As the dust settled on fiscal year 2009, pharmaceutical executives could be excused for thinking that the industry had avoided a serious crisis. During 2008, while the Dow Jones Industrial Average fell by about one-third, pharmaceutical indices declined by only 18% [1]. Then in 2009, both the Dow Jones as a whole and the pharmaceutical sector in particular recovered roughly 17% [2]. However, by all indications, change is coming. Most of the industry’s growth (5% in 2008 [1],the latest year for which complete data are available) is driven by emerging markets; annual U.S. market growth is no more than 1-2% [1].The patents on pharmaceuticals with a total annual revenue of $119 billion [1] – an amount larger than the entire market capitalization (June 2009) of Pfizer, Google, Coca-Cola, or Goldman Sachs [3] – will expire between 2009 and 2012. And in the current legislative milieu, where fundamental changes to the provision of healthcare are debated throughout the public sphere, the sustainability of current models of financing healthcare can no longer be taken for granted. There is no sign that a commercial environment that once handsomely rewarded overly cautious behavior – for example, the much-criticized reliance on “me-too” pharmaceuticals released into well-served market niches – will live on forever.
In the pharmaceutical industry as in any other, reductions in revenue, both actual and predicted, naturally lead companies to contain their costs. Drug companies of all sizes are, therefore, increasingly outsourcing development operations to third-party suppliers (TPSs) – converting the fixed costs of maintaining internal, vertically integrated development and clinical manufacture divisions into the variable costs of contracting work to TPSs on an as-needed basis. In one especially common approach, certain aspects of development (such as API and formulation development, with their associated analytical methods), as well as GMP manufacture of clinical supplies, are outsourced, keeping the work that generates the most critical intellectual property (such as the composition of matter, form and formulation, and synthetic route) to be addressed in house. A particular strength of this approach is that outsourcing such critical but less-scientifically innovative steps frees up a pharma company’s resources for the pathbreaking work – solving hard problems, developing novel products for un-served niches – that will likely soon prove essential for that firm to thrive, or even to survive.
Nonetheless, this model leaves room for improvement. Currently, in an effort to contract each service out to (frequently) the lowest bidder, different development operations are often spread among a number of separate contractors – at times dozens – who have little communication with each other, leading to inefficiencies in managing operations and timeline delays at the handoffs between suppliers. As an alternative, some TPSs offer “soup-to-nuts” drug development, from API synthesis route-scouting and pre-formulation through clinical manufacturing. Many of these so-called integrated TPSs are located in Asia (particularly China and India), far removed from the American and European headquarters of many pharmaceutical companies. Others, which have expanded over time by acquisition of smaller TPSs, divide their operation among a number of sites.
This paper proposes a third option: a new type of organization, the integrated local CMC provider (ILCP). This organization is distinctly different from both small and integrated TPSs. Unlike smaller TPSs, the ILCP will offer the “soup-to-nuts” services of an integrated contract firm, replacing the need to spread pharmaceutical development and manufacturing among a large number of partners. Facilities for all of its services, from form selection and API manufacture through production of the final drug product, will be at a single, convenient site.
What will distinguish the ILCP from existing integrated TPSs, however, is its location. The ideal ILCP would be located in a region with an extensive and mature pharmaceutical community, such as metropolitan Boston. The concentration of the drug industry in and around Boston is well known as a classic example of a Porter cluster – a critical mass of interconnected companies and institutions with “unusual competitive success” in the same industry, collocated in the same geographic region. As characterized by Harvard Business School professor Michael Porter, such a cluster crucially includes not only competing firms, but also their suppliers of primary and even intermediate inputs. The proximity of these firms, and their repeated interactions (both corporate and individual), have the net effect of improving productivity, promoting innovation, and providing a nurturing environment for new businesses to grow. Each member of the cluster accrues the benefits of an economy of scale that would be seen by a much larger and more vertically integrated corporation, but without the costs in flexibility and adaptability that afflict a vertically integrated firm [4].
The existence of clusters is paradoxical at first glance, given the traditional view of a global economy in which goods, services, labor, and capital are readily sourced with the click of a mouse. However, the presence of Porter clusters is evident and their strength is undeniable: in California alone, the strength of the wine industry in the north, technology in Silicon Valley, and the film business in Hollywood stand as testament to that. This endorsement of Porter clusters also should not detract from the need for pharmaceutical companies to have a global presence. On the contrary, Vertex Pharmaceuticals has major research sites in the United States, Canada, and the United Kingdom, and has built a world-wide network of R&D institutions that extends to Asia. However, it would still be strategically advantageous to manufacture clinical materials in regions where R&D sites are located in established or developing biotech clusters in each of these countries.
With the ILCP located in a Porter cluster like Boston, collaboration between the ILCP and its partner pharmaceutical companies will be much more extensive than in the usual TPS-client relationship. This collaboration responds to a call, in much recent literature, for an extension of what counts as “in house,” expanding the definition of a company’s “internal” resources to include ‘privileged’ partners acting as extensions of the company’s operations.” [1] The ILCP is designed to be this privileged partner; in a real, practical sense, the ILCP will be able to work with the partnering pharma company, not for it. This collaboration will be based, formally, on the integration in the quality systems of the two firms. By placing QA, as well as pharmaceutical development, personnel from both sides at the focal point of the interaction, cooperation – such as tech transfer – will be nearly seamless. The entire process will be directed by a dedicated Outsourcing Management Team at the partnering drug company, which will include seasoned scientists from each functional area of pharmaceutical development. With this team, the lessons learned from experience of outsourcing will not be confined to a single project, but instead will be entrusted to a team that applies this knowledge to all outsourced projects. Lastly, the collocation of discovery and development services will greatly improve the ease of translational pharmaceutical development – the incorporation of CMC concerns, such as ease of manufacturing and formulation, into the process of selecting candidates for development.
In parallel, an informal mechanism will promote collaboration between the ILCP and its pharmaceutical partners as well. Since scientists from both organizations will be situated near each other, meetings outside the office, such as over lunch, will be much more common. As in any Porter cluster, this will not only promote trust and ease communication between them, but will also serve as a kind of personal, one-on-one tech transfer [3]. These interactions will be educational as well: pharmaceutical scientists will learn the possibilities and limitations of the manufacturing setting, or even see it first-hand, while ILCP scientists will hear of upcoming projects in which they could become involved. As trust develops between scientists at the two organizations, the production, review, and approval of documentation can be streamlined too. And, notably, the easy flow of information demands a salutary level of attention to corporate reputation: knowledge of fair pricing and honored commitments will spread quickly in such an environment. As an added bonus, extensive face-to-face interaction will not only improve the trust among scientists and the ease of information sharing – the elimination of air travel and long-range shipping of materials will also be more environmentally sound, a step towards “green” pharmaceutical development.
While the ILCP could boast all of these advantages in its search for pharmaceutical partners, those partners will stand to gain handsomely from the collaboration as well. The pharmaceutical company will realize time savings through reductions in tech transfers and shipping, and through the benefit of a more proactive partner involved in the development process. Cost savings, meanwhile, will come about through reductions in the need for project management, tech transfer, and travel to remote sites (often on the other side of the world). These savings should partially offset the difference in labor costs between an ILCP in US or Europe versus an integrated TPS in India or China. The risks inherent in adopting new technology – including the risk of under capacity – will also be reduced, as well as being shared across the ILCP and all of its clients. In addition, because the ILCP will be capable of the full range of development services, there will be no need for relationship building with several different TPSs. Also, the reduction in the number of interfacing bodies (there will be no tech transfer between TPSs, for example) mitigates the risk of failure even as both the throughput and the success rate of the pharmaceutical company are increased. All of these improvements, if realized, should be measurable as an increase in the number of compounds reaching clinical use per unit time per dollar.
Lastly, the ILCP may avoid a common complaint about full-service TPSs, which are often said to constrain the flexibility of a drug company. For instance, a company may realize, too late, that a TPS does not have the equipment to accommodate an unanticipated process change. The ILCP, in contrast, could be outfitted with more specialized equipment to respond to the partner pharmaceutical company’s needs. In the event of such unforeseen circumstances, an extremely broad range of services at the ILCP – developed in cooperation with its partner drug companies – will make it more probable that any alternative plans could also be accommodated.
One practical obstacle to establishing an ILCP, especially in the current economic climate, is financing. A logical way to proceed is to expand the capacity of an API or formulation service provider to include the full range of integrated services. Though this may be less demanding than starting a new entity from scratch, it would still involve capital investment in facilities and equipment, as well as hiring of experienced staff. However, a well-located ILCP would have access to certain private equity investors who prefer to focus their businesses on local interests, as well as an appropriately educated potential workforce. Nonetheless, without being sure of new business and interest in the integrated approach from the sponsoring pharmaceutical companies, some risk still exists in such an expansion. The remaining risk inherent in this chicken-and-egg dilemma could be further mitigated, though, by creating multi-year agreements between local pharma companies and the ILCP. A pharma company could commit, for instance, to a certain volume of ongoing business in exchange for services, as well as the creation of the ILCP’s facility and team. In this fashion, two (or more) corporations are drawn together to create a platform for a longer-term business relationship (i.e., further contracts for ILCP work), while working together in the short term (on contracts for existing services). In the longer term, the collocation of the ILCP with its partner pharmaceutical companies will promote a rapid business expansion for the same reason it is easier for local investors to back operations they can see: there will be ample opportunities to become personally familiar with the ILCP staff and, thereby, with its work.
Any new proposal for pharmaceutical outsourcing would do well to consider the example of Chorus Pharma, an autonomous division of Eli Lilly and Co. that has achieved notably quick and inexpensive early development with a virtual R&D, or all-outsourcing, model. Chorus draws on a network of up to 200 TPSs worldwide for preclinical and clinical development, taking it as given that this “flexibility” is preferable to a smaller group of preferred partners [5]. We suggest, in contrast, that having “preferred” providers – like an ILCP – offers comparable flexibility while avoiding the tremendous logistical demands and organizational complexity of managing a multi-member network. Reduced operating costs, simplified tech transfer and problem solving, and minimized risk of communication errors could well lead to results similar to those at Chorus with even lower costs and shorter timelines than Chorus’s already impressive achievement. It is important to stress, however, that our proposal does not replicate a virtual R&D model, only with one provider instead of many. With an ILCP, those phases of development that generate the most critical intellectual property – determining composition of matter, form and formulation, and process – can remain in house if the sponsoring pharmaceutical company is capable of conducting those studies on its own. In fact, keeping certain operations – the most technically complex stages of the most scientifically demanding programs – in house can be of substantial benefit to an organization that seeks to improve speed to POC, and hence productivity, in the future, through the constant accumulation of in-process learning. In either case, GMP manufacturing, as well as less IP-critical stages of development, can be outsourced to the ILCP.
It is important to note, in conclusion, that the ILCP will offer profound advantages not only to each of its partners individually, but to all of them as a whole. As the proactive and seamless partner of numerous local drug companies, the ILCP could develop into the key unifying force of a new, specifically local pharmaceutical economy – a “deep economy,” to borrow a phrase from writer Bill McKibben [6]. For McKibben, a “deep economy” is a local system of collaborative enterprises, modeled after communities (like those that sustain farmer’s markets, for example). Such a system, he argues, is more durable in the long term – and thus better able to survive even a grave downturn in the broader economy.
Of course, as the fulcrum of this “deep economy,” the ILCP would seem to share equally in the standard criticisms of locally oriented, community-style businesses (again like farmers’ markets). Collaborative service is more time intensive, and hence less easily scalable and – at least initially – more expensive. Much as the owners of small farms cannot benefit from the economies of scale of massive corporate agriculture, the ILCP will have no access to lower-cost labor in developing nations. It is an open question whether outsourcing to an ILCP will ever be as directly cost competitive as an Asian TPS; however, improvements to productivity and flexibility with the ILCP may offset this cost differential.
While, as Michael Porter observes, a globalized economy means that anything can be sourced from pretty much anywhere, it also means that a company cannot depend on ready access to its inputs as a source of competitive advantage. “The enduring competitive advantages in a global economy,” he writes, “lie increasingly in local things – knowledge, relationships, motivation – that distant rivals cannot match.” [3] Similarly, as McKibben’s argument leads us to conclude, the greater “efficiency” of typical pharmaceutical outsourcing may be an efficiency that is spurious and temporary. Drastically reduced revenues will join with shrinking development pipelines in the near future of the pharmaceutical industry – a perfect storm that argues strongly for modifications to existing business models. The time for a new, deep economy has already arrived.
References
- Thayer AM 2009. Contract manufacturers look for ways to cope with economic challenges and changes at pharmaceutical customers. C&E News 87(03): 13-20.
- Financial Times Global 500, www.ft.com.
- Porter ME 1998. Clusters and the new economics of competition. Harvard Business Review Nov-Dec 1998: 77-90.
- www.choruspharma.com. Accessed 20 August 2009. 5. McKibben B 2008. Deep Economy: The Wealth of Communities and the Durable Future. Oneworld Books: Oxford, UK.
Vertex Pharmaceuticals Incorporated is a global biotechnology company committed to the discovery and development of breakthrough small-molecule drugs for serious diseases. Vertex is developing a fully capable, integrated research, development and commercialization (RD&C) organization to markedly and durably increase the efficiency of bringing high value drugs to market. The Company relies on, and values, close relationships with its suppliers to achieve its RD&C objectives.
You may contact the principal author, Patrick Connelly, at 781-389-0682 or email him at [email protected]
This article was printed in the January/February 2010 issue of Pharmaceutical Outsourcing, Volume 11, Issue 1. Copyright rests with the publisher. For more information about Pharmaceutical Outsourcing and to read similar articles, visit www.pharmoutsourcing.com and subscribe for free.