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European Pharmaceutical Contractor

The CRO Scene in 2010

Graham Hughes, editor of EPC, looks at what the past year has meant for pharma companies and CROs, and predicts that the line between them may become increasingly blurred in the future

We all expected 2009/2010 to be a difficult year for CROs – and so it proved to be, but perhaps it was better than we feared. The challenges, of course, arose from the financial constraints being placed on the biopharmaceutical industry – just part of the constraints put on the industry and society as a whole. There is no doubt that pharmaceutical companies were, and continue to be, under huge pressure to show evidence of cost reduction, but this needed to be achieved through a sustainable model which today must include outsourcing. While there will be some ‘knee-jerk’ deals done as a reaction to the economic downturn, supplier value propositions are under the microscope as clients look to ensure not only value for money, but also strategic success. In addition, the amount of highly skilled labour currently unemployed around the world has made staffing a shared service centre or centre of excellence somewhat easier.

Companies around the world need to ask themselves a series of questions. As an outsourcing supplier or CRO, does the market truly understand your value proposition? Are you speaking to the right people, at the right time, to get your value proposition across? As a company looking to outsource, do you know whom to go ahead with, how and where, and how to get optimum value from your supplier?

OUTSOURCING: AN OPTION OR A NECESSITY?

Over the last two turbulent years, the outsourcing industry has actually grown – not just in the biopharmaceutical industry but in the industry as a whole. Companies have found that outsourcing has shifted from a management option to a necessity. Moreover, customer companies are looking at further expanding their future outsourcing programmes across more divisions, and provider firms are facing the challenges that come with presenting outsourcing solutions in today’s more complex environment. This has created an environment where outsourcing professionals, be they customers, providers or advisors, are sought after for advice and counsel by their companies. It is predicted that companies will opt to return to using outsourcing to recapture innovation and provide flexibility in 2010/2011, rather than simply saving money. However, global economic uncertainty will continue to affect the industry according to predictions by the International Association of Outsourcing Professionals (IAOP). The following predictions apply to the industry in general and many to the biopharmaceutical industry specifically:

  • Delayed deals get the green light – the economic downturn over the past 12 to 18 months put many outsourcing deals on hold. Companies are now forging ahead with renewed confidence in the stability and growth of economic markets.
  • Desperately seeking value – the tremendous pricing pressure on outsourcing deals helped some companies to see the damaged relationships caused by deep pricing cuts and highlighted the business value that outsourcing brings. Providers and customers are beginning to re-negotiate contracts more collaboratively to regain innovation and flexibility, and enhance total value.
  • Flexibility to get out of contracts – with uncertainty still surrounding the economy, companies are hesitating to make long-term commitments with outsourcing service providers because of the fear of the unknown.
  • Uncertainty leading to consolidation – global economic uncertainty, currency fluctuations and other market forces have encouraged increasing levels of mergers and acquisitions on a global basis, particularly among service providers.
  • Outsourcing hiring return – we expect to see growth in the hiring of graduates in emerging outsourcing locations, as well as wage increases of eight to 10 per cent in India and many other Asia Pacific locations, while North America and western Europe will see much smaller rises.
  • New outsourcing destinations emerge – rising geographies in Central and South America will continue to take market share away from traditional outsourcing locations, such as China.
  • New destinations differentiate themselves – as new destinations emerge, the competition among outsourcing providers will intensify, encouraging parts of the world – particularly the BRIC (Brazil, Russia, India and China) nations – to differentiate themselves.
  • Tooling up with technology – companies will increasingly make use of advanced management practices, tools and technologies – such as outsourcing relationship management and cloud computing – to provide improved value and operational flexibility and performance.
  • Social responsibility – outsourcing practices will continue to be affected by increased environmental awareness and social responsibility. The industry will be called on to step up its role as a leader in corporate social responsibility globally.
  • Political shifts – further increased government regulation and the resulting need for compliance will affect outsourcing in the coming year.

While writing this article, I Googled ‘Outsourcing in 2010’. There were very few hits that concerned the pharmaceutical industry; indeed outsourcing seemed to be about IT and engineering manufacture. Moreover, outsourcing seemed to be synonymous with off-shoring. On this latter point a contrast must be pointed out: the vast majority of outsourcing in the pharmaceutical industry is to traditional territories. PhRMA reported that in 2009 its member companies spent 24 per cent of its R&D expenditure within the US and in 2009 reduced their offshore expenditure by 7.1 per cent (1).

A VOICE IN THE WILDERNESS

As I started to go through the Google search results, I noticed two things. First, we’re not alone. The topics that we’ve been discussing in the pharmaceutical industry for several years now – declining profits, stagnating product pipelines and an industry in crisis – are being written about by many people in industry. In addition, and this surprised me, people have been writing about this for a long time, years in fact. I started writing about strategic outsourcing back in the 1990s and commented then that the pharmaceutical industry was years behind industry in general when it came to outsourcing. This may still be true but I think, and hope, that the gap is closing. For a while I thought I was something of a voice crying in the wilderness but there were others.

One writer, Bianca Piachaud, wrote a particularly good article back in March 2002 for Contemporary Review on the issues facing the pharmaceutical industry which are still relevant today (2). Dr Piachaud made one particularly prescient observation that the past eight years has borne out. She noted the unsustainability of pharmaceutical profits because of increasing competition from generics, government policies, and the increasing costs of finding new drugs. Reports from the then Arthur Anderson Consulting also made this point. Dr Piachaud made reference to the cost-cutting programmes being put into place to try to fend off the inevitable.

I also found in this article the first rational explanation of why product pipelines are stagnating. Dr Piachaud highlights the increasing diminishing returns from research as technology with its costs becomes a larger part of the work undertaken. She also notes the contributions of administrative inefficiencies and increasing bureaucracy in lowering profits. The unsettling aspect of her article is that there does not appear to be any good news soon for the pharmaceutical industry. We may be moving through the middle game preparing for the end game.

RE-ENGINEERING R&D PIPELINES

Current trends in pharmaceutical and biotechnology business practices indicate that they are facing the same reality that many other industries have already embraced; they must utilise outsourcing partners as an integral aspect of their R&D engine. Pharmaceutical leaders are coming to the realisation that outsourcing has the potential to deliver excellent business value beyond simple cost savings and operational flexibility, albeit slowly. An observable outcome of this shift in ideology is a major realignment of even the largest pharmaceutical companies. This now commonplace occurrence is an inevitable effect of the changes in strategic implementation of the re-engineering of their R&D pipelines.

The outsourcing paradigm supporting R&D needs to continue to transform rapidly to support industry needs – a pattern seen in other industries such as IT, banking and manufacturing. Early outsourcing decisions were made on a tactical level, primarily to leverage cost out of low-risk, large-scale functions. In the pharmaceutical industry this included clinical support, manufacturing, as well as large scale screening library synthesis. This tactical approach was easy to measure and proved to be a low risk means of removing fixed expenditure from the drug discovery process. Unfortunately, in my view, these changes have yielded scant success. As an example, if looking for a new candidate is like searching for the proverbial needle in a haystack then large-scale screening library synthesis has merely created larger and more impenetrable haystacks. These early approaches have matured to include capacity management, flexibility and the externalisation of non-core functionality, which still have a focus on cost containment rather than value generation which is the key to strategic outsourcing success.

The pharmaceutical industry is now realising that, as in other industries, the traditional view of outsourcing as a tactical, cost takeout solution can spell failure in today’s intensely competitive, dynamic business climate. This is apparent in the pharmaceutical industry, as key decision makers have at last indicated the need for more strategic, value-creation approaches to support their pipelines. It appears that the industry is looking more towards outsourcing partners, not only for the cost containment and flexibility they afford the organisation, but even more for opportunities for collaborative innovation, new ideas and fresh perspectives. In fact, dozens of fully integrated drug discovery relationships between pharmaceutical and contract research industries have been announced in recent years.

EMERGING TRENDS

It is not easy to obtain a lucid picture of the current state of utilisation of contract research by the industry as practices vary dramatically between companies. For a while, Solvay stood out as a proponent of true strategic outsourcing, but recently Eli Lilly, AstraZeneca and Pfizer have followed suit to a lesser extent. Clearly however, a number of trends are starting to emerge. Pharmaceutical companies are looking to become more flexible through the divestiture of fixed assets and, in certain instances, entire segments of their drug discovery engine as noted with Eli Lilly. Indeed reduction of fixed costs seems to be a developing theme. In instances where pharmaceutical companies divest entire aspects of the discovery pipeline to others, or utilise contract partners to augment or accommodate capacity needs in a strategic manner, it is clear that the contract partner stepping in to fill the gap must be able to act as a true partner rather than a sub-contractor. In other words, the outsourcing partner’s capabilities and skill sets need to dovetail with the talent and facilities that the pharmaceutical company has retained internally in a seamless manner. Many CROs are very familiar with such a concept, having done this for the biotechnology industry for years. The industry is also familiar with this approach in its dealings with smaller, more innovative biotech companies, although few of them would regard this as outsourcing.

Another important trend that is emerging is outsourcing to companies that have facilities in locations that provide significant research or tax credits through government sponsorship programmes. Such incentive programmes have created a demand for R&D infrastructure in Singapore, Canada, certain areas of the EU, as well as China. Indeed, many companies have now established wholly owned R&D facilities in such areas largely, I would suggest, to save on costs rather than to exploit the native inventiveness of their new host countries. Decisions regarding outsourcing placement are increasingly taking local governmental support into account. It is likely that government involvement in the industry will increase in coming years, particularly as a result of new regulations and managed care policies emerging in the US.

Regardless of the eventualities of the various drivers related to outsourcing trends in the industry, the demand on the contract research industry will only continue to increase. Contract research companies must be able to respond proactively to this demand; those unable to do so could be potentially subject to dissolution or acquisition. Many companies are already reacting to this demand by aggressively expanding their offerings to support a broader footprint of the R&D pipeline under one roof. Maybe the return of the one-stop shop is being heralded.

Of course, the pharmaceutical industry’s tribulations are not new. The lag in productivity – fewer new drugs and modest sales for the drugs that do launch – has been a problem for over a decade. Companies are trying to shake off their addiction to blockbuster drugs, and for good reason: 10 of the products on pharmaceutical consulting firm IMS Health’s list of the 15 bestselling drugs in 2009 have been on the market for more than 10 years. No product approved since 2004 has joined the list, and few new drugs have even broken the $1 billion annual sales mark in that time. With fewer successes, healthcare consultancy Datamonitor says that the average cost to bring a drug to market is now a staggering $1.3 billion, up 60 per cent from 2001. And this may well be an underestimate.

The economic pressures on pharmaceutical companies has been accompanied by deep cuts in R&D organisations at nearly every major drug firm, even if the total spend has decreased but little. That alone means that outsourcing has increased as a direct result of financial tensions. Last year’s mergers between Pfizer and Wyeth, and between Merck & Co and Schering-Plough, and the accompanying major layoffs, underscored the efforts to change strategies.

R&D: HOLDING BACK THE DECLINE

So far, the industry has taken a number of measures to address the challenge of declining R&D productivity but nothing really substantial has emerged as a result. One of the most extensive measures has been the acquisition of small pharmaceutical and biotechnology companies with specialised R&D capabilities and promising pipeline candidates of the acquirer’s interest. In addition, the pharmaceutical industry has also witnessed significant consolidation with some of the largest mergers of the decade such as Pfizer-Wyeth, Roche- Genentech and Merck-Schering-Plough. Pharmaceutical companies also underwent significant restructuring of their R&D processes in order to realign their focus to the key strategic therapeutic areas, while divesting from the non-core areas of business. Other measures include outsourcing clinical and preclinical drug research to CROs and better life cycle management of the existing drugs.

However, so far, none of the measures have generated the desired results; R&D productivity continues to remain a matter of concern for the pharmaceutical companies. While outsourcing R&D to CROs and drug discovery companies in emerging countries provides cost advantages, the advantage is partially offset by the increase in failure rates. Other solutions such as life cycle management have their own limitations in terms of safeguarding the company’s revenues against the declining R&D productivity. Thus, none of the solutions, so far, have been able to effectively counter the challenge of declining R&D productivity.

The CRO scene is one of constant change. It suffers or benefits (depending on your point of view) from the stresses and strains of the pharmaceutical industry. Some companies, notably MDS, have found the strains passed down to them too much and have decided to exit the CRO scene altogether. Others have embraced the challenge and seek to respond even if it means an element of rebranding (Quintiles for example). Yet others have decided that they cannot go it alone and have either merged, been acquired or set up some form of strategic alliance. In the 12 months to May 2010 we recorded 73 mergers, acquisitions, joint ventures and strategic alliances – rather more than in the same period of 2008/2009. Thus this last year has been something of a bumper period.

In spite of the difficulties, the market has still grown in the last two years and I expect it to continue to do so. The total size of the CRO market was currently estimated at $23.5 billion in 2009, illustrating a growth rate of 11 per cent from the revised figure for 2008 of $20.8 billion. At first this looks to reflect a very healthy industry sector. Phase III consumes some 32 per cent of R&D expenditure and it is here that pharmaceutical companies will exert the greatest pressure on CROs to reduce their costs – thinking, perhaps erroneously, that this is an area where least value can be added by outsourcing partners. We expect nonetheless this sector to continue to grow. The other area of outsourcing that will surely grow is the pre-clinical and toxicology sector not least because of the REACH legislation that has been enacted in the EU.

CONCLUSION

I commented in 2007 that the 15 per cent growth in CROs in 2006 was very healthy and impressive by any standards. I subsequently thought that the 25 per cent growth rate in 2007 was astonishing. In 2008 the growth was much more modest – 12 per cent – while in Q1 2009 for the first time in many years (if not ever) we had an actual decline of two per cent and promises of worse to come. However, the forecast annual decline did not occur and the market remained at a very high level of around $23 billion with a growth of 11 per cent. Despite this, the prospect of more mega mergers and the subsequent cutting of major therapeutic programmes did little to suppress the gloom which had begun to settle over the industry, but the industry survived and indeed grew, if not prospered.

As well as the 11 per cent growth, we have again seen a record number of mergers, acquisitions and joint ventures between CROs; many of these are international and many involve developing countries. We have also noted a sustained but reduced interest from private equity and investment banks in the sector. Off-shoring of clinical research has continued to be a trend as both the expertise and experience of CROs in developing areas continues to increase. There is still something of a trend towards therapeutically specialised CROs, but this is overshadowed by the growth of the major publicly traded CROs. The one-stop shop however has almost disappeared, so that outsourcing the complete development of a drug to a single CRO is now unlikely, although not impossible.

The CRO industry, as I have frequently noted, is now indispensable to the pharmaceutical industry. As the industry struggles with its challenges of governmental price control, apparent lack of new blockbuster candidates, personalised medicine and patent expiry, we will, I predict, see increasing relations between CROs and the pharmaceutical companies, and a growing blurring of the dividing line between the two. We look forward to a more profitable 2010/2011.

Note
Dr Hughes’ comprehensive analysis of the CRO scene, including details of annual revenues, profitability and stock market performance of the public CROs, and a host of statistical analyses is available from BiopharmKnowledge Publications (http://www.biopharmknowledge.com/).

References

  1. PhRMA Profile 2010, Table 1: Domestic R&D and R&D Abroad, PhRMA Member Companies: 1970 to 2009, www.phrma.org/sites/phrma.org/files/attachments/Profile_2010_FINAL.pdf
  2. Piachaud B, Challenges facing the pharmaceutical industry, Contemporary Review, March 2002, http://findarticles.com/p/articles/mi_m2242/is_1634_280/ai_85370544/?tag=content;col1

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Graham Hughes is a leading expert in the field of outsourcing in pharmaceutical development. He was the founder and Scientific Director of Technomark Consulting Services in 1987. Graham is Editor of European Pharmaceutical Contractor and International Clinical Trials. He is a frequent speaker and chairman at national and international conferences on outsourcing and drug development. He has also run numerous workshops on the selection and management of CROs. He has recently been Chairman of Auxetica, a UK-based medical device company, and is President of Aginko AG, a Swiss CRO specialising in musculo-skeletal medicine. He is currently a Director of Oxford Cardiac Pharmacology Ltd and Vice President of Technomark Life Sciences, which is based in the US.
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