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

Jim Miller

One of the hallmarks of the growth of outsourcing in the pharmaceutical industry has been the evolution of new sourcing models. As outsourcing gains acceptance, pharmaceutical companies and contract service providers experiment with and adopt various approaches to the packaging and delivery of services. The major themes in model evolution include:  

moving from bidding individual projects to establishing preferred provider relationships covering multiple projects; 

various approaches to bundling services together 

 outsourcing the delivery of a single capability in support of multiple projects or studies.

Sourcing models pursued in clinical and nonclinical development services have evolved in somewhat opposite directions. For most of the past 10 years, buyers of clinical research services have preferred to buy contract research organization (CRO) services on a full-service basis. That is, they have tended to buy the range of services needed to complete a clinical study—study management, site monitoring, data management, biostatistics, and medical writing—from a single CRO for a fixed price. By contrast, buyers of nonclinical services have tended to buy the necessary services for a particular drug candidate—process development and manufacturing for active pharmaceutical ingredients, dose formulation and development, clinical packaging, and analytical services—from multiple vendors, each specializing in a particular discipline. 

Today, the trends in the two sectors are moving in opposite directions. Major pharmaceutical companies are embracing a functional outsourcing approach for clinical research under which they contract with a single provider to deliver a particular service in support of all their clinical trials. In the nonclinical realm, the trend is toward a full-service model, often referred to as the one-stop shop. 

These opposing trends reflect some very different dynamics in these two sectors of the pharmaceutical services industry. The rise of functional outsourcing in clinical research is being driven primarily by the industry's embrace of clinical information technology (IT). This change brings with it the need for new areas of expertise such as systems integration as well as new opportunities to realize cost savings by offshoring software development and data processing. Creating a single data infrastructure for all clinical trials facilitates using clinical data for applications beyond the study for which it was collected, including strategic planning, marketing, and disease modeling. Contracting with a single, dedicated information technology services provider to build and maintain the clinical data infrastructure offers the promise of best-in-class capabilities and cost savings across all clinical operations. 

The functional outsourcing model in clinical research has been adopted in several major pharmaceutical companies, including 

(Madison, NJ), and based on discussions at April's 

 conference in Orlando, Florida, more companies appear to be adopting it. Furthermore, the model is moving beyond data management into other clinical research areas: Wyeth has struck a deal with 

 (Dallas, TX), a clinical CRO, to provide site monitors for clinical trials, and the company recently contracted with 

(Plantation, FL) to provide logistics for distributing clinical supplies to investigator sites. 

One interesting implication of the trend toward the functional model is that it has opened the door to new competitors in the clinical research sector. IT outsourcing giants 

(Mumbai, India) have become important players in clinical data management, and it is widely speculated that Federal Express and UPS will join DHL in competing with established clinical packagers and couriers. That specter of increased competition from global leaders has traditional CROs very worried. 

Functional outsourcing has been the rule rather than the exception in nonclinical outsourcing. The reason has little to do with the cost and performance advantages being pursued in clinical research, however.  

Instead, the predominance of the functional model in nonclinical development reflects the fact that the component disciplines of nonclinical development have very different and specific technical and operation bases and require expensive specialized capital infrastructure. (Clinical research requires very little capital investment, and its human resource requirements can be met with job-specific training in most cases.) Nonclinical services companies have traditionally been unwilling or unable to make the capital investments and assemble the expertise necessary to offer a full-service nonclinical offering. An early effort to assemble a full-service nonclinical offering, Oread, flamed out more than  five years ago because it couldn't support the cost of maintaining so many capital- and technology-intensive capabilities. 

The return of the one-stop-shop model in recent years reflects two major trends in the pharmaceutical industry. The first is the renewed support for early-stage companies developing new drug candidates and their focus on getting to proof-of-concept (positive results at Phase IIA) as quickly as possible. Venture-backed early-stage companies account for over 50% of the new drug candidates in early development (preclinical through Phase IIA), and their development programs are geared toward achieving proof-of-concept as quickly and cheaply as possible. Most of these companies lack the facilities and breadth of scientific and development know-how to manage a program to proof-of-concept, let alone to commercialization. The full-service nonclinical CROs are promising these early-stage companies a quick and cost-effective route to proof-of-concept by providing a turnkey offering with complete nonclinical capabilities and project-management skills to tie it all together. 

The second trend is the interest of private equity investors in the pharmaceutical services market. The nonclinical contract services business is highly fragmented and presents many acquisition opportunities for private equity investors looking to build a large CRO operation by buying up a number of smaller operations. The full-service CRO presents a logical model around which to build an acquisition strategy. 

As the pharmaceutical service industry continues to mature, we will see many variations of the basic full-service and functional models. Early-stage and virtual companies will tend toward the full-service model for both clinical and nonclinical services. That's because they need the regulatory and project-management expertise embedded in the full-service model along with the basic technical disciplines. 

Large pharmaceutical companies are likely to use a hybrid approach, mixing and matching the models as appropriate to meet their objectives of greater flexibility and lower costs. In clinical research, data management, clinical supplies logistics, and central laboratory services will be sourced largely on the functional model, but study management and monitoring services could be provided by full-service CROs with expertise built around specific therapeutic areas. In the nonclinical area, services that are closely linked, (

 formulation and clinical supplies manufacturing, may be sourced on a full-service basis) but we expect functional capabilities to count more heavily in nonclinical sourcing arrangements.

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

Articles

Preferred models for clinical and nonclinical services move in opposite directions.

Functional Versus Full-Service Outsourcing Models

One of the hallmarks of the growth of outsourcing in the pharmaceutical industry has been the evolution of new sourcing models. As outsourcing gains acceptance, pharmaceutical companies and contract service providers experiment with and adopt various approaches to the packaging and delivery of services. The major themes in model evolution include  

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

Functional versus Full-Service Outsourcing Models

I received a call the other day from a sourcing professional at a top five pharmaceutical company looking for recommendations for manufacturers of clinical supplies. It seems that his current three suppliers aren't answering his phone calls in a timely manner, and he is getting fed up with the poor service he is receiving. He's also frustrated with the constant turnover in project managers at his suppliers. 

The sourcing professional's problems are a common story these days, as demand for development services has never been greater. Major biotechnology and pharmaceutical companies are under enormous pressure to advance their pipeline compounds, while funding for early-stage companies continues to flow. As biotechnology and pharmaceutical companies push to keep studies moving, contractor resources are being stretched as they try to meet client requirements.  

Project managers are the focal point of most customer interactions once a contract has been signed, and their performance affects both the reality and the perception of how well a study and a relationship are going. Clients depend on project managers to be their advocates to ensure that their studies get scheduling priority and the necessary resources. They also expect project managers to keep them informed about progress and problems as they arise. When a project manager has worked a long time with a particular client, he or she can make studies run more smoothly by knowing the way a client expects work to be done or reports to be written. The very personal relationship between a project manager and his or her client counterpart is viewed as critical to study success, and any disruption is seen as putting the project at risk. 

Clinical contract research organizations (CROs) have long been aware of the critical role of the project manager in maintaining client confidence, and have occasionally taken advantage of it during the competitive bidding process by promising to assign a trusted project manager to a study. Too often, however, the promised project manager was moved to another study shortly after the contract was signed, creating a sense of distrust and alarm on the part of the client. Many biotechnology and pharmaceutical companies have taken to insisting on contract language that assures the client that this "bait-and-switch" doesn't happen again. 

Attributes of the current market environment are particularly tough on project managers. The large number of early-stage companies needing services is especially demanding because managers at those companies often have little hands-on drug development experience and depend on project managers for guidance on what needs to be done and when. As a result, the project management input for these clients is often way out of scale to the size and nature of the work that actually has been done. 

As for the major pharmaceutical companies, many are using contractors to an unprecedented degree so their sourcing managers have little direct experience with contractor performance or managing outsourcing relationships. The fact that much of this work was previously done in-house may mean that the client-side managers are unaware of the cost and time implications of changes to the scope of work or project schedules. It may take all of the project manager's diplomatic skills to explain to the client that doubling the order for clinical trial supplies will increase delivery time because suite capacity already has been committed to other projects. 

Clearly, the industry must invest more in its project-management capabilities, but it's not always easy to justify. The benefits of excellent project management are often intangible and difficult to justify on a cost-benefit basis, so it may be easier to spend $40,000 on a new high-performance liquid chromatography system than it is to invest that amount in training project managers (especially given the rate at which project managers seem to be changing companies). Still, companies are getting the message, and companies such as 

 (Phoenixville, PA) are going so far as to have their project managers earn professional certification from organizations such as the 

A further impetus comes from CRO business models built around integrated solutions that promise to get a biotechnology and pharmaceutical company's candidates into the clinic faster than if the company were using independent suppliers. The success of these "one-stop shops" will depend on the effectiveness of their project-management groups in tying the various and geographically dispersed services into a seamless offering. 

Patheon (Toronto, Canada) completed its search for "strategic and financial alternatives" last month with the announcement that it would receive a cash infusion from a private equity firm. The new investor, 

(New York, NY), will invest $150 million in Patheon ($138 million after expenses) in exchange for preferred stock, three seats on the company's board of directors, and voting rights equivalent to 25% of shares outstanding. The investment is subject to shareholder approval, which is expected at a shareholder meeting scheduled for mid-April. The new funds will be used to reduce Patheon's long-term debt, which stood at $338 million at the end of January. 

With the completion of the investment, Patheon's executives will turn their attention to restructuring the company's operations to improve profitability and performance. Despite 10 years of rapid, acquisition-driven growth, the company has had problems achieving sustained profitability and its cash flow has been insufficient to fund ongoing capital improvements. The problems came to a head in 2005–2006, when its Mova Pharmaceuticals operation in Puerto Rico, acquired at the end of 2004, received a warning letter from the US Food and Drug Administration and failed to achieve revenue projections. In April 2006, the company's long-time CEO was dismissed, and the company began a concerted focus on performance improvement while its board evaluated its strategic and financial options. 

The restructuring efforts to date have included plant-level operating improvement campaigns, a program to generate savings in procurement by leveraging the company's buying power, and ongoing reductions in staffing. The restructuring drive is expected to pick up steam once the JLL investment is completed and its nominees join the board of directors. JLL Partners is known for investing in turnaround situations, and JLL is expected to push for more aggressive measures, including possible plant closings. Rumors to that effect are already circulating on Internet discussion sites. 

Evidence from Patheon's first-quarter results indicate that the company is already seeing results from its restructuring efforts while benefiting from the strong drug-development services environment. Revenues were up almost 9%, driven by a whopping 23% jump in product development services (formulation, analytical and clinical trial material manufacturing) and 13% growth in commercial prescription drug manufacturing. A sharp decline in manufacturing of over-the-counter products prevented even stronger top-line performance. Driven by higher utilization and greater efficiency, operating profit margins rose to 13.5% from 8.9% in 2006. 

The strong first-quarter results suggest that clients are sticking with Patheon despite its recent problems. Some difficult issues remain to be tackled, but indications are that the company may once again be headed in the right direction. 

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

Strong demand is straining service providers' project-management capabilities; Patheon receives a much-needed cash infusion.

Project Managers in the Spotlight

Executives of contract research and manufacturing organizations (CROs and CMOs) are undoubtedly licking their chops over the prospective flood of business opportunities with

. (New York, NY). The opportunities are expected to arise from Pfizer's decision, announced by new CEO Jeffrey Kindler, to close down or sell five R&D sites and three manufacturing facilities and outsource more of the activities conducted at those sites. Given that in 2006 Pfizer spent nearly $7.5 billion on R&D and a similar amount on cost of goods, even a small incremental increase in the share going to contract services would be a bonanza for the pharmaceutical services industry. In fact, the plan calls for Pfizer to increase its outsourced manufacturing activity from 15% of requirements today to 30% in the next few years. 

Taken in total, Kindler's plan for fixing Pfizer amounts to a wholesale overhaul of the traditional Big Pharma business model. It entails a focus on costs that has been unusual for Big Pharma, albeit standard practice for most major industries. Consider these quotes from the Jan. 22 meeting where the Pfizer senior executive team unveiled their plan for Wall Street analysts: 					

". . . establishing a lower, more flexible cost base";

". . . establish a more flexible cost structure that can be modulated depending on our needs and opportunities at any given time";

". . . maintaining a flat R&D budget" while tripling the number of Phase III candidates by 2009;

". . . no-growth R&D budget environment";

". . . a culture of productivity and continuous improvement and continuous increases in efficiency";

". . . major development sites in Mumbai and Shanghai."

Those statements suggest that the CMOs and CROs that benefit from Pfizer's increased outsourcing activity are really going to have to work to maintain the business and keep it profitable. Clearly, Pfizer will be looking for more than just vendors: it will be looking for partners to help remake its R&D processes and manufacturing operations. The partnership role will require service providers to examine their own cost structures and business practices to find opportunities to continually deliver cost savings and performance improvements. Doing so will be wrenching for many service providers, who have become accustomed to the traditional Big Pharma way of doing business and have been quite profitable operating that way. 

Consider a traditional practice such as "take-or-pay" contracts, which obligate a customer to pay for capacity regardless of whether the capacity is used. These have long been standard practice in the pharmaceutical outsourcing industry, especially for services in which capacity is viewed as being tight, and they are quite popular today in the preclinical toxicology segment. Nonetheless, take-or-pay deals would seem to be contrary to Pfizer's objective of keeping costs flexible. How will service providers balance their own needs to maintain capacity utilization against Pfizer's needs to keep costs flexible? 

Pfizer's insistence on maintaining flat R&D expenditures while increasing the number of development projects will challenge CROs and CMOs even further. Profit margins will undoubtedly come under pressure, especially as the company explores sourcing options in Asia and as it insists on continuous improvement in pricing and performance each year. Those pressures also will force service providers to manage their businesses more effectively and also may lead to a rush of innovation as companies seek to squeeze costs out of the development process. 

Kindler's 2008 target for closing the facilities and realizing the cost savings suggests that contractors should start harvesting the windfall from Pfizer spending by the second half of 2007. The initial efforts are likely to hit some significant rough spots, given the large number of projects and the challenges of overcoming Pfizer's preference in recent years to work in house. The current industry environment, characterized by high utilization and tight capacity at most development services operations, also will be challenging for Pfizer. 

It's difficult to gauge how far reaching the effects of Pfizer's restructuring will be on the pharmaceutical services industry. Much depends on whether, and to what extent, other major pharmaceutical companies follow Pfizer's lead. In fact, other major pharmaceutical companies with their backs against the wall have been changing their traditional ways of doing business: witness 

's new willingness to outsource manufacturing and 

's efforts to restructure its R&D processes. Most major pharmaceutical companies, however, are still run by company veterans for whom the traditional business model is deeply ingrained. If Kindler's remodeling effort is successful, it may encourage the boards of other Big Pharma companies to look outside for new leadership with a fresh perspective. That could really shake up the CRO and CMO business. 

The other big outsourcing industry news in January was 

's (Dublin, OH) announcement that it will sell its Pharmaceutical Technologies and Services (PTS) unit to 

(New York, NY), a very large private equity firm, for $3.3 billion. PTS has capabilities in packaging, oral drug delivery, and sterile products manufacturing, with more than 30 sites worldwide. 

The sale of PTS was not itself a surprise because Cardinal Health had announced its intention to sell the business in November 2006. The surprise was that PTS never went to auction: Blackstone was able to pre-empt other potentially interested parties with its bid, which is 1.8 times PTS's revenues of $1.8 billion and 10 times its earnings before interest, taxes, depreciation, and amortization (EBITDA) of $320 million. 

Undoubtedly, Blackstone was willing to bid so aggressively for PTS because it knows the business and industry so well. Its senior advisor on the deal is Alex Erdeljan, the former CEO and chairman of 

, the softgel manufacturer that was bought by Cardinal Health in 1998 and forms the core of PTS's oral drug delivery business. After the R.P. Scherer sale, Erdeljan was a managing director with Global Healthcare Partners, a part of CSFB Private Equity Group, which owns contract manufacturer 

In addition, just a week after the deal was announced, Blackstone announced that George Fotiades, the former CEO of PTS and COO of Cardinal Health, would join the board of the new PTS. Fotiades is also an R.P. Scherer veteran. 

Although the price paid for PTS is significant, it is practically "chump change" for Blackstone. Right after announcing the PTS deal, Blackstone won the bidding war for Equity Properties, a company that owns a large commercial real estate portfolio. The deal, the value of which will exceed $38 billion, is said to be the largest private equity deal of all time.  

Blackstone's other pharma-related properties include 

 an Indian pharmaceutical business with activities in API manufacturing; developing branded formulations and biotech products; 

 a mid-sized specialty pharmaceutical company headquartered in Denmark; and 

 a manufacturer of specialty glass products used in packaging in the pharmaceutical, cosmetic, and specialty food and beverage industries. 

On the basis of its past history, Blackstone is likely to hold on to PTS for three to five years, perhaps acquiring additional businesses to add to its offerings. With the favorable industry market conditions and PTS's major investments nearly completed (especially in sterile manufacturing), Blackstone is entering the contract manufacturing and development business at an especially propitious time.  

As big pharmaceutical companies restructure and reevaluate the way they do business, contract research and manufacturing organizations could reap greater financial rewards.