Penny-Wise, Pound-Foolish

Over the past decade, the big pharmaceutical companies have been making major efforts to restructure their manufacturing networks. In their haste to shed costs and assets, however, some may be adding risk to their product supply chains.

Jim Miller

The number of manufacturing facilities owned and operated by the major pharmaceutical companies mushroomed in the 1980s and 1990s as new blockbuster products were introduced and as companies opened markets globally. In the days before the establishment of regional free trade pacts such as the European Union (EU) and the North American Free Trade Agreement (NAFTA), much of industry viewed having a manufacturing operation in a foreign country as a necessary investment to ensure that country's regulatory approval of their drug product.

In the past decade, the major pharmaceutical companies have determined that they don't need to maintain large, far-flung, and costly manufacturing organizations around the globe. Several factors have contributed to the drive to streamline manufacturing networks, including:

• The establishment of the EU and NAFTA, along with various mutual recognition efforts, which has facilitated the approval and movement of products across borders

• Mergers among the major pharmaceutical companies, which left the merged entities with too much capacity

• The decline of blockbuster-drug sales and the need for less capacity

• The transition from chemical-based drugs to biologics, which require different manufacturing assets.

Shedding these redundant assets is not as simple as shutting the doors, however. Transferring products is costly and time-consuming under good manufacturing practice (GMP) guidelines. In many countries outside the United States, labor laws often require long union negotiations and large severance payments to affected workers. In all countries, legacy environmental issues can make it difficult to just walk away from a site.

Under these circumstances, selling a facility to a party that intends to maintain it has obvious appeal. Such a sale could help the owner avoid costs incurred in an outright shutdown while maintaining some goodwill with the workers, community, and government. It may generate a little cash as well.

Two-sided sales

The availability of redundant facilities has been something of a mixed blessing for the contract manufacturing industry. On one hand, the opportunity has helped some of industry's largest players to quickly and relatively inexpensively build global networks. Major contract manufacturing organizations (CMOs), including Patheon (Toronto), Recipharm (Haninge, Sweden), Famar (Athens), Haupt (Berlin), Piramal Healthcare (Mumbai), and DSM (Heerlen, The Netherlands), have used acquisitions of redundant manufacturing sites from major pharmaceutical companies to build critical mass. Paris-based Fareva went from zero to EUR 300 million ($409 million) of pharmaceutical manufacturing revenues in just four years by acquiring redundant sites in France, principally from Pfizer.

On the other hand, the purchase of these facilities has been a bane of the CMO industry because it maintains capacity that the market really doesn't need. Major CMOs have the experience and industry understanding to recognize when an available facility has limited marketability. There have been plenty of potential buyers, however, lured by the chance to get into the business for almost no money down and a cushion of contracts for legacy products. This was especially true in the easy-money environment of the past decade.

Too often, the groups that take over these facilities have little knowledge or experience of pharmaceutical manufacturing or the contract services business. They are especially naïve about the major investment needed in new business development and the long lead times involved in building market awareness and establishing new client relationships. They may not appreciate just how far behind the state-of-the-art their facilities and equipment are. Also, they learn the hard way that GMP compliance is costly and must be maintained regardless of the level of plant utilization. Their working capital resources to cover these requirements are often inadequate.

Often, the pharmaceutical companies selling these facilities create a major supply-chain headache for themselves because the buyer encounters financial distress. Examples litter the decade. In a somewhat notorious but illustrative example, sanofi-aventis (Paris) sold a facility in Puerto Rico in 2005 to Inyx, a UK-based company, after several larger and more-established CMOs had looked at the facility and passed on it. Inyx's principal owner and executive was known to have some questionable financial dealings and had already led one CMO into bankruptcy earlier in the decade. So it should have been no real surprise that two years after acquiring the Sanofi facility, Inyx filed Chapter 11, ultimately leading to unfilled orders, financial losses, and a great deal of litigation.

Oread (Lawrence, KS) is another prime example. One of the pioneer providers of analytical and formulation development services, Oread acquired a manufacturing facility in Palo Alto, California, from Roche (Basel, Switzerland) in the late 1990s, and filed for bankruptcy a few years later because it became overextended.

More recently, PharmEng (Toronto), an engineering and validation firm whose Keata CMO subsidiary acquired a Pfizer (New York) manufacturing site in Ontario, filed for bankruptcy protection in Canada.

These problems could have been avoided if the selling parties had exerted better due diligence. This is especially true in cases where the buyers were depending on the divested site to supply product through the transition period.

Next wave?

The concern over the financial viability of divested manufacturing operations has become more relevant because industry has entered another period of consolidation that will undoubtedly spark another round of manufacturing facility sales. Most industry observers expect that Pfizer, after its acquisition of Wyeth (Madison, NJ), and Merck (Whitehouse Station, NJ), after it merges with Schering-Plough (Kenilworth, NJ), will have to shed manufacturing facilities in order to achieve cost savings. Wyeth will bring 33 manufacturing sites with it, adding to the 44 Pfizer will have after it finishes its current 13-site divestiture program. Schering-Plough has 23 sites to add to Merck's existing network.

The sale of manufacturing sites to investors without the staying power to make them successful doesn't benefit any of the parties involved. Moreover, the resulting financial problems could give the entire CMO industry an undeserved black eye. Let's hope that the next round of plant divestitures is handled with more due diligence and foresight.

Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, info@pharmsource.com, www.pharmsource.com.