Outsourcing: The Next Generation

Over the last few decades, the pharmaceutical industry has been highly profitable, whilst keeping ownership of all components of its value chain. However, the traditional pharma business model is now seriously challenged by a number of market forces, such as steeply increasing drug development costs and a lack of new promising drug candidates. In response to this challenging environment, adjustments to the classic big pharma model were realised and resulted in an increased use of outsourcing and in-licensing opportunities. In this article, we would like to propose a direction for future development in order to build on lessons learnt in recent years and to provide an assessment of how current trends might influence the pharma business model.

Until recently, multinational pharmaceutical companies turned around hefty profit margins, whilst maintaining ownership of the totality of components of an all-inclusive value chain comprising three stages; drug discovery, drug development, and sales and marketing. However, the low yield of innovative therapeutic compounds, and the steep increase in drug development costs that occurred within the last decade, created the impression that a single organisation can no longer excel in each of the three categories of the value chain. This should not come as a surprise, considering that in most other industries – the airline and information technology for example – the various components of the value chain have increasingly been transferred to the responsibility of independent specialised entities, and that this latter model steadily provided noticeable value increase for the end customers.

In an attempt to counteract the effects of rising drug development costs, large pharmaceutical companies began to outsource segments of the drug development activities for which they lacked resources to contract research organisations (CROs). The rationale behind this strategy was to increase the operational flexibility, whilst aiming to reduce fixed costs and deliver a higher return on investment. This approach was based on the assumption that the development portion of the value chain was far less promising than the primary research or sales in terms of value capture. Since pharmaceutical development, and more particularly nonclinical and clinical testing, was implicitly analysed as having the potential to become a value outflow sector, it was reasoned that these activities could be outsourced without a significant negative affect on the company’s overall value creation. However, even though this business model seemed conceptually viable only a few years ago, nothing is farther from the truth in the brave new world of intense cross-sector competition for margins derived from value perception by the client.