CMOs chose innovation vs. capacity paths to compete in the pharma market.
While industry participants and observers talk about the “CMO industry,” they know that it is not an undifferentiated mass of manufacturers. The contract and manufacturing organization (CMO) industry can be segmented along obvious lines such as API versus drug product manufacturers, biologics versus small molecule, dose form(s) manufactured, and geographic focus. But none of these designations reflect the strategies that each CMO is pursuing, and without that basic understanding, one cannot fully understand the prospects for the industry.
In PharmSource’s update of the drug product manufacturing industry’s size and structure (1), the CMO industry was parsed into two strategic segments: innovation-driven CMOs and capacity-driven CMOs.
Innovation-driven CMOs target higher-value market opportunities including new molecular entities and improved dose forms and formulations of older drugs. Innovation-driven CMOs are distinguished by several key characteristics and capabilities:
Capacity-driven CMOs are focused on filling largely undifferentiated manufacturing capacity primarily by producing generics, undifferentiated over-the-counter (OTC) medications, and late lifecycle branded products. Characteristics of capacity-driven CMOs include:
PharmSource considers only 25 (9%) of the 280 CMOs in the CMO industry to be innovation-focused, but they account for one-third of the dose CMO industry’s revenues. The PharmSource categorization of CMO segments is a function of strategy and track record rather than size. Consider the differences in the top six drug-product CMOs by revenue:
Clearly these two groups of companies are addressing different customers and pursuing different strategies. Those strategies are important because individual CMOs cannot depend on general organic market growth alone to propel their own revenue and profitability growth. Having well-thought-out strategies that target more attractive market segments, align capabilities to serve those segments, and capture market share are more crucial than ever for achieving healthy returns and meeting investor expectations.
The challenges are particularly intense for capacity-driven CMOs, which are dependent on older, often undifferentiated products including generics and branded products in the late phases of their lifecycle. Capacity-driven CMOs face several significant difficulties, notably too much capacity relative to market size and declining prices.
In Europe, in particular, government efforts to hold the line on healthcare costs have triggered a move away from branded generics to commodity generics that are procured by government tenders. Tendering not only lowers prices, it results in CMOs losing unit volumes when their clients lose tenders. Several CMOs have reported revenue declines resulting from lost tenders in recent years. There is a similar process going on in Japan.
There are two areas where capacity-driven CMOs have promising opportunities. One is generic injectables, where product shortages owing to capacity exits and compliance problems at both domestic and offshore suppliers continue to plague the market. The other promising area, in North America at least, is generic semisolid topical products, for which sharp price increases have drawn competitors to the market; however, most generic-drug companies lack formulation capability or manufacturing capacity for semisolids.
Innovation-driven CMOs are focused on developing, manufacturing, and supporting truly new products, including NMEs and novel formulations of older products. Innovation-driven strategies should produce faster growth and better profit margins than the strategies pursued by capacity-driven CMOs. The key to their success is a combination of technical expertise, operational dependability, and regulatory savvy that ensures a new product application will navigate the approval process in multiple jurisdictions with few problems.
The current bio/pharma industry environment is a positive one for the innovation-driven CMOs. New product approvals have surged in recent years, while the convergence of new technologies and a generous financing environment has swelled the pipeline of new product candidates and seemingly assures a continued flow of new opportunities and approvals.
Nevertheless, innovation-driven CMOs face some significant challenges. Perhaps the biggest is the reduced propensity of global bio/pharma companies to outsource manufacture of their newest products, especially biopharmaceuticals. New product approvals earned by global bio/pharma companies (i.e., the 25 largest companies by revenues) have more than doubled in recent years, thanks in part to in-licensing and acquisition of candidates from smaller companies. At the same time, they have substantially increased their investment in new in-house manufacturing facilities, especially for biopharmaceuticals. That combination of a greater share of approvals and reduced propensity to outsource creates a significant headwind for innovation-driven CMOs.
CMOs are also contending with smaller unit volumes per product as new drugs are better targeted than previous generations. To some degree, the smaller volumes will be offset by higher unit prices reflecting more complex processing requirements as well as smaller batch sizes, but CMOs may need more products to generate a given volume of new growth.
The segmentation between innovation-driven and capacity-driven CMOs is not hard and fast; innovation-driven CMOs, in particular, have the ability to pursue the kind of opportunities that capacity-driven CMOs would typically target, although their higher cost structure will reduce the profitability of those deals. Capacity-driven CMOs, however, are much more constrained in their strategic options, in particular by their meager track records of NDA and NME approvals. For a company bringing an innovative product to market, the risk of working with a CMO that has gained only one or two NDA approvals in a 10-year period is great relative to working with a CMO that gets two-to-five NDA approvals annually. Track record is a huge barrier that protects innovation-driven CMOs from their capacity-driven competitors, and the height of that barrier will only increase over time.
1. PharmSource, Contract Dose Manufacturing Industry by the Numbers: Composition, Size, Market Share and Outlook-2016 Edition (PharmSource, 2016).