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

Jim Miller

More so than established contract manufacturing organizations and nonclinical contract research organizations in Europe and North America, up-and-coming contract service providers born in India and China have embraced the global nature of drug development. These companies were originally established to exploit the big differentials in wages paid to chemists and other scientists in their home countries versus North America and Europe. However, the most strategically committed CROs have realized that in addition to offering a platform for low-cost drug development, they need to be near their customers to secure those relationships. 

Proximity increases opportunities for relationship building, which leads to trust and more business. Further, there are certain activities such as projects that require close interaction with client scientists and/or involve intellectual property protection issues that are best carried out when close to the client's research and development (R&D) operations. 

In the past two years, several India-based contractors have stepped up to acquire European and North American bases of operations, sometimes paying a considerable premium for the privilege. These include companies such as Nicholas Piramal (Mumbai), which bought operations from Avecia and Pfizer in the United Kingdom; Dishman Pharmaceuticals and Chemicals (Ahmedabad), which bought Carbogen and Amcis in Switzerland; and Jubilant Organosys (Noida), which acquired injectables manufacturer Hollister-Stier Laboratories in the US. 

Those companies are about to be joined by Shanghai-based WuXi PharmaTech, which announced plans in late December to acquire AppTec Laboratory Services, Inc. (St. Paul, MN) for $162.7 million. AppTec, which has 495 employees, provides manufacturing and laboratory services to the biopharmaceutical and medical device industries. The company also provides clinical-scale cell culture manufacturing at its Philadelphia facility, where it has a 2500 L bioreactor train and a number of Wave bioreactors.  

AppTec's growth has been nothing short of phenomenal. Revenues for 2007 of $71 million were up 40% from $51 million in 2006 and more than three times 2004 revenues of $23 million. Most of that growth has been organic and has come from the biopharmaceutical sector. 

WuXi's story has been striking as well, as it has emerged as a major player in chemistry-based discovery, process development, and manufacturing services since 2002. Its 2007 revenues of $133 million were double its 2006 revenues and almost eight times its 2004 revenues of $21 million. In 2007, WuXi successfully completed an initial public offering (IPO) on the New York Stock Exchange, raising $155 million. It has 2700 employees, including 2100 scientists and claims most major pharmaceutical companies as clients. 

Aside from AppTec's growth prospects, WuXi CEO Ge Li cited three elements in his strategic rationale for the AppTec acquisition: WuXi gets biologics capabilities and expertise to complement its chemistry position; it expands its US customer base and addressable market; and it gains an operational footprint in the US. Li added that the company plans to "amplify" AppTec's capabilities in China rather than replicate them; we take this to mean building larger scale biomanufacturing capabilities. 

Building very large-scale facilities has been a key part of WuXi's strategy. Its facilities include a 630,000-ft

  discovery chemistry laboratory, a 220,000-ft

  process development and manufacturing facility in Shanghai, and a 130,000-ft

  chemical manufacturing facility in Tianjin. It is building a 267,000-ft

 preclinical toxicology facility in Suzhou, China, a bold move to expand its service offerings beyond chemistry and leap ahead of preclinical market leaders Covance (Princeton, NJ) and Charles River Laboratories (Wilmington, MA) in terms of China-based preclinical capacity.  

The aggressive moves by WuXi PharmaTech, Jubilant Organosys, Nicholas Piramal, and other Asian pharmaceutical services providers stand out in contrast to Western competitors who have been in the business much longer and would seem to have more resources and stronger pharmaceutical company relationships to draw on. Thus far, only a few Western companies, notably Albany Molecular Research, Aptuit (Greenwich, CT), and Lonza (Basel, Switzerland), have taken the plunge to set up wholly owned chemistry and development operations in Asia.  

Admittedly, it is more difficult for Western companies to establish themselves in India and China than for Asian companies to come west due to restrictive regulations governing foreign investment and the challenges of learning to operate in a different culture. But most Western service companies seem to be held back by a severe aversion to risk and an unwillingness to accept near-term losses and uncertainties in return for longterm strategic opportunities. It would be unfortunate if the pharmaceutical services industry's pioneers ceded their future to a band of relative newcomers, but it wouldn't be the first time that happened in the history of business. 

Like all corporations, CROs and CMOs have three principal constituencies: customers, employees, and shareholders. Presentations to customers and employees are usually focused on how the company will help them be successful, but presentations to shareholders are about how the company itself will be successful. As such, shareholder presentations provide a window into company strategies, their executives, and how they view market trends. 

The annual JPMorgan Healthcare Conference, held in San Francisco last month, brought together CEOs and CFOs from more than 200 public and private bio/pharmaceutical, medical device, diagnostic, and managed care companies. The CEOs and CFOs addressed some 7000 money managers and dealmakers to explain why they should invest in their companies. The CRO and pharmaceutical supplier sectors were well represented at this year's conference, with more than 15 companies presenting. 

Because profit margins and growth prospects drive stock valuations, investors want to know how companies will grow their revenues and profits. The CRO executives, in particular, had a very compelling story: major pharmaceutical companies are embracing outsourcing as part of their efforts to restructure their business models, and those efforts will drive the CRO business for years to come. All noted that the bio/pharmaceutical industry outsources only about 25% of its R&D spending, so they expect to enjoy robust growth simply by taking a piece of the growing share that will be outsourced. The bigger CROs also expect to fuel growth by increasing their market share of outsourced spending (e.g., by building massive preclinical toxicology laboratories or enhancing their ability to conduct large global trials). In their view, the balance of power has shifted from the pharmaceutical companies to the service providers over the past three years.  

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

Articles

Another Asian services provider demonstrates the global nature of pharmaceutical outsourcing.

Global Pharmaceutical Powers

Contract research organizations (CROs) had a very good year in 2007, but the same can't be said for their clients. While contractor revenues and profits were growing at double-digit rates, sales at major pharmaceutical companies were getting whacked by generic competition, price pressures from insurers, and growing safety concerns surrounding some long-marketed drugs. Restructuring became the principal task at hand for senior executives at many of the 15 largest pharmaceutical companies as thousands of professionals lost their jobs.  

 Developments surrounding the research and development (R&D) pipeline should be of particular concern for CROs and contract management organizations (CMOs). During the last six months, some very high-profile, late-phase candidates have run into adverse event problems, often just months before they were due to be filed with the US Food and Drug Administration. For instance, Novartis (Basel, Switzerland) has been forced to reconsider filing its diabetes drug, Galvus, in the United States due to concerns about its safety profile, and Eli Lilly (Indianapolis, IN) ran into problems in Phase III testing of its cardiovascular drug, prasugrel. Merck (Whitehouse Station, NJ) was forced to terminate Phase II trials of a highly touted HIV/AIDs vaccine. All were considered highly promising blockbuster candidates. 

The late-stage failures are symptomatic of the problems major pharmaceutical companies are having in introducing new molecular entities (NMEs), despite efforts to make their R&D operations more effective and despite billions spent on in-licensing deals and acquisitions. In fact, 2007 is shaping up to be the worst year yet in the continuing decline of NME filings, and the raft of late-phase problems isn't helping. 

The situations involving prasugrel, Galvus, and torcetrapib, the good cholesterol-raising drug that Pfizer (New York) terminated last year, point to a vexing problem for drug companies: the high therapeutic potency of many new candidates is being accompanied by greater risk of adverse events. The full potential for such effects apparently was not realized in early safety and efficacy studies, so the drugs were allowed to proceed to large-scale trials where the problems emerged. Furthermore, in the post-Vioxx era, FDA and other regulatory bodies are hesitant to approve drugs with increased risk profiles, despite their higher therapeutic value, when proven safe alternatives are already on the market. So potential big winners are being stopped in their tracks. 

While the number of these problem candidates is small, their impact is magnified through the R&D pipeline because there are so many "me-too" candidates in development. Take Merck's HIV/AIDs vaccine: it was considered the most promising of some 50 HIV/AIDs vaccine candidates in the pipeline, including more than 10 in late development. While different vaccines have different modes of action, the failure of an experienced vaccine developer such as Merck raises overall concern about the cost and viability of developing such a vaccine.  

Pipeline data also indicate that despite efforts to improve R&D effectiveness at major pharmaceutical companies, and despite the flow of licensing and venture-capital funding into early stage companies, candidates are not progressing into late-stage development. According to data compiled by IMS Health, the number of Phase I candidates has grown by 60% in the past five years, and the number of Phase II candidates has grown by 30%, but the number of Phase III and registered candidates has been flat. Survival rates from Phase II–Phase III are now under 25%, according to some sources, and even lower for cancer drugs. 

If compounds continue to not make it through the pipeline, companies may stop spending so much money to acquire them. Competition to replenish pipelines and technology toolboxes has driven up the cost of acquiring new compounds dramatically. According to market intelligence provider 

, the average value of an out-licensing deal by small bio/pharmaceutical companies has tripled in the last three years, and the cost of in-licensing preclinical compounds—the riskiest deals of all—has doubled. Those rapidly rising deal values have driven record flows of venture capital to biopharmaceutical companies in recent years, averaging $1 billion per quarter in the US alone.  

The flow of venture capital has, in turn, fed the demand for contract R&D services, as most of the early-stage companies the venture capitalists are supporting follow a virtual or nearly-virtual company model. This situation has especially benefited providers of early-development activities.  

The risk to the CRO industry comes from the following scenario: major pharmaceutical companies determine that failure rates for most in-licensed or acquired compounds are too high, and decide not to pay so much for them. The decline in licensing valuations lowers the expected return on biopharmaceutical investments for venture capitalists, who decide to make fewer or smaller investments. As the flow of funds from venture capital and Big Pharma dries up, demand for contract R&D services will drop dramatically. 

Without getting unduly pessimistic, it is clearly a time for caution for most CROs and CMOs. The success of recent years and their current capacity constraints have many service providers considering significant capacity expansion programs. This is beginning to mirror what happened in the pharmaceutical chemical industry at the end of the last decade, when the fine-chemical companies went on a capital investment and acquisition spree just as the pipeline opportunity was peaking. By the time the new capacity came on-line, most major pharmaceutical companies were pulling projects back in-house to absorb the capacity freed up by some major pipeline failures. 

One major difference between today and 2000 is that there has been a fundamental shift in the Big Pharma business model. Outsourcing is emerging as a CEO-driven priority as companies seek to reduce their overhead and make costs more flexible. Given that the top 15 companies account for more than 50% of the industry's R&D spending, the volume of work that comes out of these new outsourcing efforts could dwarf what is lost if virtual company business dries up.  

The business model for serving major pharmaceutical companies, however, is very different from the one that many CROs have used to reach virtual bio/pharmaceutical companies, and only a relative handful can expect to benefit from Big Pharma's embrace of contract services.  

The dynamics of the R&D pipeline could undercut recent CRO and CMO successes.

Pipeline Peril

2007 was the year that the major pharmaceutical companies accepted the fact that their traditional business model is terminally ill. That model, characterized by large vertically integrated companies developing small-molecule compounds pushed by large sales forces, failed to produce robust results for much of this decade. Efforts to rescue it such as Pfizer's attempts to leverage economies of scale through huge acquisitions, did not have much therapeutic effect, as promised economies proved difficult to deliver and promising pipeline compounds failed in late clinical trials. So the major pharmaceutical companies have embarked on large-scale restructuring efforts, including massive layoffs, site closings, divestitures, and cost-reduction efforts aimed at goods and services procured externally. 

In place of their old business model, major pharmaceutical companies are touting a new direction, one that tries to meld the successful features of the small/virtual biopharmaceutical company model with the scale, development expertise, and marketing muscle that remain their sources of long-term advantage. Details vary from company to company, but the key features of that new model share major characteristics, outlined below. 

Favoring biologics in place of small-molecule compounds. 

The major pharmaceutical companies are building up their large-molecule portfolios, including monoclonal antibodies, vaccines, and recombinant proteins, through technology, candidate in-licensing, and acquisitions. 

Focusing on specialty indications rather than primary care. 

Therapies targeting broad indications such as cholesterol levels are losing favor because new generation drugs are proving difficult to develop, and insurers aren't willing to pay for them. Major pharmaceutical companies are targeting specialty areas such as oncology and autoimmune diseases where price points and margins have generally been much better. 

The rapidly growing economies of Asia and Eastern Europe, with their burgeoning middle classes, promise more rapid growth than the traditional North American and European markets. Companies are expanding their research and development (R&D), manufacturing, and sales presence in countries such as India and China. 

The quest for lower costs is driving companies to source more of their manufacturing and R&Dneeds from low-cost countries. Big Pharma is establishing new R&D and manufacturing operations in these countries, as well as procuring more inputs and services there. 

Making the cost structure more flexible. 

A lower fixed-cost structure means fewer staff and manufacturing sites and greater use of contract research and manufacturing organizations (CROs and CMOs). 

Rather than depending on in-house laboratories alone, companies are looking to smaller companies to identify targets, develop leads, and take candidates to proof of concept. In-licensing opens the way to more potential candidates while keeping R&D costs and staffing more flexible. 

This "new" bio/pharmaceutical business model seems to address a lot of the problems facing major pharmaceutical companies. There, however, are real reasons to consider whether, in fact, the new model really is all that different or whether it will solve the critical issues facing these companies. 

For instance, the full picture indicates that Big Pharma isn't giving up manufacturing. It is simply rationalizing its small-molecule infrastructure, for which it has less use, while building a network of biomanufacturing operations. Consider the case of Bristol-Myers Squibb (New York).In December, the company announced plans to shut down 19 of its 38 manufacturing sites, but it is investing nearly $1 billion in new biomanufacturing capacity in Devens, Massachusettes, and in its injectables manufacturing operations in Manati, Puerto Rico. Merck (Whitehouse Station, NJ) and GlaxoSmithKline (London) have aggressive plant divestiture programs, but are investing heavily in new vaccine capacity. Throughout Big Pharma, companies are investing nearly $10 billion in new manufacturing capacity to support new strategic priorities, and their large-molecule programs will be as vertically integrated as their small-molecule programs have been. 

Although it is uncertain whether the "new" bio/pharmaceutical business model will really deliver long-term benefits to its adherents, there is little doubt that it will greatly benefit CROs and CMOs. Clinical CROs are already benefitting as major pharmaceutical companies outsource more of their clinical-study and clinical-data-management requirements. Clinical research is people-intensive. The need for staff waxes and wanes according to what is in the pipeline at any given time, so clinical CROs clearly contribute to the goal of keeping costs flexible. Further, clinical CROs have been at the forefront of introducing cost-saving innovations, including new data-management technologies and conducting studies in low-cost geographies. So, they will continue to be winners as major pharmaceutical companies implement the new model. 

The picture is somewhat less clear for CMOs. The move to divest small-molecule manufacturing operations will create new opportunities for CMOs to pick up the manufacture of older active pharmaceutical ingredients and dosage forms, and undoubtedly some of the new small-molecule launches as well. However, the decision by most companies to invest in vertically-integrated manufacturing operations for their most strategic product areas suggests that CMOs could be shut out of the most promising new opportunities. 

CMOs will need to come up with more innovative strategies and offerings if they really want to leverage the opportunities that will be created under the new Big Pharma business model. For instance, few CMOs have adequately addressed how to deal with the threat and opportunity of manufacturing in low-cost countries such as India and China, and only one—Lonza (Basel, Switzerland) in its deal with Genentech (SouthSan Francisco, CA) to build new cell culture facilities in Singapore—has come up with a truly innovative new business model. Most CMOs are still trying to appeal to the old Big Pharma business model. 

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

The traditional pharmaceutical business model is disintegrating, but the new model is not much different.

Old Model in New Clothes

 of London that the company would outsource all of its drug manufacturing within 10 years, the pharmaceutical contract manufacturing industry thought it had received unqualified validation from Big Pharma. David Smith, AstraZeneca's executive vice-president of operations, told reporter Robin Pagnamenta that manufacturing "is not a core activity" for the company, and admitted that there are a lot of organizations that are better at manufacturing. 

Smith's radical perspective on remaking the pharma supply chain no doubt reflects his experience outside the pharmaceutical industry. After starting his career at Wellcome Foundation (a predecessor company to GlaxoSmithKline), Smith held positions at consumer products companies, including Estee Lauder  and Timberland. Those hyper-competitive industries depend on complex global supply chains incorporating far-flung contract manufacturing operations. 

Alas, AstraZeneca quickly backtracked from Smith's candid statements. The day after the 

 article appeared, the company issued a clarification, stating that it is pursuing outsourcing "where there is a sound business case" and that its efforts are focused primarily on active pharmaceutical ingredients (APIs).   

Around the industry, Smith's comments are now interpreted not as a statement of corporate strategy, but rather as a "shot across the bow" aimed at people within the company who are resisting the changes that AstraZeneca must embrace. Like other major pharmaceutical companies, AstraZeneca is facing substantial revenue losses in the next five years as key products lose patent protection, and it must restructure its operations to survive. Because research anddevelopment (R&D) operations are viewed as critical to the replacement of those lost revenues,  sales, manufacturing, and supply chain activities will bear the brunt of such restructuring efforts. 

Aside from the cultural resistance, pharma supply chain managers face a complex calculus when sorting out their supply-chain and manufacturing strategies (see Figure 1). The decision regarding whether to manufacture a product in-house or outsource must weigh a number of variables. 

 Unit cost of goods, dependability of supply, and intellectual property protection are the most basic factors in making supply chain decisions. Costs are heavily impacted by the fixed cost nature of pharmaceutical manufacturing: the overhead of maintaining a facility's compliance with good manufacturing practices is largely the same regardless of the volume that runs through it. Unless a facility is to be closed or divested altogether, there is considerable pressure to put more products into it to absorb those fixed costs.  

 A number of financial factors beyond direct manufacturing costs impact the supply decision. Corporate cash flow can be enhanced by shifting manufacturing to tax-advantaged locations or accepting the operating and capital investment subsidies offered in countries such as Ireland and Singapore. Exchange rate movements such as the current depreciation of the US dollar against the euro and other currencies, can shift cost advantage between manufacturing locations.  

Having a manufacturing or R&D operation in a particular country can ease regulatory approvals in that country, despite treaties establishing unified markets such as the European Union. Labor laws in many countries hinder the shutdown of noneconomic manufacturing facilities, causing companies to use in-house manufacturing assets that should really be shuttered. 

 "Cost flexibility" is the new mantra of pharmaceutical executives, which usually translates into operations with fewer fixed costs. That development should favor contract manufacturers, but they often offset that advantage by insisting on "take-or-pay" agreements that limit their own downside.  

The complex interplay of these variables probably means that it will never make sense for a major pharmaceutical company to outsource 100% of its manufacturing requirements. There will always be an argument to keep strategic products in-house, whether they be high volume blockbusters with substantial economies of scale or unique high-value technologies that shouldn't be shared. 

What we will see, and are already seeing, is the emergence of sophisticated mixed sourcing models, which more effectively integrate contract manufacturers and in-house operations. Some major companies are already using such models to their advantage (e.g., Wyeth has long depended on contract manufacturing organizations [CMOs] for its API requirements, and Genentech has effectively used a mix of in-house and contract manufacturing operations). Innovative business models such as the one pioneered by 

 (Lonza, headquartered in Basel, Switzerland, will build and operate a cell culture facility dedicated to Genentech in Singapore, partially funded by local entities), will become more common. 

Indeed, despite the backtracking in AstraZeneca's response to Smith's comments, the company is already well on its way to establishing a sophisticated sourcing model for its manufacturing requirements. Earlier this year, it established a sourcing center in Shanghai that will be the focus of its worldwide sourcing activities and by its own admission is actively establishing supply relationships in Asia and elsewhere. It is also divesting redundant facilities in its manufacturing network, most recently a parenteral manufacturing site in France that it sold to contract manufacturer 

Corporate politics and financial complexities notwithstanding, it's clear that some major pharmaceutical companies are committed to radically changing their supply-chain models. Now it's up to the CMOs to retool their business models to respond to the opportunity.  

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

Candid comments from a Big Pharma executive highlight the complexity of contract manufacturing.

Mixed Message for Contract Manufacturers

Contract service providers exist to help clients meet their strategic and financial business objectives. So any prognostication on what the pharmaceutical outsourcing industry will look like in 30 years is really a forecast of the nature and speed of changes in pharmaceutical technologies and business models. 

We expect that globalization, new technologies, and efforts to control the costs of healthcare will create new market leaders among the pharmaceutical companies and the contract research and manufacturing organizations (CROs and CMOs) that service them. Globalization will be characterized not just by interregional sourcing activities, but also by the blossoming of huge new pharmaceutical markets, especially in Asia and Latin America. That means that much of the pharmaceutical industry's value-added (manufacturing as well as research and development expenditures) and decision-making will shift from the West to Asia and Latin America. The new leaders in contract services will be those companies best positioned to serve those expanding markets.  

Technological change and cost control efforts represent threats to the current players in the CRO and CMO arenas. Consider the implications for research and development services of the ability to model biological and physiological process on computers. As computing power gets ever cheaper and databases become more complete and sophisticated,

 testing of new compounds will replace much of the 

 preclinical and clinical testing that is done today. Already, toxicogenomic databases are helping to weed out harmful compounds during discovery and software that models physiological processes is being used to design and refine clinical trial designs. These developments could actually shrink the size of the preclinical and clinical research sectors, and displace established CROs with the new companies developing these technologies. 

CROs and CMOs will need to be enablers in the global efforts to cut the cost of healthcare, including drugs. It will no longer be sufficient to stick data processing centers in India or source early intermediates from the interior of China. Just as 

 testing will change preclinical and clinical research, new manufacturing technologies will lower the capital and operating costs incurred in making drugs. Just look at the biomanufacturing field, where rapidly rising cell culture yields combined with disposable technologies will rapidly drop production costs, and where some of the biggest selling drugs might be grown on farms rather than made in tanks. New delivery technologies are also likely to play a bigger role. Here again, today's market leaders are likely to be displaced by new companies. 

New players, new technologies, new geographies-in 30 years, it won't be your parent's contract services industry. 

Jim Miller, president, PharmSource Information Services

Industry experts give their predictions for the next 30 years. 

Contract service providers exist to help clients meet their strategic and financial business objectives. So any prognostication on what the pharmaceutical outsourcing industry will look like in 30 years is really a forecast of the nature and speed of changes in pharmaceutical technologies and business models.

What's Next In: Outsourcing

Developments surrounding the research and development (R&D) pipeline should be of particular concern for CROs and contract management organizations (CMOs). During the last six months, some very high-profile, late-phase candidates have run into adverse event problems, often just months before they were due to be filed with the US Food and Drug Administration. For instance, Novartis (Basel, Switzerland) has been forced to reconsider filing its diabetes drug, Galvus, in the United States due to concerns about its safety profile, and Eli Lilly (Indianapolis, IN) ran into problems in Phase III testing of its cardiovascular drug, Prasugel. Merck (Whitehouse Station, NJ) was forced to terminate Phase II trials of a highly touted HIV/AIDs vaccine. All were considered highly promising blockbuster candidates. 

The situations involving Prasugel, Galvus, and torcetrapib, the good cholesterol-raising drug that Pfizer (New York) terminated last year, point to a vexing problem for drug companies: the high therapeutic potency of many new candidates is being accompanied by greater risk of adverse events. The full potential for such effects apparently was not realized in early safety and efficacy studies, so the drugs were allowed to proceed to large-scale trials where the problems emerged. Furthermore, in the post-Vioxx era, FDA and other regulatory bodies are hesitant to approve drugs with increased risk profiles, despite their higher therapeutic value, when proven safe alternatives are already on the market. So potential big winners are being stopped in their tracks. 