Slow Climb Back

August 1, 2010
Jim Miller
Pharmaceutical Technology
Volume 2010 Supplement, Issue 3

The health of the contract-services industry is improving but the market is signaling tougher competition ahead. This article is part of the 2010 Outsourcing Resources special issue.

This article is part of PharmTech's supplement "2010 Outsourcing Resources."

The contract services industry entered 2010 with hope that the worst was behind it, even if the market didn't return to the robustness of the 2003–2008 period. The industry was happy to bid good riddance to 2009, a year in which funding shortages, mega-mergers, and a loss of confidence in the future led to a sharp drop in research and development spending. The resultant drop in demand for development and manufacturing services brought to a halt an unprecedented period of growth, and pushed several firms to the brink of insolvency (and in some cases, over it).

PHOTO ILLUSTRATIION, COMSTOCK IMAGES, GETTY IMAGES

Data from the 2010 edition of the PharmSource-Pharmaceutical Technology Outsourcing Survey indicate that, indeed, the worst may be over for contract research, development, and manufacturing organizations (CROs, CDMOs and CMOs). Respondents to this year's survey from both bio/pharmaceutical companies and service providers are more upbeat than they were a year ago, although their optimism remains constrained. Still, the survey suggests that as bio/pharmaceutical companies continue to respond to a harsher and more complex external environment, service providers are likely to face much more competitive market dynamics.

2010 somewhat better

The good news from this year's survey is that spending on contract services has stopped declining (see Figure 1). Among bio/pharmaceutical company respondents, 37% said their expenditures would be the same this year as last year and only 8% expected spending to decline. In the 2009 survey, 16% indicated that spending would decline and only 28% expected it to stay even. That leaves more than 50% of respondents expecting some level of spending growth in 2010, but that percentage is down from the 60+% experienced in the 2007 and 2008 surveys.

Figure 1: How will your contract services spending change this year?

While spending has stabilized, demand for contract services has yet to move into high gear. In fact, spending on contract services appears to be growing at or below the rate of overall research and development (R&D) spending (see Figure 2).

Figure 2: What is the trend in your company regarding outsourcing in your service area?

Although 46% of bio/pharmaceutical company respondents indicated that external spending is growing at the same rate of total R&D spending, 39% indicated that it is growing more slowly than overall spending. In 2009, only 28% indicated that outsourced spending was growing more slowly than total spending. The slowing of outsourced spending is not surprising, however, considering that the first reaction of most company executives is to preserve existing positions and avoid layoffs. Large staff reductions and wholesale changes in spending patterns tend to come with a radical restructuring or change in corporate strategy.

Service providers' outlook on 2010 is similar to their outlook in 2009—cautious (see Figure 3). Among CRO and CMO respondents to this year's survey, 75% expect business to be "good" or "very good" throughout 2010, which is about the same percentage reported last year. The share of service providers expecting 2010 to be "not very good" is 23%, which is also the same as last year. This market perspective seems to be more sober than in past years: in 2008, 33% of service-provider respondents expected the year to be "very good" and only 6% expected the year to be "not very good."

Figure 3: What will business be like for your company this year?

Still, service providers' guarded view of 2010 is more upbeat at mid-year than it was when the year started. Among, CRO and CMO respondents, 32% said this year's performance is already better than expected, and 47% said performance is as expected. After the difficulties of 2009, service providers went into 2010 with low expectations.

Responding to market realities

This year's edition of the PharmSource-Pharmaceutical Technology Outsourcing Survey indicates that service providers have learned to adjust to the new market realities.

When asked, "How badly do vendors want your business?" 50% of bio/pharmaceutical company respondents said that service providers were anxious for the business and were willing to cut price (see Figure 4). This response is similar to that reported in last year's survey, but substantially higher than the 2006 and 2007 surveys, when only 35% indicated that service providers were willing to cut price.

Figure 4: How badly do vendors want your business?

Price competition has always been anathema to CROs and CMOs, but reduced funding for smaller bio/pharmaceutical companies and the increased willingness of global companies to exercise their bargaining power, have forced contract organizations to accept a new reality.

Current funding challenges among smaller bio/pharmaceutical companies has also forced service providers to refocus their efforts according to client type (see Figure 5). In this year's survey, only 21% of CRO and CMO respondents identified small bio/pharmaceutical companies as their best performing customer segment. That percentage is down from 30% in 2009 and 43% in 2008.

Figure 5: Which client segment has been the best performing in your company this year?

The number orf respondents citing specialty pharmaceutical companies as their best performing segment was down as well, while those citing global bio/pharmaceutical companies were about the same. Interestingly, the significance of generic-drug companies jumped significantly, from 7% in 2009 to 17% in 2010. This increase may reflect some change in the outsourcing practices of generic manufacturerss, but also could be a reflection of the reduced activity in other customer segments.

Risks to the business

Perhaps more than ever, CRO and CMO respondents are keenly aware of the long-term risks and challenges to their business. The challenges of 2009 and 2010 seem to have forced service providers to take a more global view and to pay more attention to market trends.

This change in view is particularly apparent when it comes to competition from offshore service providers (see Figure 6). When asked, "What is the biggest single risk to your business in the next two-to-three years?" 25% of CRO and CMO respondents identified competition from India and China as the biggest risk. That percentage is up from 11% in 2009, and 15% in 2008, and represents the biggest single risk identified by CRO and CMO respondents.

Figure 6: What is the single biggest risk to your business in the next two to three years?

Contract organizations' concern is valid. The share of bio/pharmaceutical company respondents indicating that they are actively sourcing service from India and China today grew to 31% in the 2010 survey, up from 26% (see Figure 7). Further, the number of respondents indicating that they had no plans to source from India and China dropped from 51% in 2009 to 41% in 2010, which represents an all-time low for that response in the years we have been asking that question.

Figure 7: Plans for sourcing in India and China

Another risk area identified by service providers was overcapacity. In 2010, 17% of survey respondents to the question, "What is the biggest single risk to your business in the next two-to-three years?" indicated that "too much capacity for our services" was the biggest risk. The overcapacity problem really came to the fore in 2009 when demand for services dropped and price-based competition intensified. As major bio/pharmaceutical companies plan to divest more facilities, and many investors still eyeing the contract services industry as a major opportunity, CROs and CMOs are right to place this issue on their radar.

One area of risk that is of less concern to service providers in 2010 is the threat of declines in R&D spending. The share of CRO and CMO respondents indicating that "reduced funding for early stage companies" is a major threat to their business dropped in half, from 35% in 2009 to 17% in 2010; while those citing "cuts in Big Pharma R&D spending" dropped from 22% in 2009 to 15% in 2010. The stabilization in outsourced R&D spending discussed above supports that reduced concern, at least for the near term.

Supplier consolidation is a major threat

Another potential risk of less concern to service providers is supplier consolidation. Only 3% of CRO and CMO respondents in 2010 said that "supplier consolidation by Big Pharma" was a major concern, and at no time in our survey has the number reached 10%.

However, bio/pharmaceutical company survey respondents did signal that service providers are overlooking a major industry trend (see Figure 8). For 2010, 45% of bio/pharmaceutical company respondents indicated that they have reduced the number of service providers they work with, or plan to do so in the near future. That's the highest share ever in our survey indicating that supplier consolidation is ongoing. More dramatically, the share of respondents indicating that they plan to increase the number of suppliers they work with dropped to just 18% in the 2010. In the 2007 survey, 44% indicated their intention to increase their number of suppliers.

Figure 8: Please indicate how your company has tried to consolidate its supplier base

One factor driving supplier consolidation is vendor performance: There is a conviction, generally confirmed by actual industry experience, that working more closely with fewer service providers leads to improved vendor performance and better project outcomes. Our 2010 PharmSource-Pharmaceutical Technology Outsourcing Survey indicates that there continues to be plenty of room for improvement in vendor performance.

QbD impact minimal so far

As has been the case every year in the four years we have asked the question, CROs and CMOs rate their performance more highly than do their clients (see Figure 9). The biggest gap continues to be in project management, where 80% of service-provider respondents rate their performance as "excellent" or "good" but only 51% of clients rate them that way.

Figure 9: Client and contractor views on contractor performance

One area where the perception gap has closed over the past few years has been in customer service, where client perceptions have improved while service provider self-assessments have become more modest (see also, "Performance Metrics, A CMO Roundtable".)

Cautious about 2011

Bio/pharmaceutical company respondents to our 2010 survey did provide positive signals about 2011 (see Figure 10). Among that group, 70% indicated that they expect their contract-services spending to increase in 2011. That's a big move from one year ago, when only 54% expected the next year's spending to increase.

Figure 10: How will your contract-services spending change next year?

This indicator has to be interpreted cautiously, however, because our respondents may not have a clear view of the external factors that can impact their budgets. After all, in our 2009 survey, 69% of respondents expected their 2009 expenditures to increase, 45% by 10% or more; they failed to foresee the financial crisis and the effect it had on slowing R&D spending.

Service providers are being more cautious in their outlook for next year. Nearly half expect 2011 to be "somewhat better" than 2010, and 29% expect business next year to be similar to 2010.

Respondent profile

The 2010 edition of the PharmSource–Pharmaceutical Technology Outsourcing Survey portrays an outsourcing market that continues to mature. Buyers of contract-development services are taking a more sophisticated approach to procuring those services. They are more willing to exercise their leverage over pricing, to venture offshore for lower cost services, and to work more closely with a smaller number of providers.

For their part, CROs and CMOs seem to be taking a more realistic approach to the market and the changes taking place. They are competing harder for new business and accepting the reality of greater competition from service providers in emerging markets, especially India and China.

These developments indicate that the contract services industry should continue to thrive and grow in coming years. However, we are unlikely to return to the conditions of 2003–2008, when investment flowed like water into pharmaceutical R&D, and contract service providers had to do little more than answer the telephone to grow their businesses. That period provided fertile ground for CROs and CMOs to flourish, even those with limited capabilities and management skills. The more rigorous environment the industry faces today will lead to an industry of stronger and more skilled companies working in closer collaboration with more capable clients.

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