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Survey results indicate a healthy market, but increasing competition.
If the respondents to this year's PharmSource—Pharmaceutical Technology Outsourcing Survey are right, 2008 is shaping up to be another strong year for the contract services industry and another big step in the remaking of the biopharmaceutical/pharmaceutical business model. However, the coming months are likely to be more difficult for contract service providers than have the past three years.
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Industry trends in 2008 as reported by our respondents (see sidebar, "Respondents profile") are very similar to what we found in 2007. Nearly 45% of bio/pharma company respondents expect their spending on contract services to increase by 10% or more in 2008, about the same as in 2007 (see Figure 1). More than a quarter of these buy-side respondents say their contract services spend is growing faster than total spending in their functional area, but an equal number said spending is growing at a slower rate than total spend (see Figure 2). Still, respondents indicate that more activity is being outsourced than in past years: 42% say one quarter or more of the work in their functional area is being outsourced, up from 35% in 2007 (see Figure 3). Responses indicate that the rate of growth in outsourcing spend is slower at mid-size and generic bio/pharma companies than it is at large and small bio/pharma companies.
Responses from contract service providers reflect the optimism inherent in the buy-side responses. More than 65% of contractor respondents say they expect their revenues to increase by 10% or more in 2008, including a big jump in the number expecting growth of 20% or better (see Figure 4). Small bio/pharma companies are the most common source of new business for service providers, with 43% of contractor respondents citing them as their fastest growing segment. All market segments are contributing to contractor growth: 19% say Big Pharma is their fastest growing segment, 13% cite specialty pharma, and 17% say all segments are growing about the same.
Although major pharmaceutical companies aren't the fastest growing segment for most service providers, they are critical to the financial health of nearly all of them. Among contractor respondents, 38% say half or more of their revenue comes from Big Pharma, and another quarter say Big Pharma accounts for 25–49% of their revenue.
Survey responses indicate that bio/pharma companies are more open to using new vendors than they have been in recent years. In the 2008 survey, 43% of respondents said they are consolidating their vendor base or have plans to do so in the next two years; this statistic is down sharply from 57% in the 2007 outsourcing survey. One quarter of 2008 respondents say they have no plans to increase or consolidate their vendor base.
The results suggest more companies are looking for new vendors than in past years. In the 2008 survey, nearly 45% of respondents said their company is actively looking for new vendors; that number is up sharply from the 30% that were looking for new vendors in 2007 (see Figure 5). In last year's survey, it was more common for respondents to be looking for new contractors just to replace those they were already working with, or for special needs.
Service providers seem to be aggressive about responding to these new opportunities. Nearly 30% of respondents from contract research and contract manufacturing organizations (CMOs and CROs) say proposals to new clients account for half or more of their new proposal activity, and just under half say that 25–50% of new bids are going to prospective new clients (see Figure 6). Competition for new business seems to be intense. Nearly 85% of bio/pharma respondents say vendors are actively looking for new business, up from 70% in 2007 (see Figure 7). Further, half of those 85% say they see vendors as willing to cut prices to get new business.
In another sign of intense competition, both bio/pharma and contractor respondents say there are typically three to five bids submitted per new request for proposal. One more sign of intensifying competition: Half of respondents indicated that their sales and marketing expenditures will increase by 10% or more in 2009. That's the biggest jump we have seen in several years.
The big jump in openness to new vendor relationships is no doubt related to growth in spending on outsourced projects. At the same time, however, it may reflect issues with the vendor base itself, especially concerning capacity and performance.
As in past years, service providers are equally divided on whether limited capacity is impeding their ability to take on new business. Among the half that feel capacity-constrained, the biggest factors holding back growth are access to investment capital, recruiting new staff, and organizations' ability to manage growth. This is the first time in the history of the survey that investment capital has been identified as a significant problem for contractors, and undoubtedly reflects the reduced availability of investment capital in the general economy. The limited management capacity to support growth, which also came up in last year's survey, probably reflects the high percentage of responses coming from small CMOs and CROs, where management ranks are usually thin.
Performance expectations could be another reason that bio/pharma companies are actively looking for new vendors. This is the second year we have asked respondents to rate contractor performance in three key areas: technical and operational expertise, project management, and customer service. Once again, there are big differences in the way customers rate contractor performance and how service providers rate themselves.
As shown in Figure 8, service providers give themselves much higher marks for performance on the three performance dimensions than do their customers. This is not to say that bio/pharma respondents think the service providers are poor performers: 75% or more rate service provider performance as good or satisfactory in all three categories. For project management and customer service, 15% see contractor performance as just fair or poor.
The survey results suggest that there is big gap between customer- and service-provider definitions of performance excellence. In fact, the requirements of different client types and their perceptions of contractors vary widely. Major bio/pharmaceutical companies have substantial in-house capabilities and experience and are less dependent on their service providers than small bio/pharmaceutical companies, which expect help in navigating the drug-development process and have a broad definition of what should be included in project management and customer service. Our survey results indicate that respondents from major bio/pharma companies have a higher regard for contractor performance than smaller companies, no doubt reflecting the latter's greater need for support.
Although 2008 is shaping up to be another strong year, the outlook for 2009 is somewhat less clear. Certainly contract service providers are less optimistic: More than 30% expect next year's revenues to be similar to or less than this year's revenues. In the 2007 survey, only 20% expected 2008 revenue to be flat or down by comparison. On the other hand, bio/pharma company respondents expect continued healthy gains in their budgets in 2009, with 44% expecting budget increases of 10% or more.
The concerns of contractor respondents probably reflect broader market factors of the current industry environment. The survey identified four key concerns (see Figure 9).
Competition from providers in India and China. Just over half of respondents are in some phase of sourcing from China and/or India, whether they are actively sourcing there now, looking for vendors, or developing plans. That's about the same percentage as in the 2007 survey, but still significant. As might be expected, major pharmaceutical companies are most actively sourcing from Asia, while small bio/pharma companies are the least interested. The impact is especially being felt in manufacturing of chemical intermediates and active ingredients.
Too much capacity. Capacity is a very legitimate concern for service providers. In our industry analyses, PharmSource has quantified significant overcapacity in commercial and clinical injectables manufacturing and biomanufacturing, and expects the problem exists throughout the industry. As described, contractors are typically competing against four other service providers for each contract, and the effort to establish new client relationships is intense.
Reduced early-stage funding. The difficult investment climate in the general economy is affecting the bio/pharma sector. Financing from initial public offerings has practically disappeared and while venture capital funding in aggregate has remained level, it seems to be benefitting fewer companies. Early-stage companies depend on CROs and CMOs for development activities but need funding to pay for them.
Reduced Big Pharma R&D spending. More major pharmaceutical companies are following the "proof of concept" development model long followed by early-stage companies. The model seeks to minimize expenditures on a drug candidate until basic safety and efficacy are established, usually by Phase IIA. As a result, companies are spending less on process, formulation, and analytical development services for early-phase candidates but more on the smaller number of candidates that make it to later development. Major pharmaceutical companies are also pushing on price as never before.
Overall, the survey responses reflect what PharmSource has been hearing from frequent conversations with service providers and bio/pharma companies. The 2008 PharmSource–Pharmaceutical Technology Outsourcing Survey draws a picture of an industry that is still growing robustly but could be facing a slowdown in the months ahead. Overall demand and market conditions will be the envy of other economic sectors, but service providers will to have work harder to achieve the kind of results they have become used to in recent years.