CROs that have made big acquisitions could be outmaneuvered by evolving sourcing models.
The past six months have seen a spate of large acquisitions in the pharmaceutical services industry intended to create giant-scale service providers with global reach. Noteworthy deals are INC Research's acquisition of Kendle International, which boosted INC to $700 million in revenues; inVentiv's purchase of i3 and PharmaNet Development, which created a $900-million CRO; and Catalent Pharma Solutions' $400-million acquisition of Aptuit's clinical supplies business, which pushed Catalent into the number two slot in clinical packaging.
The rationale cited for these megadeals is that global bio/pharmaceutical companies favor large CROs with broad capabilities in their selection of preferred service providers. These "strategic partnership" deals are the cornerstone of global bio/pharmaceutical companies' current sourcing strategies, which seek to leverage their massive buying power while reducing sourcing overhead expense and improving coordination with the CRO.
The list of publicly announced preferred provider deals (see Table I) shows that global bio/pharmaceutical companies have clearly embraced the large multiservice provider, at least for now. However, there is a substantial probability that sourcing models will change significantly in coming years and threaten the business model upon which the recent megadeals are based.
Table I: Publicly announced preferred-provider deals.
We have already seen a major shift in sourcing strategies at one of the largest bio/pharmaceutical companies. Pfizer was an early proponent of the functional service provider (FSP) sourcing model but has now shifted to the integrated service provider (ISP) model. In the FSP model, Pfizer sought to engage the best-in-class service provider in each clinical research activity (e.g., site monitoring, data management, or central laboratory services) and to have those best-in-class providers support all of their trials. However, Pfizer executives found the FSP model too costly because too much internal overhead was required to coordinate the activities of the various FSPs.
In its most recently announced strategic CRO deals with Icon and Parexel, Pfizer has moved to the ISP model in hopes of eliminating the high internal overhead costs. Now, Icon and Parexel will provide a broad range of services to each of the clinical trials they will manage on behalf of Pfizer.
Coming down the learning curve
It should be remembered that both the global bio/pharmaceutical companies and their CRO partners are still very new to the strategic sourcing process. They have barely begun to progress down the learning curve of how to establish and manage these relationships; the bio/pharmaceutical industry is thought to be a decade or more behind other industries in its sourcing practices. As both sides gain experience and as some of these relationships blow up, as they inevitably will, the sourcing model will evolve in directions that have not yet been anticipated.
At many of the global bio/pharmaceutical companies, the senior executives that negotiated these strategic sourcing deals had little previous direct experience in managing CRO relationships and often did not involve lower-level colleagues who did. It is likely that they underestimated the risks and challenges of those sourcing deals and the abilities of their partners to handle them.
The consequences of adopting a radical new sourcing strategy with untested partners could be dire, if not catastrophic. Boeing demonstrated that with its Dreamliner supply-chain fiasco. The company outsourced major components of its new 787 Dreamliner passenger jet (including large sections such as the wings and fuselage) to partners around the globe. The company found out too late that many of its partners were not up to the task, which resulted in delaying delivery of the new plane by at least two years. In one case, Boeing had to acquire one of the partners providing critical components in order to regain control of the supply chain.
Boeing ran into these major problems despite decades of experience in outsourcing major components for its civilian and military aircraft programs. It is not a big leap to imagine newcomers to strategic sourcing, which the global bio/pharmaceutical companies are, having significant problems themselves as they learn to master the new model. In circumstances similar to Boeing's, several bio/pharmaceutical companies have been forced to buy back manufacturing facilities that they had sold to startup contract manufacturers after those CMOs ran into financial problems and put the bio/pharmaceutical companies' product supply at risk.
The point here is not to question the major acquisitions cited above or to question the business strategies of CROs and CMOs aimed at expanding their service offerings. They are a response to what the global bio/pharmaceutical companies are actually doing today and to ignore that would risk being shut out from the biggest opportunities.
The further risk, however, is that in the two or more years it will take to fully integrate the parent and acquired companies into a genuinely single entity, the sourcing paradigm may have moved to a different place. The lessons of the first strategic partnering efforts will have been learned and applied to different sourcing arrangements.
In the meantime, the CROs that are already big will be using their large scale to further their lead with new capabilities. For instance, Covance, the second largest clinical services provider by revenue, recently announced a new service to help bio/pharmaceutical companies select clinical sites more efficiently by using a database that incorporates information from the thousands of trials they have serviced in recent years.
The CROs playing catch-up don't want to find themselves in the position of planning for the last war. Like the French military leaders who built the "impenetrable" Maginot line after World War I, they risk being circumvented by new technologies and the innovative strategies they make possible.
Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, email@example.com, www.pharmsource.com.