Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report.

Jim Miller

The business press in May was dominated by Europe's sovereign debt crisis and its implications for the survival of the Euro as the common European currency. The crisis began in Greece, but the great fear was that it would rapidly spread to Spain and Portugal, and quite possibly to Ireland and Italy. Even the UK, though not a Euro country, was viewed to be at some risk of default on its sovereign debt.  

While the immediate nature of the crisis is financial and monetary, the efforts to remedy it will ultimately strike the bio/pharmaceutical industry. To ultimately resolve the crisis and prevent it from spreading further, the individual Euro zone countries must attack the underlying cause of the problem — excessive government spending on social programmes financed by uncontrolled government borrowing. This, however, will require acts of political resolve and courage that few political parties in any country (including the US) have ever demonstrated. 

European pharmaceutical sales likely to decline

As European governments begin to focus on their fiscal profligacy, spending on healthcare generally — and bio/pharmaceuticals in particular — will come under close scrutiny. In most European countries, healthcare accounts for 15% of public spending and has been growing faster than most budget items (

Table 1: Health expenditures in major European countries.1			

Government-run programmes account for 75% of all healthcare expenditures in Europe and at least 70% of pharmaceuticals purchased there, according to data from the OECD.

  So as European governments make drastic cuts in public expenditures to bring down deficits and reduce sovereign debt, spending on healthcare and bio/pharmaceuticals will probably be a major target. 

The decrease in pharmaceutical spending is likely to come about in several ways: 					

. The countries with some of the biggest problems also have some of the lowest generic penetration. For instance, in the market for off-patent drugs, generics account for just 41% of pharmaceutical unit volume in Spain, and 40% of unit volume in Italy, according to IMS Health.

  By contrast, generics account for 75% of unit volume in Germany and 71% in the UK. As a reference point, generic penetration in the US is 89% of unit volume. IMS Health estimates that increased use of generics by the 27 member states of the EU could generate annual savings of €30 billion. 

Lower prices for branded and generic products

. Government agencies set prices for bio/pharmaceuticals in most European countries and we may see aggressive price-cutting as governments try to reduce expenditures. Spain and Greece have already announced plans to reduce prices for generic drugs by 25% while Germany has announced 10% cuts. European drug prices are already well below US drug prices — as much as 60% below US prices in many countries. 

. Government agencies could make it more difficult for new drugs to get reimbursement eligibility, especially expensive new biopharmaceuticals. For example, NICE, the agency responsible for allowing coverage of new drugs in the UK, has put severe limits on the conditions under which the government will pay for expensive therapies for oncology and autoimmune conditions. 

The reduction in government spending on healthcare and bio/pharmaceuticals will not be the only negative factor weighing on the industry; across the board, government spending cuts and tax increases aimed at reducing deficits will have a depressing effect on European economies for several years, which probably means that private healthcare expenditures will also decrease for a few years. 

CMOs will feel the effects of reduced healthcare expenditures in the form of fewer batches and smaller batches, and pressure from clients to reduce prices. This will be especially difficult for European CMOs, which must already compete in a market saturated with capacity and widespread price-cutting.  

However, there may be some positive outcomes for European CMOs. EU CMOs typically have a significant amount of generics in their product mix and may be able to offset reduced demand for branded products with increased orders for those generic products. Unfortunately, if the pressure on drug prices is too severe it could lead to generics being imported from Asia rather than being domestically-produced, delivering a double blow to European CMOs. 

Another issue for European CMOs is the decline in the value of the Euro relative to the US dollar. The Euro has weakened considerably in 2010 relative to the US dollar, dropping to a 2year low in early May. The €750 billion bailout package approved by the European Central Bank (ECB), International Monetary Fund (IMF) and EU members in midMay stabilised the exchange rate, but the likelihood of a recession following the expected spending cuts could keep the exchange rate down for several years. 

A lower US dollar/Euro exchange rate should be a positive development for the European CMOs and CROs because it will increase their competitiveness relative to their US counterparts — the cost in dollar terms of services priced in Euros is already 15% lower than they were just 6 months ago. Development services that span a relatively short timeframe and that are not subject to the long-term currency risk of commercial manufacturing contracts should benefit from the currency depreciation, even if it is short lived.  

European CMOs may be positioned to benefit from a medium to longterm Euro decline because many have been building their North American sales presence in recent years to find relief from the intenselycompetitive European market. Because of the local market conditions, the European CMOs are more accustomed to competing on price than the North American CMOs and the cheaper Euro could make their case stronger. Some European CMOs have been able to command a price premium even with a strong Euro and they will look even more attractive with a weak Euro. 

The sovereign debt crisis has blown up just as the contract services market appeared to be emerging from the slump induced by the financial crisis that began in 2008. This latest crisis promises to make the nearterm prospects of the industry more uncertain. Perhaps the ECBIMFEU stabilisation plan announced in May will instill enough confidence in EU financial markets to allow the market improvement to continue; however, there are major forces at work that may not be entirely in the control of governments and international institutions, let alone individual companies. Only time will tell how things will play out. 

is President of PharmSource and a member of 

2. Generic Medicines: Essential contributors to the long-term health of society

Europe's sovereign debt crisis will ultimately strike the bio/pharmaceutical industry as governments seek to reduce healthcare expenditure.					

the increased use of lowerpriced generics as well as certain more expensive drugs being excluded from national health services. 					

Although CMOs will feel the impact of the new crisis, they may be able to offset the shrinking demand for branded products with increased orders for generics.					

 European CMOs with a North American sales presence will be in a strong position compared with their North American competitors because they are more accustomed to price competition. 

Articles

Having barely begun recovering from the economic slump that began in 2008, the contract services industry must now face the consequences of the debt crisis in Europe, which will include reduced bio/pharmaceutical expenditure by governments.

EU debt crisis adds uncertainty for contract services

After Moses led the Israelites out of Egypt, he faced a tough challenge: how to transform a people living as slaves among idol worshippers into a free people believing in one god. His solution to the challenge was pretty extreme: he marched his followers around the Sinai Desert for 40 years until those who had been slaves in Egypt died off and only people who had known freedom entered the Promised Land.

Chief executives at global bio/pharmaceutical companies face a challenge similar to that faced by Moses 2500 years ago: how to transform a deeply engrained corporate culture characterized by high costs and slow decision-making into a culture valuing speed and flexibility. Of course, CEOs don't have the luxury of waiting 40 years for a turnaround, but the efforts at most companies seem to be pretty tepid relative to the problem. Acquisitions and reorganizations address part of the global bio/pharmaceutical companies' problems, but they do little to transform those companies' bloated, slow-moving bureaucracies.  

One company that seems to understand that these times call for bold solutions is Eli Lilly (Indianapolis, IN). During the past two years, Lilly has established a number of strategic sourcing relationships that simultaneously have reduced its fixed cost structure while giving it access to best-in-class development and manufacturing services. 

The largest of those strategic relationships was the long-term deal with Covance (Princeton, NJ) announced in August 2008. Covance received a 10-year contract worth a minimum of $1.6 billion to provide a package of services, including most of Lilly' toxicology and central laboratory requirements. As part of the deal, Covance acquired Lilly's 450-acre campus in Greenfield, Indiana, outside of Indianapolis, with its 600,000-ft

  facility housing toxicology and bioanalytical laboratories. Covance took on most of the 265 Lilly employees working at the site. 

Most recently, Lilly announced a strategic deal with Fisher Clinical Services, a unit of Thermo Fisher Scientific (Waltham, MA), for manufacturing, packaging, labeling, and distribution of clinical-trial materials (CTM). Under the agreement, Fisher Clinical will assume responsibility for the CTM operations at Lilly Technology Center in Indianapolis and will purchase Lilly's manufacturing and packaging equipment. Staff of Lilly's CTM operations will be given the opportunity to apply for positions with Fisher Clinical Services. 

The Covance and Fisher Clinical deals are notable for their size and scope. Lilly, however, also has put into place other strategic deals for a variety of services in discovery, clinical research, and manufacturing (see Table I). 

 Table I: Eli Lillys strategic sourcing relationships.

Lilly has been forced to deal with circumstances of looming patent expirations and late-stage clinical failures that are particularly dire even by Big Pharma standards. It has responded by coming up with some of the most innovative drug-development and restructuring initiatives yet seen in the industry. 

One of those initiatives is its FIPNet (fully integrated pharmaceutical network) strategy. Under FIPNet, Lilly is partnering with service providers with which it has gained extensive experience and which have proven that they can perform key functions more quickly and cost-effectively than Lilly has been able to perform them in-house. The Covance, Fisher Clinical,  and other strategic sourcing arrangements shown in Table I are part of the FIPNet strategy. 

Another noteworthy initiative has been Chorus, Lilly's effort to do a better job of qualifying potential drug candidates and reducing the costs associated with late-stage clinical failures. Originally established as an experimental business unit focused on selected discovery candidates, Chorus completely rethought the process by which drug candidates are screened and selected for further development and devised an entirely new set of experiments to determine the drug potential of compounds identified in the discovery process. The Chorus program has been so successful that it has been expanded to encompass more compounds through the early-development process and is participating in a novel new venture with a private equity firm to develop new drug candidates. 

FIPNet and Chorus are a long way from the traditional vertically integrated and paternalistic culture of what was once described to me as "the Lilly Way." Desperate times call for desperate measures, but those desperate measures may be the innovations that Lilly and other global bio/pharmaceutical companies need in an increasingly challenging environment.  

 is president of PharmSource Information Services, Inc., and publisher of 

Eli Lilly faces up to the new realities of the bio/pharmaceutical industry through outsourcing.

The Lilly Way

One company that seems to understand that these times call for bold solutions is Eli Lilly (Indianapolis, IN). During the past two years, Lilly has established a number of strategic sourcing relationships that simultaneously have reduced its fixed cost structure while giving it access to best-in-class development and manufacturing services.			

After Moses led the Israelites out of Egypt, he faced a tough challenge: how to transform a people living as slaves among idol worshippers into a free people believing in one god. His solution to the challenge was pretty extreme: he marched his followers around the Sinai Desert for 40 years until those who had been slaves in Egypt died off and only people who had known freedom entered the Promised Land.   

Chief executives at the global bio/pharmaceutical companies face a challenge similar to that faced by Moses 2 500 years ago: how to transform a deeply engrained corporate culture characterised by high costs and slow decision-making into a culture valuing speed and flexibility. Of course, CEOs don't have the luxury of waiting 40 years for a turnaround, but the efforts at most companies seem to be pretty tepid relative to the problem. Acquisitions and reorganisations address part of global bio/pharma's problems, but they do little to transform their bloated, slow-moving bureaucracies.  

One company that seems to understand that these times call for bold solutions is Eli Lilly and Company. Over the last two years, Lilly has established a number of strategic sourcing relationships that simultaneously have reduced its fixed cost structure while giving it access to best-in-class development and manufacturing services. 

The largest and biggest of those strategic relationships was the long-term deal with Covance, first announced in August 2008. Covance received a 10-year contract worth a minimum of $1.6 billion to provide a package of toxicology, clinical pharmacology (Phase I), Phase II–IV clinical research and central laboratory services. As part of the deal, Covance acquired Lilly's 450acre campus in Greenfield (IN, USA) outside of Indianapolis, with its 600000 square foot housing toxicology and bioanalytical labs. Covance took on most of the 265 Lilly employees working at the site. 

Most recently, Lilly announced a strategic deal with Fisher Clinical Services, a unit of Thermo Fisher scientific, for manufacturing, packaging, labelling and distribution of clinical trial materials (CTM). Under the agreement, Fisher Clinical will assume responsibility for the CTM operations at Lilly Technology Center in Indianapolis, and will purchase Lilly's manufacturing and packaging equipment. Staff of Lilly's CTM operations will be given the opportunity to apply for positions with Fisher Clinical Services. 

The Covance and Fisher Clinical deals are notable for their size and scope, but Lilly also has put into place other strategic deals for a variety of services in discovery, clinical research and manufacturing (

Table 1: Lilly strategic sourcing relationships. 

Lilly has been forced to deal with circumstances of looming patent expirations and late stage clinical failures that are particularly dire even by Big Pharma standards. It has responded by coming up with some of the most innovative drug development and restructuring initiatives yet seen in the industry. 

One of those initiatives is its FIPNet — fully integrated pharmaceutical network — strategy. Under FIPNet, Lilly is partnering with service providers with which it has gained extensive experience and which have proven that they can perform key functions more quickly and costeffectively than Lilly has been able to perform them inhouse. The Covance, Fisher Clinical and other strategic sourcing arrangements shown in the table are part of the FIPNet strategy. 

Another noteworthy initiative has been Chorus, Lilly's effort to perform a better job of qualifying potential drug candidates and reducing the costs associated with late stage clinical failures. Originally established as an experimental business unit focused on selected discovery candidates, Chorus completely re-thought the process by which drug candidates are screened and selected for further development, and devised an entirely new set of experiments to determine the drug potential of compounds identified in the discovery process. The Chorus concept has been so successful that it has been expanded to encompass more compounds through the early development process, and is participating in a novel new venture with a private equity firm to develop new drug candidates. 

FIPNet and Chorus are long way from the traditional verticallyintegrated and paternalistic culture of what was once described to me as "the Lilly way." Desperate times call for desperate measures, but those desperate measures may be the innovations that Lilly and other global bio/pharmaceutical companies need in an increasingly challenging environment.  

Lilly faces up to the new realities of the bio/pharmaceutical industry by embracing outsourcing.

Ever since the contract manufacturing industry began to take off in the late 1990s, it has hailed itself as a great savior to the pharmaceutical and biopharmaceutical industries. Contract manufacturing organizations (CMOs) set out to enable companies to reduce capital expenditures, lower costs, and access new technologies, while unburdening them of facilities they no longer needed.  

Looking back over the past 10 years, the industry has achieved much of what it promised. CMOs have proven to be a desirable and dependable option for small and mid-size pharmaceutical and biopharmaceutical companies, and they have taken a lot of redundant facilities off the hands of larger companies. The major drug companies have not fully endorsed CMOs as an option, however, and they continue to build new capacity, especially for manufacturing dose forms and biologics. Contractors manufacture less than 20% of newly approved drugs for the global pharmaceutical companies, according to a recent PharmSource analysis. 

Furthermore, CMOs have  not been financially successful businesses. Except for a few standout performers with unique capabilities, most CMOs have been marginally profitable at best, generating barely enough cash flow to maintain their equipment.  

Contractors' performance has exposed a fundamental flaw in the business concept. CMOs haven't really changed the manufacturing model that has been predominant in the pharmaceutical and biopharmaceutical industries during the past 50 years; they've simply adapted it to a fee-for-service payment arrangement. As a result, they have inherited the problems of the traditional pharmaceutical manufacturing model, namely, high fixed costs, too much capacity, low utilization, and the high risk of product failure. 

The capital intensiveness of manufacturing makes it a high-fixed-cost business, and the special needs of complying with good manufacturing practice (GMP) drive those costs even higher. Meanwhile, the primary reason for the CMO industry's growth—the desire of the major pharmaceutical and biopharmaceutical companies to shed redundant manufacturing sites at any cost—exacerbates the overcapacity problem by keeping capacity in the market that should rightfully be shuttered. Ultimately, high fixed costs and overcapacity lead to price wars as companies compete to get any business they can to help cover their fixed costs. 

For the CMO industry, reducing overall capacity is critical, but consolidation isn't likely to occur soon. The problem seems destined to get worse as the global biopharmaceutical companies go through successive rounds of facility divestitures and European governments continue to force or assist unprofitable facilities to stay open. 

Reducing fixed costs could help many CMOs, but that is easier said than done. Multiproduct facilities require various processing capabilities, guaranteeing that much of their capacity will not be used at any one time. Organizing manufacturing networks into "centers of excellence" that each specialize in a single dosage form could reduce complexity and improve utilization. However, the costs of transferring products between facilities in a GMP regulatory environment are prohibitively high, thus making it difficult to implement such a strategy in the near term.  

CMO executives could help by resisting the urge to invest in capabilities they don't currently have but that are occasionally requested by clients. For instance, many CMO executives in the injectable segment are aching to invest in new prefilled-syringe capacity despite ample evidence of sufficient capacity, and an incipient price war, in the market. 

Looking ahead, CMOs need to find ways to reduce the risk they face from product failures during clinical development and from the underperformance of approved products once they reach the market. The most obvious defensive measure CMOs can take is to sign multiple candidates for each capacity slot they have available. Given the likelihood that a new product candidate will fail, CMOs need to sign two or three of them for every available capacity slot.  

As pharmaceutical and biopharmaceutical companies pursue a lean business model, they are increasingly clear about what they need from manufacturers: low prices, flexible capacity, and reliable supply. CMO executives need to examine their current business models closely and determine what it will take for them to meet those requirements while ensuring a return for their investors.  

CMOs' business model has all of the flaws of the captive model it is meant to replace.