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

Jim Miller

Outsourcing Survey, the results of which are published in this month's Outsourcing Resources supplement, paints a bright picture for providers of formulation, analytical, and clinical trial manufacturing services. Nearly two-thirds of service providers surveyed say they expect revenues to grow by 10% or more in 2008, and they expect 2009 to be just as promising.

As optimistic as this outlook is, it pales beside the effervescent outlook of the clinical-research contract research organizations (CROs). In an informal PharmSource survey of exhibitors at the 2008 Drug Information Association (DIA) annual meeting held in Boston in June, 88% of clinical CROs surveyed said they expect 20% growth over last year. Respondents credited a growing number of studies as a principal factor, driven by downsizing at major pharmaceutical companies and the growth of trials in emerging markets. Respondents also emphasized the expansion of their own capabilities to meet that demand.

The greater expectations of the clinical CROs reflect the fact that outsourcing of clinical research activities has always outpaced outsourcing of chemistry, manufacturing, and control (CMC) functions. We're not entirely sure why that is, but we believe three factors are at work. First, CMC services involve fixed assets (laboratories and facilities), which are difficult and costly to shut down. Clinical research, on the other hand, involves mostly labor and information technology, which are easier to shed in favor of contract service providers. Second, CMC development often involves developing intellectual property (IP) whereas clinical research activities are less likely to expose IP to potential competitors and are more about operational effectiveness. Third, the need to access patient populations globally to recruit sufficient numbers of subjects, reduce costs, and support global regulatory submissions encourages use of clinical CROs.

JASON REED AND IGOR KOPELNITSKY/GETTY IMAGES

Clinical-research CROs do, however, face several challenges. For starters, recruiting and retaining qualified staff is a real challenge today, especially for qualified scientific and technical professionals. Competition is driving up compensation costs, even with the hiring pool being deepened by professionals leaving pharmaceutical companies. In addition, many companies are concerned about meeting client demands and timelines. Patient-recruitment requirements, investigator needs, and site and study logistics require increasingly sophisticated management and planning. Competition was the third most frequently listed challenge for companies. Respondents cited the need to be flexible in responding to the market, and the importance of keeping costs competitive. Almost 68% of respondents plan to increase resource allocations to sales and marketing.

A recent survey of research and development (R&D) and outsourcing professionals by Jefferies & Company indicates that market conditions are highly favorable for continued growth in the clinical research sector. The survey found that R&D spending is expected to grow at a faster pace in coming years than it has in recent years, with the fastest growth in late-stage development (Phase IIb and Phase III). This undoubtedly reflects the maturing of the pipeline as rapid growth in early-phase compounds yields more late-stage candidates.

Jefferies' respondents expect the fastest growth in outsourced spend to be in early development, including preclinical toxicology and Phase I clinical testing. This reflects a growing reliance on early-phase testing to demonstrate proof-of-concept as a means of controlling R&D costs and identifying candidates likely to fail earlier in the development process.

Respondents to the Jefferies survey also expect more offshoring of clinical research activities, with a focus on data management and use of clinical sites in emerging markets. In fact, they expect the share of R&D budgets spent outside North America and Europe to almost double, from 29% in 2008 to 54% by 2011. For this to happen, however, they must overcome a variety of obstacles including IP protection, communication problems, and cultural differences.

There are already signs that outsourcing of development services for clinical-trial materials is headed in the same direction as clinical research. It may pay for nonclinical outsourcing professionals to "look over the wall" at what their clinical counterparts are doing.

 is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, 

Articles

CMC service providers are doing well, but clinical and preclinical CROs are doing even better.

Clinical Outsourcing Steams Ahead

 If the respondents to this year's PharmSource—

Outsourcing Survey are right, 2008 is shaping up to be another strong year for the contract services industry and another big step in the remaking of the biopharmaceutical/pharmaceutical business model. However, the coming months are likely to be more difficult for contract service providers than have the past three years. 

Chad Baker, Thomas Northcut, Tom Grill/Getty Images 

Industry trends in 2008 as reported by our respondents (see sidebar, "Respondents profile") are very similar to what we found in 2007. Nearly 45% of bio/pharma company respondents expect their spending on contract services to increase by 10% or more in 2008, about the same as in 2007 (see Figure 1). More than a quarter of these buy-side respondents say their contract services spend is growing faster than total spending in their functional area, but an equal number said spending is growing at a slower rate than total spend (see Figure 2). Still, respondents indicate that more activity is being outsourced than in past years: 42% say one quarter or more of the work in their functional area is being outsourced, up from 35% in 2007 (see Figure 3). Responses indicate that the rate of growth in outsourcing spend is slower at mid-size and generic bio/pharma companies than it is at large and small bio/pharma companies.    

Responses from contract service providers reflect the optimism inherent in the buy-side responses. More than 65% of contractor respondents say they expect their revenues to increase by 10% or more in 2008, including a big jump in the number expecting growth of 20% or better (see Figure 4). Small bio/pharma companies are the most common source of new business for service providers, with 43% of contractor respondents citing them as their fastest growing segment. All market segments are contributing to contractor growth: 19% say Big Pharma is their fastest growing segment, 13% cite specialty pharma, and 17% say all segments are growing about the same. 

Although major pharmaceutical companies aren't the fastest growing segment for most service providers, they are critical to the financial health of nearly all of them. Among contractor respondents, 38% say half or more of their revenue comes from Big Pharma, and another quarter say Big Pharma accounts for 25–49% of their revenue. 

Survey responses indicate that bio/pharma companies are more open to using new vendors than they have been in recent years. In the 2008 survey, 43% of respondents said they are consolidating their vendor base or have plans to do so in the next two years; this statistic is down sharply from 57% in the 2007 outsourcing survey. One quarter of 2008 respondents say they have no plans to increase or consolidate their vendor base.  

The results suggest more companies are looking for new vendors than in past years. In the 2008 survey, nearly 45% of respondents said their company is actively looking for new vendors; that number is up sharply from the 30% that were looking for new vendors in 2007 (see Figure 5). In last year's survey, it was more common for respondents to be looking for new contractors just to replace those they were already working with, or for special needs. 

Service providers seem to be aggressive about responding to these new opportunities. Nearly 30% of respondents from contract research and contract manufacturing organizations (CMOs and CROs) say proposals to new clients account for half or more of their new proposal activity, and just under half say that 25–50% of new bids are going to prospective new clients (see Figure 6). Competition for new business seems to be intense. Nearly 85% of bio/pharma respondents say vendors are actively looking for new business, up from 70% in 2007 (see Figure 7). Further, half of those 85% say they see vendors as willing to cut prices to get new business.  

In another sign of intense competition, both bio/pharma and contractor respondents say there are typically three to five bids submitted per new request for proposal. One more sign of intensifying competition: Half of respondents indicated that their sales and marketing expenditures will increase by 10% or more in 2009. That's the biggest jump we have seen in several years. 

The big jump in openness to new vendor relationships is no doubt related to growth in spending on outsourced projects. At the same time, however, it may reflect issues with the vendor base itself, especially concerning capacity and performance. 

As in past years, service providers are equally divided on whether limited capacity is impeding their ability to take on new business. Among the half that feel capacity-constrained, the biggest factors holding back growth are access to investment capital, recruiting new staff, and organizations' ability to manage growth. This is the first time in the history of the survey that investment capital has been identified as a significant problem for contractors, and undoubtedly reflects the reduced availability of investment capital in the general economy. The limited management capacity to support growth, which also came up in last year's survey, probably reflects the high percentage of responses coming from small CMOs and CROs, where management ranks are usually thin. 

Performance expectations could be another reason that bio/pharma companies are actively looking for new vendors. This is the second year we have asked respondents to rate contractor performance in three key areas: technical and operational expertise, project management, and customer service. Once again, there are big differences in the way customers rate contractor performance and how service providers rate themselves. 

 As shown in Figure 8, service providers give themselves much higher marks for performance on the three performance dimensions than do their customers. This is not to say that bio/pharma respondents think the service providers are poor performers: 75% or more rate service provider performance as good or satisfactory in all three categories. For project management and customer service, 15% see contractor performance as just fair or poor. 

The survey results suggest that there is big gap between customer- and service-provider definitions of performance excellence. In fact, the requirements of different client types and their perceptions of contractors vary widely. Major bio/pharmaceutical companies have substantial in-house capabilities and experience and are less dependent on their service providers than small bio/pharmaceutical companies, which expect help in navigating the drug-development process and have a broad definition of what should be included in project management and customer service. Our survey results indicate that respondents from major bio/pharma companies have a higher regard for contractor performance than smaller companies, no doubt reflecting the latter's greater need for support. 

Although 2008 is shaping up to be another strong year, the outlook for 2009 is somewhat less clear. Certainly contract service providers are less optimistic: More than 30% expect next year's revenues to be similar to or less than this year's revenues. In the 2007 survey, only 20% expected 2008 revenue to be flat or down by comparison. On the other hand, bio/pharma company respondents expect continued healthy gains in their budgets in 2009, with 44% expecting budget increases of 10% or more. 

The concerns of contractor respondents probably reflect broader market factors of the current industry environment. The survey identified four key concerns (see Figure 9). 

Competition from providers in India and China.

 Just over half of respondents are in some phase of sourcing from China and/or India, whether they are actively sourcing there now, looking for vendors, or developing plans. That's about the same percentage as in the 2007 survey, but still significant. As might be expected, major pharmaceutical companies are most actively sourcing from Asia, while small bio/pharma companies are the least interested. The impact is especially being felt in manufacturing of chemical intermediates and active ingredients. 

 Capacity is a very legitimate concern for service providers. In our industry analyses, PharmSource has quantified significant overcapacity in commercial and clinical injectables manufacturing and biomanufacturing, and expects the problem exists throughout the industry. As described, contractors are typically competing against four other service providers for each contract, and the effort to establish new client relationships is intense.  

 The difficult investment climate in the general economy is affecting the bio/pharma sector. Financing from initial public offerings has practically disappeared and while venture capital funding in aggregate has remained level, it seems to be benefitting fewer companies. Early-stage companies depend on CROs and CMOs for development activities but need funding to pay for them. 

More major pharmaceutical companies are following the "proof of concept" development model long followed by early-stage companies. The model seeks to minimize expenditures on a drug candidate until basic safety and efficacy are established, usually by Phase IIA. As a result, companies are spending less on process, formulation, and analytical development services for early-phase candidates but more on the smaller number of candidates that make it to later development. Major pharmaceutical companies are also pushing on price as never before. 

Overall, the survey responses reflect what PharmSource has been hearing from frequent conversations with service providers and bio/pharma companies. The 2008 PharmSource–

 Outsourcing Survey draws a picture of an industry that is still growing robustly but could be facing a slowdown in the months ahead. Overall demand and market conditions will be the envy of other economic sectors, but service providers will to have work harder to achieve the kind of results they have become used to in recent years.  

Survey results indicate a healthy market, but increasing competition.

Industry Outlook: Mixed Signals Lead to a New Outsourcing Equation

In last month's column, I argued that the contract manufacturing business model was badly outdated. Most contract manufacturing organizations (CMOs) seem to be following strategies based on pharmaceutical industry conditions that no longer exist, including assumptions that unit volumes will grow, retail drug prices will rise, and major pharma companies will stop investing in manufacturing capacity and embrace outsourcing.  

The CMO business model is still based on selling capacity, but manufacturing capacity is really an undifferentiated commodity. The industry is facing an 

 problem. CMOs are building new capacity, Indian and Chinese companies are entering the market, and new companies are coming into the industry by buying Big Pharma's old facilities. In the absence of other differentiating elements, overcapacity drives down prices. 

CMOs need to find new business models and strategies that reflect these new realities. These realities include Big Pharma's growing emphasis on reducing costs and making costs more flexible, and the globalization of the industry from both the end-user market and sourcing perspectives. New strategies need to better differentiate CMOs from one another to cut down on price competition. This will pave the way for multiple models targeting different customer groups and needs.  

One emerging model likely to predominate in the industry will be the integrated-service offering provider, or the so-called contract development and manufacturing organization (CDMO). These organizations are especially suited to small and mid-size bio/pharmaceutical companies, which have more willingly embraced outsourcing of their value chain than the major companies. CDMOs provide a complete suite of services related to the physical product, from early process development to commercial manufacture. In addition to offering first-class technical expertise, these companies claim the ability to move products through development and commercialization quickly and cost-effectively. We are already seeing a number of companies emerge that are explicitly pursuing this strategy. 

For CMOs targeting major pharmaceutical companies, manufacturing and supply-chain management excellence will be the hallmark of the emerging strategies. Those CMOs will seek to bring manufacturing practice to a level still unknown in pharmaceuticals but common in most of the industrial economy. They will focus on reducing manufacturing costs through continuous-improvement activities and optimizing plant utilization.

"Manufacturing excellence" CMOs will also learn how to manufacture in a "just-in-time" environment, rather than insisting that clients lock in schedules three to six months in advance. Major pharmaceutical companies no longer want to carry large inventories of raw materials and finished products.  

Operating global plant networks will also be characteristic of these CMOs. The ability to run efficient operations in countries such as India and China will be critical if they are to support the efforts of major pharmaceutical companies to expand their sales in those countries. That's partly a matter of cost—they need to produce at a lower cost to be competitive in those markets, which don't necessarily require expensive regulatory standards. It's also a matter of access—many of those countries have 

 barriers to imports that make market access difficult unless you are located there.  

In the end, relatively few CMOs may be able to attain this level of manufacturing excellence. Even as I write, there are several major CMOs operating under warning letters and others that publicly admit to being unable to meet delivery schedules. Further, only a handful of CMOs may be able to make this global shift. Some Indian and Chinese companies are already well along this path, but only a few Western companies have established assets in the emerging markets. 

However, the "manufacturing excellence" business model will be the real game changer for the CMO industry. Its strategy offers major pharmaceutical companies the ability to revamp their business models by addressing costs and globalization without sacrificing supply security. CMOs that can deliver it will be the big winners in the contract-manufacturing stakes. 

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

Global manufacturing excellence will be a game changer for CMOs that can achieve it.

Toward a New Model for Contract Manufacturing

Contract research organizations (CROs) offering clinical research services had a terrific year in 2007. Revenues of the publicly-traded clinical CROs jumped 20% during the year, well ahead of the respectable 15% growth they achieved in 2006. What is really eye-popping is the phenomenal performance of some of the largest CROs. Kendle International (Cincinnati), which had 2006 revenues of $283 million, grew 40% in 2007 to $398 million. ICON (Dublin) grew almost as fast when it jumped to $631 million in 2007 from $455 million in 2006.  Parexel (Boston) grew its revenues 25% to $741 million. 

The large clinical CROs benefited from several favorable trends, including growth in the drug development pipeline and efforts by the major pharmaceutical companies to reduce the number of vendors they work with. At the same time, however, big CROs are reaping the benefits of important investments they've made in recent years in anticipation of changes in the pharmaceutical industry. These changes include:  

Greater capabilities in electronic data capture and management are helping to feed back trial results faster 

Expanding networks of offices and clinical site relationships in Asia, Eastern Europe, and Latin America are opening doors to more patients and establishing new markets 

Increased clinical pharmacology capacity is serving the expanding Phase I pipeline and the emphasis on proof of concept

Scalable organizational models are enabling companies to improve service quality as they grow.

While it was a blow-out year for clinical and preclinical CROs (toxicology services grew 21%), the year was dismal for contract manufacturing organizations (CMOs). For the second straight year, the dose manufacturing and small-molecule active pharmaceutical ingredient (API) segments experienced overall growth of less than 5%. CMOs were hurt by a number of factors, including the shrinking number of new drug application and biologic license application approvals coming out of the US Food and Drug Administration, declining sales for key client products, clients repatriating products as utilization of their in-house manufacturing assets falls, and overcapacity that generates increased price competition. The two bright spots in the manufacturing universe were biomanufacturing (cell culture and fermentation) and manufacturing of clinical-trial supplies. 

A look at the new pharamceutical environment 

The immediate prospects for CMOs could improve if their clients are able to get more products approved in the next year or so. However, CMOs may be in trouble over the long term because most of them continue to operate with business models and strategies based on old perceptions that don't reflect the current realities of the pharmaceutical industry. This is especially true in several key areas outlined below. 

Most CMO strategies were established in the early part of this decade, and included substantial capacity expansions and aggressive acquisition campaigns. This was a time when new product approvals were expected to be plentiful, and drug prices and unit volumes were rising. The assumption was that growth would continue, meaning there would always be a need for capacity and CMOs could expect annual price increases. It was also a time when industry assumed "price doesn't matter" (i.e., drug sales were so high and profitable that pharmaceutical companies were more concerned about assuring a dependable supply than they were about the cost of goods). 

The pharmaceutical industry's growth prospects have changed considerably in the past few years. FDA approvals have continued a 10-year decline, governments and private insurers have fought back against drug-price increases, and safety concerns and utilization guidelines are limiting the growth of blockbuster drugs, especially biologics. 

Five years ago, CMOs geared their strategies to the North American and European markets, where prices were highest and usage was growing most rapidly. CMOs geared their facility design and quality assurance practices to meet FDA and European Medicines Agency (EMEA) standards of compliance.  

Today, the market focus of the major pharmaceutical companies is turning to the emerging economies, the so-called "BRIC" countries (Brazil, Russia, India, and China). Serving these countries is an entirely different challenge: they either have their own stiff regulatory requirements, as in the case of Brazil, or lower compliance standards that make the costs of maintaining FDA and EMEA compliance uneconomic. In many cases, laws and/or regulatory practices require local manufacture and discourage imports. Most Western CMOs lack facilities in the emerging economies to take advantage of these expanding opportunities. 

While major pharmaceutical companies have made major announcements about their intentions to outsource more, they have continued to invest heavily in new facilities and equipment, especially for development and manufacture of large-molecule products. Capital investment by the 15 largest pharmaceutical companies grew 14% in 2007 to almost $22 billion. With the major pharmaceutical companies on a spree to acquire or in-license large-molecule candidates, the high-value opportunities that CMOs were counting on are likely to be staying in-house. 

CMOs are also being hurt by sourcing strategies that are increasingly global. Not only has global sourcing introduced new low-cost competitors in countries such as India and China, it has also greatly extended the pharmaceutical supply chain. Dose CMOs more frequently are dealing with the inability of clients to ship adequate supplies of APIs, resulting in schedule disruptions and revenue shortfalls. 

Like the French military planners that built the Maginot Line after World War I, CMO executives find that the scenario they planned for is no longer relevant. In next month's column, I'll cover what the new CMO business model might look like going forward. 

CMO business models are out of touch with current pharma industry realities. It's time for new thinking.

CMOs are Planning for the Last War

CMOs need to find new business models and strategies that reflect these new realities. These realities include Big Pharma's growing emphasis on reducing costs and making costs more flexible, and the globalization of the industry from both the end-user market and sourcing perspectives. New strategies need to better differentiate CMOs from one another to cut down on price competition. This will pave the way for multiple models targeting different customer groups and needs. 

Jason Reed and Igor Kopelnitsky/Getty Images 

Baxter Healthcare, the US Food and Drug Administration, and the pharmaceutical industry in general got a big dose of bad news in late February, when it was reported that several batches of heparin manufactured and marketed by Baxter (Deerfield, IL) may have caused a large number of adverse events, including some deaths. Additional reports of adverse events associated with heparin were also coming out of Germany, relating to product manufactured by Rotexmedica. 

The heparin problem arose less than four months after the US Government Accountability Office (GAO) presented testimony highlighting the deficiencies in FDA's oversight of foreign drug manufacturers. The active pharmaceutical ingredient in Baxter's heparin was supplied by Changzhou SPL  in Changzhou, China, which is partly owned by Scientific Protein Laboratories LLC (Waunakee, WI). GAO noted that FDA "does not know how many foreign establishments are subject to inspection," and that its two principal internal databases counted vastly different numbers of foreign establishments (3000 in one case, 6800 in another). The GAO report estimated that FDA was inspecting only about 7% of foreign establishments deserving inspection each year, meaning it would take more than 13 years to visit each site once. The report noted other problems, including the need to preannounce FDA inspections of foreign facilities and the lack of translators on FDA inspection teams. 

In fact, GAO noted, FDA does not have the authority to compel foreign establishments to allow it to inspect their facilities. Further, foreign drug establishments making product for the US market do not have to be inspected every two years, as domestic requirements must be. FDA's authority is currently limited to inspecting imported drugs and preventing their entry into the US. There is now a movement in Congress, backed by the Bush administration, to give FDA more explicit responsibility for imported drugs. 

Baxter and SPL's heparin problems, and the difficulties FDA has keeping up with foreign establishment inspections, represent just some of the issues that pharmaceutical companies are likely to encounter as they source key ingredients and intermediates from countries such as China and India. Pharmaceutical supply chains are getting longer and more complex; companies are not only geographically farther from their suppliers, they are transactionally farther as well, because they increasingly depend on their primary suppliers to source intermediates and other inputs used to manufacture the products they are ultimately purchasing. This is a far cry from just a few years ago when vertically integrated pharmaceutical companies controlled much more of the supply chain and manufactured most active ingredients and late-stage intermediates in-house. 

The learning curve for complex sourcing relationships has been a long one in most industries, not just pharmaceuticals. Companies that have sought to outsource more of the value chain almost invariably have found that their internal systems are not up to the task and that they must have greater involvement with their suppliers to effectively integrate them into their supply chain. For example, when Boeing developed its new 787 Dreamliner aircraft program, it decided to outsource the production of many of its components to suppliers around the world. Now, it has had to delay delivery of the Dreamliner several times because it failed to effectively integrate those suppliers into its scheduling and engineering systems. In addition, the suppliers have not been able to deliver their components on time and in sufficient quantities. When the automobile companies began seriously outsourcing more than 10 years ago, they found that they had to establish stringent quality standards and specifications and invest in training their suppliers in continuous improvement and quality control practices before they could meet these standards. 

The globalization of supply chains is creating new political, logistical, and scientific challenges for the pharmaceutical industry. Establishing inspection programs of foreign establishments, for example, will require agreements with foreign governments to allow FDA to exercise some oversight authority over manufacturers in their countries. That will be especially tricky with countries such as China, where there is no history of mutual recognition and cooperation such as exists with European governments.  

There will be technical and scientific issues as well. For instance, while investigating the heparin recall, FDA found that the heparin API supplied by SPL to Baxter contained a heparin-like compound that was not heparin but reacted like heparin in traditional analytical tests. FDA did not immediately establish a causal link between the contaminant and the adverse events but issued guidelines for additional analytical tests to identify the foreign substance. 

In fact, comprehensive analytical testing is likely to become a more important link in pharma's global supply chain and in FDA's efforts to maintain the safety of human and animal products. This will become a major opportunity for contract analytical labs, especially the worldwide laboratory networks run by companies such as SGS and Intertek, which already have extensive consumer-testing operations and dozens of facilities around the world. Other contract analytical services providers have been slow to establish operations in India and China but are likely to move more deliberately in the near future. 

The explosive growth in offshore sourcing by the pharmaceutical industry is a relatively recent phenomenon and is directly related to margin pressures felt by pharmaceutical companies resulting from efforts by governments and health insurance providers worldwide to slow the growth of healthcare expenditures. Offshore sourcing has grown so quickly that it has overwhelmed the systems put in place by industry to maintain product quality and safety, and it has afforded no room for "on-the-job" learning. Regulatory agencies and pharmaceutical companies will have to devote more resources to anticipating potential supply-chain risks and implementing mechanisms to prevent them. 

The recent heparin contamination event calls for a new approach to manage a lengthening pharmaceutical supply chain.