EU debt crisis adds uncertainty for contract services

The business press in May was dominated by Europe's sovereign debt crisis and its implications for the survival of the Euro as the common European currency. The crisis began in Greece, but the great fear was that it would rapidly spread to Spain and Portugal, and quite possibly to Ireland and Italy. Even the UK, though not a Euro country, was viewed to be at some risk of default on its sovereign debt.

Jim Miller

While the immediate nature of the crisis is financial and monetary, the efforts to remedy it will ultimately strike the bio/pharmaceutical industry. To ultimately resolve the crisis and prevent it from spreading further, the individual Euro zone countries must attack the underlying cause of the problem — excessive government spending on social programmes financed by uncontrolled government borrowing. This, however, will require acts of political resolve and courage that few political parties in any country (including the US) have ever demonstrated.

European pharmaceutical sales likely to decline

As European governments begin to focus on their fiscal profligacy, spending on healthcare generally — and bio/pharmaceuticals in particular — will come under close scrutiny. In most European countries, healthcare accounts for 15% of public spending and has been growing faster than most budget items (Table 1).

Table 1: Health expenditures in major European countries.1

Government-run programmes account for 75% of all healthcare expenditures in Europe and at least 70% of pharmaceuticals purchased there, according to data from the OECD.¹ So as European governments make drastic cuts in public expenditures to bring down deficits and reduce sovereign debt, spending on healthcare and bio/pharmaceuticals will probably be a major target.

The decrease in pharmaceutical spending is likely to come about in several ways:

• Increased use of generics. The countries with some of the biggest problems also have some of the lowest generic penetration. For instance, in the market for off-patent drugs, generics account for just 41% of pharmaceutical unit volume in Spain, and 40% of unit volume in Italy, according to IMS Health.² By contrast, generics account for 75% of unit volume in Germany and 71% in the UK. As a reference point, generic penetration in the US is 89% of unit volume. IMS Health estimates that increased use of generics by the 27 member states of the EU could generate annual savings of €30 billion.

• Lower prices for branded and generic products. Government agencies set prices for bio/pharmaceuticals in most European countries and we may see aggressive price-cutting as governments try to reduce expenditures. Spain and Greece have already announced plans to reduce prices for generic drugs by 25% while Germany has announced 10% cuts. European drug prices are already well below US drug prices — as much as 60% below US prices in many countries.

• Exclusion from formularies. Government agencies could make it more difficult for new drugs to get reimbursement eligibility, especially expensive new biopharmaceuticals. For example, NICE, the agency responsible for allowing coverage of new drugs in the UK, has put severe limits on the conditions under which the government will pay for expensive therapies for oncology and autoimmune conditions.

The reduction in government spending on healthcare and bio/pharmaceuticals will not be the only negative factor weighing on the industry; across the board, government spending cuts and tax increases aimed at reducing deficits will have a depressing effect on European economies for several years, which probably means that private healthcare expenditures will also decrease for a few years.

Mixed news for European CMOs

CMOs will feel the effects of reduced healthcare expenditures in the form of fewer batches and smaller batches, and pressure from clients to reduce prices. This will be especially difficult for European CMOs, which must already compete in a market saturated with capacity and widespread price-cutting.

However, there may be some positive outcomes for European CMOs. EU CMOs typically have a significant amount of generics in their product mix and may be able to offset reduced demand for branded products with increased orders for those generic products. Unfortunately, if the pressure on drug prices is too severe it could lead to generics being imported from Asia rather than being domestically-produced, delivering a double blow to European CMOs.

Another issue for European CMOs is the decline in the value of the Euro relative to the US dollar. The Euro has weakened considerably in 2010 relative to the US dollar, dropping to a 2year low in early May. The €750 billion bailout package approved by the European Central Bank (ECB), International Monetary Fund (IMF) and EU members in midMay stabilised the exchange rate, but the likelihood of a recession following the expected spending cuts could keep the exchange rate down for several years.

A lower US dollar/Euro exchange rate should be a positive development for the European CMOs and CROs because it will increase their competitiveness relative to their US counterparts — the cost in dollar terms of services priced in Euros is already 15% lower than they were just 6 months ago. Development services that span a relatively short timeframe and that are not subject to the long-term currency risk of commercial manufacturing contracts should benefit from the currency depreciation, even if it is short lived.

European CMOs may be positioned to benefit from a medium to longterm Euro decline because many have been building their North American sales presence in recent years to find relief from the intenselycompetitive European market. Because of the local market conditions, the European CMOs are more accustomed to competing on price than the North American CMOs and the cheaper Euro could make their case stronger. Some European CMOs have been able to command a price premium even with a strong Euro and they will look even more attractive with a weak Euro.

Uncertain outlook

The sovereign debt crisis has blown up just as the contract services market appeared to be emerging from the slump induced by the financial crisis that began in 2008. This latest crisis promises to make the nearterm prospects of the industry more uncertain. Perhaps the ECBIMFEU stabilisation plan announced in May will instill enough confidence in EU financial markets to allow the market improvement to continue; however, there are major forces at work that may not be entirely in the control of governments and international institutions, let alone individual companies. Only time will tell how things will play out.

Jim Miller is President of PharmSource and a member of Pharmaceutical Technology Europe's Editorial Advisory Board.

References

1. OECD.Stat Extracts. http://stats.oecd.org/index.aspx

2. Generic Medicines: Essential contributors to the long-term health of society (IMSHealth, March 2010).

The author says...

1. Europe's sovereign debt crisis will ultimately strike the bio/pharmaceutical industry as governments seek to reduce healthcare expenditure.
2. Savings will come about via the increased use of lowerpriced generics as well as certain more expensive drugs being excluded from national health services.
3. Although CMOs will feel the impact of the new crisis, they may be able to offset the shrinking demand for branded products with increased orders for generics.
4. European CMOs with a North American sales presence will be in a strong position compared with their North American competitors because they are more accustomed to price competition.