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European Pharmaceutical Contractor

The Race Towards Strategic Outsourcing?

In 2010/2011 22 alliances with CROs were announced by major pharma companies – a sign that the industry was willing to accept the virtues of strategic outsourcing. In his latest Contract Research Annual Review, EPC’s Editor Graham Hughes provides a complete picture of the CRO market, looks at the latest trends, and explains how they will affect the future of the industry.

In my annual review last year I quoted Mike Martorelli of Fairmount Partners: “Last year was a challenging one for the biopharmaceutical industry. Companies of all sizes took important steps to refocus their research and development efforts; many discontinued further research in some important therapeutic categories. To no one’s surprise, 2009 also proved difficult for the outsourcing companies that serve the research, manufacturing and marketing needs of the biopharmaceutical industry. The largest providers of contract services in the preclinical, clinical, manufacturing and sales and marketing arenas posted their weakest financial comparisons in several years.”

My review this time around could have begun in exactly the same way, merely substituting 2010 for 2009. But in 2010 there has, in my view, been something of a sea change in the CRO industry. At long last pharmaceutical companies have begun to get the message about strategic outsourcing for drug development, and the landscape has been transformed by the 22 strategic alliances announced in the last 12 months. Thus, drug development seems to be beginning to catch up quickly in terms of outsourcing with other aspects of pharmaceutical business and with the industry in general. As an example, a press release from Takeda – one of the companies to announce a strategic alliance in 2011 – that I received was entitled: “ As development costs continue to rise in the pharmaceutical industry, it is becoming increasingly important for companies to keep expenditure to a minimum.”

The theme of strategic outsourcing was one taken up by Dave Windley, Managing Director of Healthcare Equity Research at Jeffries & Company. He believes that the top seven CROs will have captured half the market by 2015 as Big Pharma, including Pfizer, enters into strategic relationships with major players.

Clearly 2010/2011 has seen a major change in the attitude of the big pharmaceutical companies towards the idea of strategic outsourcing. The CROs themselves have quite naturally embraced this with open arms and although there are some with reservations, it looks to be the fashion of the moment.

Analysis of CROs by Company Type

In each of the regions analysed, 50 per cent or more of the CROs are independent, privately owned companies; globally the total is 56 per cent less than the last report.This can be accounted for by the increasing number of foreign subsidiaries being set up by major CROs.Overall public companies account for only 1.4 per cent of the total numbers, but well over 50 per cent of the total revenues.Thus, as can be seen in Table 1, the public company is still a real rarity. Only 16 companies are both public and independent; this figure has decreased from 18 in 2005, 22 in 2007, and 28 in 2008. In 2010 there were a number of public companies that were privatised (for example, Kendle was acquired by the private company INC Research). In addition, there is a dwindling number of very large CROs that are subsidiaries of much larger public companies (for example, SGS).

Analysis of the Size of the CRO Market

As I have noted in previous annual CRO reviews, the estimation (or calculation) of the size of the market is a formidable task. Part of the challenge is that very few CROs are publicly quoted and hence are not required to reveal their revenue figures, particularly with the number of recently privatised companies that are very large – notably Quintiles. Unfortunately the task is becoming that much harder, with more companies either opting to become private or being acquired by private CROs or private equity. Privacy seems to be ruling the day and many of the privately owned CROs regard their revenue figures as highly confidential. However, while difficult, it is possible to estimate a reliable figure for the global market using data supplied by the CROs themselves.The public companies make up over 50 per cent of the total market and hence errors in the estimates of the private companies are of somewhat less importance.

Another challenge arises from the situation where companies are subsidiaries of public or private companies; in such cases, several of the public companies have given revenue figures for the various divisions in their annual reports and this makes it possible to estimate the revenues reasonably accurately. In 2011, the situation has shifted as two of the large CRO subsidiaries of very large public companies – Omnicare and i3 – have been divested by their mother companies.

Table 2 highlights the projected annual revenues.The results show that 2010 was hardly a stellar year for the publicly quoted CROs; the overall growth rate was just 3.7 per cent.However, if we exclude the Japanese and Chinese CROs – CMIC and WuXi – then the overall growth was just 2.5 per cent.Th prospects for 2011 seem a little brighter; figures in the first quarter of 2011 are 7.7 per cent higher than the same quarter in 2010 (data from Eurofins has not been included, as it divides its revenues geographically, which make estimation of its pharmaceutical revenues impossible).

As mentioned previously, private companies are more reluctant to give out annual revenues and profitability figures.Table 3 records the data we have had historically with estimates of current revenues in red.

As with the public companies, there seems to have been limited growth overall. What growth there has been in individual companies has been through mergers and acquisition rather than organic growth. (The ‘total’ figures take account of changing ownerships and uses estimates of 2010 figures not specified in the table). This year, the review has managed to obtain figures for more companies so that a direct comparison with the data from the previous years to estimate the total market would be less confusing.With these extra data points the review estimates the market as being larger than previously thought.

The sums for the large public and private companies alone add up to some $19.5 billion. With the increase in market share of the larger CROs due to the significant increase in strategic alliances – the review estimates that the companies reported represent some 70 per cent of the total market (rather than 65 per cent in previous years), which can then be estimated as $27.5 billion. In 2010, the market is estimated at $23.5 billion, but, as mentioned above, this figure is not strictly comparable. This figure also included estimates of the value of the market for central clinical laboratories. I am in the process of updating the report in this area, and plan to publish it in the autumn. Preliminary estimates would put this market at around $1 billion. Thus, it can be estimated that the total market for preclinical, clinical and analytical companies is at around $28.5 billion.

The health of the CRO industry, of course, depends greatly on its profitability. It is not enough for the total revenues to increase if profits do not keep pace. In this respect, 2010 was not a good year in general for the publicly quoted companies for which we have data (see Table 4).

For the sake of the CRO industry, and especially its sponsors, it is hoped that the recent trend of decreasing profitability is reversed.

Mergers,Acquisitions, Joint Ventures and Strategic Alliances

In the 12 months, up to May 2011, I recorded 66 mergers, acquisitions, joint ventures and strategic alliances – fewer than during the same period of 2008 to 2009. Just over half the deals (35) recorded were acquisitions, the largest of which were the INC acquisition of Kendle,Warburg Pincus acquisition of RPS, Eurofins acquisition of Lancaster and, by far the largest of all,Medco’s $730 million acquisition of United BioSource Corporation (UBC).

Unsurprisingly, the US dominated, with 52 out of the 66 acquisitions involving US-based companies.The emergence of inVentiv as a major player with its two major acquisitions of i3 (from Ingenix) and PharmaNet is of particular interest. That the major healthcare benefits organisations of Omnicare and United Health have exited the CRO space is no great surprise; they both seem to have made the decision at about the same time. Interestingly the entry of Medco with its huge acquisition of UBC can be seen as reversing this trend. Again, as we have seen earlier, the effect of these mergers and acquisition has been to reduce further still, the number of large publicly owned CROs.

Strategic Alliances between CROs and Pharmaceutical Companies

There has been a rapidly growing and, to me, astonishing, if belated, number of strategic alliances between CROs and big pharmaceutical companies. As followers of this report will have noted in the past, I have almost despaired of the industry ever outsourcing strategically. Suddenly, 13 companies have announced a total of 22 strategic alliances; these are recorded in Table 5, page 19. Whether these alliances will be successful remains to be seen as there are very few already up and running, but as far as the major CROs are concerned this is a sudden but extremely welcome trend.

Analysis by Size of CRO

Five hundred and fifty-three CROs provided us with figures (often in a range) for their annual revenues. Figures 1 and 2 present a summary of the CROs in Europe and North America respectively, that have provided data, presented as a percentage of the CROs reporting. The data is representative of the total numbers. The average sizes of small to medium CROs (that is, less than $100 million in annual revenues) in Europe and North America are estimated as approximately $7.9 million and $10.98 million, respectively. These figures compare with $6.3 and $10.7 for 2007 showing that by this measure the CRO market continues to grow. It is interesting to note that the average size of the European CRO in the $1 to $100 million range is 70 per cent of that of the average North American CRO, and that, with a few notable exceptions (Quotient, ICON, SGS and Chiltern), all the CROs worth over $100 million are from the US.

In both regions it is clear that the great majority of CROs are small companies, with 47 per cent of North American and 48 per cent of European CROs having annual revenues of $3 million or less. It is mainly the smaller CROs that have not presented us with annual revenue figures, and thus we estimate that the CROs with revenues less than $100 million underestimate the total market by 35 to 40 per cent. Using this figure, the report estimates the marke represented by these CROs is approximately $6 to $6.8 billion. To this figure we can add the annual revenue figures of the leading public and private CROs – as shown above of $19 billion and the independent central laboratory revenue of $1 billion. The total revenue is thus $20 to 26 billion, which is in agreement with the figure given above of $28.5 billion.

The growth of the overall market from 1993 to 2010 is shown in Figure 3. The growth from 2009 to 2010 is estimated at 16 per cent above last year’s figure of 11 per cent. Since 1993 the market has grown by nearly nine-fold, with a compound annual growth rate of 13.75 per cent.

Conclusion

Last year I commented that the growth rate of 13 per cent was highly satisfactory for an industry sector that was thought to be under significant pressure. I hoped that 2010 would be a good year as well, and, in spite of all forebodings of gloom, so it has proved. This year the annual growth for 2010 was estimated to be around 16 per cent to a total of $27 billion (although this increase may be in part due to improved reporting and distorted a little by exchange rate fluctuations).

The health of the CRO industry, of course depends greatly on its profitability. It is not enough for the total revenues to increase if profits do not keep pace. In this respect 2010 was not a good year in general for the publicly quoted companies where the report has data. Profitability has certainly declined. Companies may be trying to address this problem by downsizing their workforces, but this may have some quality issues if increases in the use of automated processes in CROs are not also introduced. Pharmaceutical companies must be aware that an unprofitable CRO sector would be bad news.

As well as the 16 per cent growth, there have been a large number of mergers, acquisitions and joint ventures between CROs; many of these are international and many involve developing countries although the US continues to dominate. 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 continue to increase.

The big change in 2010-2011 has been the announcement of a whole series of strategic alliances between big pharmaceutical companies and, in general, major, publicly quoted CROs. If this trend continues, it looks set to have a major impact on the size of the outsourced sector and we would predict significantly greater growth in the market once these deals get underway. What is not clear, however, is how they will affect the declining profitability of the CRO sector of the industry, and whether the economies of scale that in other industries have accompanied strategic deals will be forthcoming. The strategic deals may also have an adverse effect on the small to medium-sized CROs as far as their business with Big Pharma is concerned; they may find themselves squeezed out if the deals produce the benefits that the sponsors expect. The upside may be in that the small and medium-sized CROs will be increasingly attractive to smaller sized companies who may feel like second-tier clients of those major CROs who have consummated strategic alliances.

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 quite unlikely, although not impossible, unless the CRO is permitted to outsource in its turn without reference to its strategic partner or sponsor.

The CRO industry is, as we noted in earlier reviews, now indispensable to the pharmaceutical industry. The researchbased industry continues to struggle with its challenges of governmental price control, apparent lack of new blockbuster candidates, personalised medicine and patent expiry. The rising and rapid trend to strategic outsourcing has been a sudden and somewhat unexpected response to the industry’s pressures. Perhaps in 2011/2012 we will see a pause in the strategic deals while their effectiveness and benefits are assessed.

Note

Graham Hughes’ full review of the CRO scene, together with news from the CROs over the past 12 months, is available to purchase: Contract Research Annual Review 2011, The Complete Picture of the Contract Research Market, Biopharm Knowledge Publications, July 2011, www.biopharmknowledge.com/guides.htm#annualreview2011


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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. Email the editor: rgh1805@btinternet.com
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