OR WAIT 15 SECS
Volume 6, Issue 4
CMOs' business model has all of the flaws of the captive model it is meant to replace.
Ever since the contract manufacturing industry began to take off in the late 1990s, it has hailed itself as a great savior to the pharmaceutical and biopharmaceutical industries. Contract manufacturing organizations (CMOs) set out to enable companies to reduce capital expenditures, lower costs, and access new technologies, while unburdening them of facilities they no longer needed.
Looking back over the past 10 years, the industry has achieved much of what it promised. CMOs have proven to be a desirable and dependable option for small and mid-size pharmaceutical and biopharmaceutical companies, and they have taken a lot of redundant facilities off the hands of larger companies. The major drug companies have not fully endorsed CMOs as an option, however, and they continue to build new capacity, especially for manufacturing dose forms and biologics. Contractors manufacture less than 20% of newly approved drugs for the global pharmaceutical companies, according to a recent PharmSource analysis.
Furthermore, CMOs have not been financially successful businesses. Except for a few standout performers with unique capabilities, most CMOs have been marginally profitable at best, generating barely enough cash flow to maintain their equipment.
Contractors' performance has exposed a fundamental flaw in the business concept. CMOs haven't really changed the manufacturing model that has been predominant in the pharmaceutical and biopharmaceutical industries during the past 50 years; they've simply adapted it to a fee-for-service payment arrangement. As a result, they have inherited the problems of the traditional pharmaceutical manufacturing model, namely, high fixed costs, too much capacity, low utilization, and the high risk of product failure.
The capital intensiveness of manufacturing makes it a high-fixed-cost business, and the special needs of complying with good manufacturing practice (GMP) drive those costs even higher. Meanwhile, the primary reason for the CMO industry's growth—the desire of the major pharmaceutical and biopharmaceutical companies to shed redundant manufacturing sites at any cost—exacerbates the overcapacity problem by keeping capacity in the market that should rightfully be shuttered. Ultimately, high fixed costs and overcapacity lead to price wars as companies compete to get any business they can to help cover their fixed costs.
For the CMO industry, reducing overall capacity is critical, but consolidation isn't likely to occur soon. The problem seems destined to get worse as the global biopharmaceutical companies go through successive rounds of facility divestitures and European governments continue to force or assist unprofitable facilities to stay open.
Reducing fixed costs could help many CMOs, but that is easier said than done. Multiproduct facilities require various processing capabilities, guaranteeing that much of their capacity will not be used at any one time. Organizing manufacturing networks into "centers of excellence" that each specialize in a single dosage form could reduce complexity and improve utilization. However, the costs of transferring products between facilities in a GMP regulatory environment are prohibitively high, thus making it difficult to implement such a strategy in the near term.
CMO executives could help by resisting the urge to invest in capabilities they don't currently have but that are occasionally requested by clients. For instance, many CMO executives in the injectable segment are aching to invest in new prefilled-syringe capacity despite ample evidence of sufficient capacity, and an incipient price war, in the market.
Looking ahead, CMOs need to find ways to reduce the risk they face from product failures during clinical development and from the underperformance of approved products once they reach the market. The most obvious defensive measure CMOs can take is to sign multiple candidates for each capacity slot they have available. Given the likelihood that a new product candidate will fail, CMOs need to sign two or three of them for every available capacity slot.
As pharmaceutical and biopharmaceutical companies pursue a lean business model, they are increasingly clear about what they need from manufacturers: low prices, flexible capacity, and reliable supply. CMO executives need to examine their current business models closely and determine what it will take for them to meet those requirements while ensuring a return for their investors.
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.