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European Pharmaceutical Contractor

Back to the Future

Some years ago, I was able to do a review of the previous year by concentrating mainly on the publicly quoted contract research organisations (CROs). For a variety of reasons, mainly the interest of private equity, this has become increasingly difficult in recent years. It used to be said that about 80 per cent of the revenues in the contract research area was in these public companies, and so making an analysis of market size and market predictions for the future was relatively straightforward. However, with this relative lack of publicly quoted companies – there are now fewer than 10 of any significance – the analysis has become more difficult and more complex.

In the past 14 months, we have seen PPD International and eResearch taken into private hands. This means that my analysis of the public companies now concentrates on eight companies that are exclusively CROs. Table 1 shows an analysis of how these companies have performed in the last four quarters for which figures are available.

This is not at all a bad result and is probably reflective of the sector as a whole, representing a good cross-section of the companies and perhaps 25 per cent of the whole market. What is noticeable is that the sector is not wildly profitable and that the profits vary considerably from year to year. Interestingly, these profitability figures are of the same order of magnitude as the current return on investment in pharmaceutical R&D. However, they are well below the profit margins that investors in pharma companies themselves would be expecting.

In terms of share price, these companies have done very well over the past year, as Table 2 shows. These figures compare well with the composite NASDAQ index, which gained 14.2 per cent in the same period.

The big acquisitions by private equity in 2012 have been the completion of the acquisition of PPDi by affiliates of The Carlyle Group and affiliates of Hellman & Friedman in an all-cash transaction valued at approximately $3.9 billion, and the acquisition of eResearch Technology by Genstar Capital Llc for $400 million. Compared to a few years ago, the public ownership scene has changed quite dramatically, with companies such as Kendle, PharmaNet and Averion all being taken private, while major players such as i3 and Omnicare have been disposed of by their publicly quoted owners and MDS quit the CRO market altogether. At one time, Quintiles – arguably still the largest CRO – was public, but it ceased being a public company in 2003. There are rumours that it could file for an IPO within the next 18 months. However, even if Quintiles does become a public company, the challenge of estimating the total market size of the CRO sector will still remain.

So, how large was the CRO sector in 2012? Over the past year, there have been a number of wildly differing estimates of the market. Two recent reports stand out: the Harris Williams & Company 2008 Market Monitor report and the 2011 BCC Research report. These attempt to estimate the size of the overall CRO market and affirm the growing interest in this aggregate market metric. The former report focused on the larger healthcare and life sciences arena but estimated – using a top-down approach – the size of the contract clinical, preclinical, manufacturing, clinical laboratory and sales markets. Harris Williams, a private investment banking firm, estimated that the total market for these specific service areas in 2008 reached approximately $75 billion. The later BCC Research report sized the overall 2011 global outsourcing market at $217.9 billion. This top-down analysis included not only contract service providers supporting prescription drugs, but also over-the-counter and nutraceuticals products.

In April 2012, GBI Research, a leading business intelligence provider, released its latest report, ‘Contract Research Organizations Market to 2018’. According to this report, CRO industry market revenues were estimated to total $21.4 billion in 2010. In 2009, the revenues recorded were $19.1 billion. From 2009 to 2010, the industry grew at the rate of 12 per cent, which was considered to be very healthy in comparison with other R&D industry growth.

According to clinicaltrials.gov, by November 2011, 43.9 per cent of clinical trials were carried out in the US; 22.9 per cent of the trials were carried out in Europe; 11.6 per cent in Asia; and the rest in Canada, Mexico, Australia, Middle East and Africa – approximating 21.4 per cent of the total clinical trials. GBI Research estimated that the global R&D outsourcing market in 2010 was 25.3 per cent of the total pharmaceutical R&D expenditure. The expenditure is estimated to increase at the rate of five per cent annually and is expected to reach 37.1 per cent of the total R&D expenditure by 2018. Extrapolation of these figures would give a market size of $23.6 billion, which is below the figure that I estimated for 2011 ($28.5 billion). As an aside, CMRI, a Thompson subsidiary, has estimated, using figures provided by the industry itself, that only some 20 per cent of clinical development was outsourced in 2010 – a figure they expect to rise, but one nonetheless below many commentators’ estimates.

In May 2012, a group from Tufts University took a rather different approach. The five primary market segments they evaluated corresponded with primary R&D and manufacturing processes: applied research; non-clinical research; clinical research; chemistry manufacturing and controls (CMC); and staffing-consulting-management (other) services. This ‘other’ segment includes a wide variety of small, independent companies, as well as large providers offering contract professional staffing, supply chain management, import/export and distribution services, as well as business development support. The analysis was confined to the US, but provided an interesting insight into the structure of the market. In total, 3,244 unique contract R&D service companies actively operating in the US were identified and analysed. These companies generated an estimated $32.9 to $39.5 billion in contract R&D services revenue, with the largest share coming from the CMC and non-clinical market segments – 29 per cent and 21 per cent ($7.6 billion) respectively. The clinical sector (including regulatory affairs) was estimated as $6.5 billion. Tufts estimates that the total global market for all contract services supporting prescription drug R&D is $90 to $105 billion. The total global market for contract R&D services could be more than fi ve times larger than commonly cited fi gures. These fi gures can be contrasted with those from other analyses.

At the recent Partnerships in Clinical Trials (PCT) conference in Hamburg, Tim Wilcock of Leader Partners also reported on the size of the CRO market. His fi gures and those from industry fi nancial analysts average out at some $26 billion, the US being $11 billion, EU $6 billion, Eastern Europe $4 billion and the rest of the world $5 billion. This average figure is very much the figure that I would have forecast based on my annual report from 2011, and is wildly different from estimates given above. Wilcock forecasted that penetration of the market would grow at between fi ve and eight per cent, leading to an average growth rate of eight-and-ahalf per cent, the majority of this being in Phases 2 and 3. He thought that the rest of the world contribution would double by 2017.

So it is clear that the market is very large – somewhere in the region of $30 to $100 billion a year. However, the size of the market clearly depends on what you define as a CRO. I myself prefer not to include contract manufacturing services, as well as contract sales and marketing services, and would estimate the market at around $32 billion.

How the market will evolve in future years depends critically on two issues. The first of these is how industry will continue to respond to financial pressures which are increasingly being heaped upon it. Will R&D continue to grow at an historical rate, or will it be much more stable and become perhaps a declining percentage of pharmaceutical industry revenues? At the PCT Hamburg conference, there was general agreement that the cost of R&D was becoming rapidly unsustainable. The view was that it would have to be reined in, particularly in the clinical trials area, while many of the innovative initiatives to discovering new clinical development candidates had failed to bear fruit. One speaker likened it to looking for a needle in a haystack, but that some initiatives had merely produced larger haystacks with the same number of needles.

The other critical issue is the one to which I referred in my report last year, namely strategic outsourcing. I think it is fair to say that the jury is still out on whether strategic outsourcing has been a success and is here to stay. Pfizer and Eli Lilly have reported major savings of around 20 per cent compared with in-house clinical development. However, US consulting company Avoca looked at the type of sponsors that have formed strategic partnerships – predominantly larger companies – and the type of CROs they have selected, which are the larger research organisations. In its evaluation of the impact of strategic relationships, Avoca has found that sponsor ‘satisfaction levels’ – defined using measures like overall project success, resourcing and regional expertise – are higher for strategic partners than for CROs engaged in more traditional client-vendor relationships. While this suggests strategic CROs are delivering in areas in which they already have expertise, the other key finding – that around 25 per cent of all strategic deals are scrapped ahead of time – indicates that there are still some improvements to be made. These findings, coupled with the fact that only 47 per cent of Avoca’s respondents have formed strategic partnerships so far, suggest that while more strategic deals are likely, they are going to be of a smaller scale and involve mid-tier pharmas and smaller CROs.

So what can we expect in the future? Strategic outsourcing will continue to be a topic of great interest, with some companies opting for more and perhaps some companies opting for less. Globalisation of clinical trials will take studies into further far-flung areas of the world (notably China as India has somewhat lost its attraction) which will encourage the major CROs to either partner with local companies or simply acquire them. Medium-sized CROs, from $50 to $200 million in size, will become, in my view, targets for acquisition or merge with each other in order to take on the major players and achieve the critical size that will allow them to become strategic partners with some of the larger pharma companies. For years, people have talked about driving down the cost of clinical research. Perhaps social media, driven by the continuing electronic communications revolution, can contribute to some extent toward reducing costs. Of course, the pharma companies would like to reduce costs, but if CROs are able to innovate, and they are certainly big enough to spend internally on innovation, they will only do so if they can reduce costs while pushing up margins and increasing their market share. 2013 will be an interesting year for the industry and I look forward to reporting on it in 12 months’ time!

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