivery of the required quantity of materials and high accuracy of actual costs against
budget. PharmCo’s spend on Chem Ltd increased by more than 100% in 2010. PharmCo has
developed a transactional outsourcing relationship with Chem Ltd in which the interface is
confined to sales and purchasing employees with limited executive management support and
strategic level involvement from each party. All information is transmitted through a single
dedicated channel in a consistent manner. This interface structure has been established with
limited resource inputs and commitments from both Chem Ltd and PharmCo. According to
PharmCo’s managers, cost reduction is the main driver for the outsourcing and they expect
Chem Ltd to deliver only the exact products and amounts ordered by PharmCo.
PharSol Ltd (CRMO #3) has a very strong financial position with plans to expand
globally. It started to collaborate with PharmCo in 2009, and PharmCo’s spend on PharSol
Ltd more than doubled in 2010. PharSol Ltd has established strong alliances with many
international drug distributors and research-based companies. It has a good understanding on
process safety and high manufacturing flexibility, which make it a potential tier 1 supplier.
However, its project management capabilities are low and PharSol Ltd relies significantly on
the Indian market.
Syne Ltd (CRMO #4) has successfully partnered with leading players in the global
pharmaceutical industry across a range of challenging programs, from discovery to supply of
complex development compounds. It has a good understanding of the uncertainties of early
phase projects. Syne Ltd also has a good infrastructure and is good at on-time delivery, with
very flexible processes which make it a potential tier 1 supplier. However, it lacks capability
in the drug discovery area. PharmCo’s outsourcing relationship with Syne Ltd began only in
2010; hence, collaboration experiences have so far been limited. Both PharSol Ltd and Syne
Ltd are able to ensure the quality and quantity of the delivered materials and the accuracy of
actual cost against budget. PharmCo has developed a partial integrated relationship with each
of them. Interactions prior to project execution are between PharmCo’s outsourcing project
manager and PharSol Ltd and Syne Ltd’s business development executives. Only during the
project execution do the rest of the departments interact. Table 1 summarizes the profiles of
the four CRMOs.
--------------------------
Table 1 about here
--------------------------

11
5. Case analysis
5.1 CRMO evaluation
In this section we examine how PharmCo assessed its CRMOs’ DC by evaluating
their processes, positions, and paths. The results are summarized in Table 2. PharmCo
evaluated CRMOs’ processes using three criteria: project deliverables, communication and
accuracy of costs. Project deliverables were assessed by on-time delivery, quantity and
quality of the materials. Communication was appraised by regularity (ease of contacting staff
during the project, availability of technical contacts, and quality of weekly updates) and
problem response (time to respond to technical queries, questions and comments, time to
report critical issues affecting the project, and openness and honesty). Accuracy to costs was
assessed by the accuracy of actual costs and invoices against the budget and cash flow
forecasts.
PharmCo conducted evaluations based on the last two completed projects using a
subjective score ranging from “very good” to “very poor”. The executives made judgements
based on their perceptions and internal reports incorporating the criteria described in
Appendix II. All four CRMOs were able to provide slightly better delivery speed compared
with the original project plans. The CRMOs were able to meet the quality and quantity targets.
If deliveries were slightly behind original plans, they would re-prioritize the company’s
projects to put in extra resources at their own expense to limit schedule and cost variations.
AppTech Ltd communicated all significant problems immediately with possible solutions and
all weekly updates were on time with appropriate content and clear indications of current
project status. For Chem Ltd and Syne Ltd, only significant problems were communicated
weekly with limited possible solutions; most weekly updates were on time, but without
appropriate content or with no clear indications of current project status. The communication
with PharSol Ltd was not satisfactory because only significant problems were communicated
weekly, with no possible solutions; problems were overcome according to PharmCo’s
directions, and a significant number of updates were delayed or not sent. All four CRMOs
ensured the project delivered to budget.
The CRMOs’ positions were evaluated by the firm-specific resources and market
capabilities. In particular, resources were measured by CRMOs’ financial assets and human
capital, and the market capabilities were assessed by their spectrum of services and
geographical presence. Partners’ well-qualified and trained scientists allowed PharmCo to
acquire know-how and gain access to new technologies without having to buy the physical
assets or recruit staff. Recently, a large part of PharmCo’s revenues were at high risk due to
12
increasing R&D costs coupled with a gradually depleting portfolio of patents and competition
from generics. PharmCo believed that CRMOs’ financial assets could provide financial
flexibility and free it to invest in areas that maximize cash flow or profits. CRMOs’ financial
stability could also mitigate potential supply chain risks. CRMOs’ market capabilities helped
PharmCo enter new markets and develop new products by reducing geographical distance
from the customers and providing complementary services. A manager commented that
geographical presence reflected the degree to which a CRMO could contribute to PharmCo’s
market development and optimization of global operations. Moreover, a wide spectrum of
services indicated that a CRMO could provide complementary assets and capabilities for
PharmCo to enhance the value creation potentials of its own resource endowments.
PharmCo made evaluations based on managers’ judgement and the bi-annual reports
provided by the CRMOs. Objective scores regarding CRMOs’ revenue and the number of
scientists were used to measure financial assets and human capital. Subjective scores ranging
from “very good” to “poor” were employed to measure geographical presence and the
spectrum of services based on the criteria described in Appendix III. AppTech Ltd and
PharSol Ltd had very strong financial positions and Syne Ltd also possessed good financial
assets. Chem Ltd’s financial resources were weaker when compared with the others.
AppTech Ltd, Syne Ltd, and PharSol Ltd had a large number of scientists, while the human
capital in Chem Ltd was not as high. AppTech Ltd had a global presence and Chem Ltd
operated in both the west (America and Europe) and the east (Asia), while Syne Ltd only
served the regional market and PharSol Ltd’s main stage was in India. AppTech Ltd provided
fully integrated one stop shop services, and PharSol Ltd and Syne Ltd sold partial integrated
services to customers. However, Chem Ltd’s spectrum of services was relatively narrow in
comparison to the others.
Paths were assessed by the past collaboration experiences between PharmCo and the
CRMOs. A manager commented that PharmCo might encounter significant risks and
unanticipated challenges when it applied strategic outsourcing with new partners. In order to
avoid potential threats and pre-empt supplier failures, PharmCo would choose partners that
had good past cooperation experiences, which indicated that they could meet PharmCo’s
requirements and that the objectives in outsourcing could be achieved.
PharmCo used the objective scores for transaction value, collaboration areas (i.e.
R&D or manufacturing), and length (i.e. years) in the last three years to evaluate past
experiences based on the internal reports. AppTech Ltd had collaborated with PharmCo in the
last three years with high value in areas of both contract manufacturing and R&D. Chem Ltd
13
had also worked with PharmCo for three years, but only in contract manufacturing with
middle spends. PharmCo had collaborated with PharSol Ltd for two years with middle value
in contract manufacturing. It had built a contract R&D relationship with Syne Ltd for only
one year with low value.
--------------------------
Table 2 about here
--------------------------
5.2 The effects of DC on outsourcing relationship management
PharmCo used different methods to manage outsourcing relationships. AppTech Ltd
represented the supplier with which PharmCo had developed an integrated relationship. For
Syne Ltd and PharSol Ltd, PharmCo adopted a partial integrated relationship. PharmCo
maintained only a transactional relationship with Chem Ltd. Our empirical evidence reveals
that all four CRMOs had similar process performance in terms of project deliverables and
accuracy of costs. These two criteria reveal the outsourcees’ performance on cost control,
quality, quantity, and delivery, which indicate CRMOs’ operational capabilities on
exploitation of existing resources (Winter, 2003).
Resources and market capabilities reflect the abundance of scientific talent, strength
of manufacturing base, modernization of R&D capacity, and market power, which indicate
what a firm might achieve in the future. Compared with other CRMOs, Chem Ltd had lower
financial assets and fewer scientists, and provided only a limited number of loosely integrated
services. Hence, in the long term, it is unlikely that Chem Ltd would be able to co-develop
with PharmCo and provide valuable resources and capabilities when required. For AppTech
Ltd, PharSol Ltd and Syne Ltd, PharmCo would like to invest to improve collaboration
through supplier development and supply chain integration because their strong resource
positions showed that they could contribute to PharmCo’s future development. PharmCo
evaluated the outsourcees according to “forward-looking” firm level resources and
capabilities, which determined its relationship management method.
PharmCo adopted a partial integrated relationship with PharSol Ltd and Syne Ltd.
Compared with AppTech Ltd, they had fewer collaboration experiences and lower transaction
value. Good cooperation experiences indicated that PharmCo and AppTech Ltd were
familiar with each other through historical associations, rather than immediate task
requirements. Collaboration is a process of trial, feedback, and adjustment (Teece et al.,
1997). The current relationship is shaped by the difficult-to-replicate experiences between
organizations, especially for geographically diversified networks (Teece, 2007). History
matters because it helps a company identify externalities, supporting infrastructure,
14
complementarities among resources, and “technical” and “evolutionary” fitness (Teece et al.,
1997; Teece, 2007). An integrated relationship is path dependent because past experiences
allow a company to develop co-specific assets with the partners, which demand a long time to
build (Li et al., 2008). Syne Ltd and PharSol Ltd were relative newcomers, and not fully
tested. PharmCo hesitated to fully integrate with them without first taking time to build a
relationship (Prahinski and Benton, 2004). Hence, the partial integrated relationship became
a good choice for PharSol Ltd and Syne Ltd.
AppTech Ltd had better communication processes with PharmCo compared with the
other CRMOs. Through communications, PharmCo could not only monitor AppTech’s task
execution but also develop a good understanding about the complementarities of the
resources and capabilities and the compatibility of organizational culture. Communications
represent a unique form of competence that facilitates cooperation, solves conflicts, and
reduces the barriers in knowledge transfer between partners (Lager and Frishammar, 2010).
Poor communications have been viewed as a prime cause of supplier problems (Modi and
Mabert, 2007). Lack of consistency and poor data quality, as well as the global nature of
suppliers, have been identified as key issues in pharmaceutical supply chains (Meijboom et
al., 2011). Moreover, integration and coordination of information flows between partners can
fulfil the requirements for co-development and external competence acquisition (De Vries
and Huijsman, 2011). Communications enabled AppTech Ltd and PharmCo to build social
capitals that are critical for long-term integrated relationships and knowledge dissemination
and absorption.

6. Discussion and managerial implications

The pharmaceutical industry is experiencing a fast changing and challenging phase
(De Vries and Huijsman, 2011; Nepal et al., 2011). The increased pace of globalization has
necessitated many pharmaceutical companies to restructure their supply chains through
outsourcing R&D, manufacturing, and distribution to a network of capability-based partners
(PricewaterhouseCoopers, 2011). Capitalisation of external expertise and specialist know-
how enhances companies’ propensity to develop and produce drugs with shorter time-to-
market and lower costs. In essence, they are becoming network integrators and co-developing
products with increased support and reliance from different CRMOs (Pawar et al., 2009).
Further support for this viewpoint comes from Chen and Hung (2010), who argued that
outsourcing in the pharmaceutical industry is increasingly becoming strategic at global level,
and knowledge intensive. Our study indicates that a pharmaceutical company will manage its
15
CRMOs through building either an integrated relationship or a transactional relationship,
depending on partners’ DC.
The increased reliance on network partners’ capability also poses many risks due to
suppliers’ failure to meet the changing and demanding requirements of buyers. Pawar et al.
(2004) claimed that a high percentage of outsourcing relationships end in failure due to
factors such as selecting outsourcing partners based solely on cost, failing to consider a
location’s security and/or risk status, inadequate planning and “expectation management”,
inappropriate communication channels and poor transition management. Hence, the key
challenge faced by the outsourcers is how to evaluate multiple outsourcees at the strategic
level to fully leverage their capabilities and resources. The evaluation of suppliers in foreign
countries is of utmost importance because it involves a large number of closely inter-related
decisions regarding finance, negotiation, distribution, procurement, discovery and
development, and product quality assurance at the source. Our analysis reveals that a
pharmaceutical company will use CRMOs’ DC (i.e. processes, positions, and paths) as the
key criteria when evaluating strategic outsourcing relationships and selecting partners.
This study indicates that a company only integrates with those CRMOs with high DC.
In particular, if a CRMO has good communication processes, good past experiences, and
strong resources and market capabilities, a company will adopt an integrated relationship in
outsourcing. Good project deliverables and accuracy of costs will lead to an outsourcing
relationship, but the outsourcer might only collaborate with the outsourcee in a limited way.
Having a good performance on operational capability ensures the partner can deliver project
outputs according to the original plan and budget and that no additional resources are
required, making a CRMO an order qualifier. However, an integrated relationship requires
long-term commitment and co-development. Such outsourcing emphasizes relational
exchange and the focus is towards sourcing capabilities rather than short-term project
performance, which requires a company to build a network of competence to deal with
complexities, risks, and new challenges in the environment. Operational capabilities, which
are critical for transactional exchanges, do not guarantee that a CRMO will co-evolve with
the company and tackle market uncertainties. Therefore, we develop the following
propositions:
P1: If a supplier has good operational capabilities in terms of project deliverables
and accuracy of costs, a company will establish an outsourcing relationship with the
supplier.
P2: If a supplier has good DC in terms of processes, positions and paths, a company
16
 will establish an integrated outsourcing relationship with the supplier.
Theoretically, we contribute to the DC literature by conceptualizing DC as a
multidimensional construct and empirically illustrating how to measure it based on evidence
from the pharmaceutical industry, which can be used in future large scale surveys. This fills
the gaps exposed in previous studies. For example, Pavlou and El Sawy (2011) argued that
DC has been described mostly as an abstract concept, which makes it difficult to study how it
can be used in actionable managerial decision making. Second, we contribute to the
outsourcing literature by exploring the effects of a supplier’s capabilities on outsourcing
relationship management. Our analysis indicates that operational capabilities provide a
foundation for an outsourcing relationship and DC leads to integrated relationships, which
suggests that a cumulative model should be used in outsourcing research (Flynn and Flynn,
2004). Third, our study shows that a company can successfully pursue both strategic and
operational outsourcing simultaneously by applying different supplier evaluation criteria and
relationship management methods. Hence, a company can source new external knowledge
and resources and reduce operational costs at the same time, which provides a way to tackle
the potential negative consequences associated with outsourcing.
Findings from this study also provide guidelines for manufacturers to direct their
managerial decisions and actions with regard to evaluating strategic partners and managing
outsourcing relationships. First, managers should evaluate the outsourcing partners’
capabilities and resources rather than operational performance (e.g. quality, delivery, and
price). Strategic outsourcing requires long-term commitments for the evolution of
organizational processes and routines, and capability formation. Managers should note that a
partner that has high operational capability might not be able to provide the resources to
tackle uncertainties and co-develop with them. Hence, manufacturers should establish
multiple assessment criteria that include more than operational performance, such as human
capital, communication capability, and market capability; this will help the company identify
partners that have complementary resources and competencies for future development.
Second, we suggest managers devote increased effort and resources to better integrate with
suppliers that have good communication processes and collaboration experiences. Only
through intensive and regular communications can an outsourcer acquire knowledge about
partners’ ability to execute tasks, the complementarities of the resources and capabilities and
the compatibility of organizational culture. Past experiences also enable an outsourcer to
build a supplier network operating in a state of continuous indebtedness and mutual
obligations between partners. Third, we recommend that suppliers focus on the co-alignment
17
and inter-relatedness of the key parameters of DC and take a holistic perspective on DC to
exploit the synergetic effects among different dimensions.

7. Conclusions
This study uses exploratory multiple case studies to investigate how a pharmaceutical
company evaluates its CRMOs, and argues that a company outsources its R&D and
manufacturing to a partner with high operational capability, but only develops integrated
outsourcing relationships with those that possess high DC in terms of processes (project
deliverables, communication, and accuracy of costs), positions (financial assets, number of
scientists, spectrum of services, and geographical presence), and paths (past experiences).
Such CRMOs can not only deal with environmental uncertainties but also co-develop with
the company. Pharmaceutical companies are sourcing for CRMOs’ DC in order to develop
sustainable competitive advantage.
This study has limitations due to its reliance on the method of exploratory multiple
case study, and these limitations open up avenues for future research. Follow-up investigation
through confirmatory studies, such as large scale surveys, can be conducted to validate and
generalize the findings. Second, the present study does not consider the impact of business
environments, such as uncertainty and competitiveness, on the outsourcee evaluation and
outsourcing relationship management. Future studies may investigate how environmental
contingencies moderate the effects of DC on relationship management. Third, Sinha and
Kohnke (2009) proposed a supply chain-centric view of health care and emphasized the
interdependences among CRMOs, pharmaceutical companies, hospitals, pharmacies, and
patients. Hence, how to facilitate the collaboration among different stakeholders in the
healthcare supply chain to provide a care bundle, including goods, services, and experiences,
is a very interesting topic.

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Appendix I Research Protocol

1. Outsourcing
1) What actitivies and operations does the company outsouce?
2) Describe the company's supply chain management practices in detail.

21
 3) What roles do the suppliers play in the company's value chain?
4) Are the suppliers able to provide new knowledge and capabilities that are critical for the
company's development?
5) What is the nature of the collaborative efforts between the company and suppliers?
6) Describe the relationships between the company and the suppliers.

2. Supplier evaluation
1) Describe the supplier evaluation process in detail and who is involved in this process.
2) What criteria are used for supplier evaluation?
3) How does the company measure supplier performance and judge their capabilities?
4) What kind of suppliers will the company select to build a close relationship with?
5) How does the company improve its supply chain according to evaluation results?

3. Dynamic capability
1) Are the suppliers able to help the company deal with the changing business enviroment?
2) Are the suppliers able to fulfil the company's new requirements quickly and efficiently?
3) How does the company evaluate supplier operational performance and project
deliverables?
4) How does the company evaluate supplier current specific endowments and assets?
5) How does the company evaluate the past collaboration experiences with the suppliers?

Appendix II Evaluation criteria for the CRMOs’ processes

------------------------------
Table 3 about here
-------------------------------

These general criteria will be operationalized into more detailed measurements

according to the context. For example, in assessing on time delivery for a three month project,
if a CRMO finishes the project 14 days early, it is very good. Good performance means on
time delivery. A 14 day delay is viewed as average. Poor performance means a 28 day delay.
If a CRMO delays for more than 56 days, its performance will be appraised as very poor.
When assessing the quality and quantity, if a CRMO can not only meet the target but also
deal with contingencies (e.g. 20% volume change), it will be viewed as very good. Good
quantity means a CRMO can meet the target. A CRMO’s process is average if it fulfils 90%
of target. Poor performance implies that 70% of the target can be satisfied. A CRMO’s
processes will be evaluated as very poor if it only meets 50% or less of the target.

Appendix III Evaluation criteria for CRMOs' geographical presence and spectrum of
services
------------------------------
Table 4 about here
-------------------------------

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