Biopharma, medtech and other life sciences companies frequently leverage third-party partners to help produce and commercialize their products. This strategy is often an integral part of a business’ ongoing operations and vital to its profitability; however, while there are many benefits related to these relationships, there are risks that also should be weighed. In particular, risks associated with monetary contract compliance are especially important as failure to properly oversee these agreements could mean costly contractual missteps and lost profits. To uncover these risk areas, a comprehensive contract compliance audit should be completed on existing contracts to ensure optimal compliance.
In the following Q and A, RSM’s Nate Ruey, an RSM risk consulting partner, shares his insights on important areas to focus on related to the third-party contract compliance audit.
Why are third-party vendor royalty audits important, especially for businesses in the life sciences industry?
Life sciences companies excel at innovation, but frequently require a third party to help realize the commercialization, production and distribution of their final products. These key relationships are often bound by mutually agreed upon contracts to ensure adherence to variable revenue and expense structures. These agreements regularly include a right-to-audit clause within the contract. As part of an organization’s third-party risk management plan, it’s important for life sciences businesses to monitor the third-party obligations and exercise that right to ensure that contractual agreements are being met. Failure to do so could translate into thousands or even millions of additional dollars lost due to mathematical errors, misinterpretation of agreement language, new or missing products not appropriately reported, or sometimes, unfortunately, intentional understatement.
What are key triggers to prompt a contract compliance audit?
If over time you realize your life sciences business isn’t receiving regular payments from your third party or appears to be overbilled, there are irregularities or deviations from expectations, the payments are consistently late or the amounts received are decreasing, these are significant triggers to conduct a contract compliance audit. Other concern areas that might warrant an audit could include:
- Establishing a new agreement with a new third-party partner to ensure they are correctly interpreting the contract
- Undergoing an acquisition, either on your business’ end or your third party’s end
- Ending an agreement with an existing third-party partner and closing out the relationship
- Development of new products or sizes and types of existing products
- Producing or selling products in international markets
- Your third party uses additional parties or affiliates, such as sub-licensees or distributors, to market and or sell licensed products
While these instances above may trigger the need for an audit and subsequent contract alignment, it’s ideal to be proactive with your oversight of existing third-party partners rather than reactive to a certain event. Scheduling periodic audits is ideal, but varies with your business’ risk appetite and the unique conditions you have with your third party; however, conducting an audit every one to three years is common in today’s complex life sciences business environment.
When selecting a contract compliance audit provider, what key characteristics should a life sciences business look for?
Obviously life sciences companies should look for audit experience among their potential audit providers, along with demonstrated knowledge of the contractual language and mechanics of a third-party relationship. Also, does your potential provider have references and a proven record of identifying non-compliance in a majority of their investigations? In addition, providers who have in-depth knowledge of the life sciences industry is essential, as these professionals can anticipate and pinpoint risk areas unique to the industry. Providers who also have an international reach within their service offerings is key as today’s business is frequently a global company. Knowledge of international customs, business practices, culture and language are all-important. And, finally, does your potential partner understand and appreciate the strategic relationship of your partner? Audits are a point in time in the relationship to ensure the third party is meeting the terms and conditions of the agreement; however, the relationship will continue after the audit.
What are the advantages of a supplier, distributor, commercialization and royalty audits?
The benefits of an audit are often monetary as financial recoveries are identified during the process. This can mean millions of dollars for some companies. While this is key, having regularly scheduled audits with your third party also induces future compliance and alignment with your company. Quite simply, it’s good business practice to conduct an audit; it can provide peace of mind that your third party is adhering to the contract’s terms and conditions.