Good Times and Expanding Horizons in Pharmaceutical Manufacturing

Expected growth in contract services spending by pharmaceutical companies for 2005 versus 2004

2005 has been a good year for the contract services industry, and 2006 promises to be nearly as successful, according to the 2005 PharmSource–Pharmaceutical Technology outsourcing survey. But as pharmaceutical outsourcing activity grows, companies are looking for more sophisticated ways to manage and control their contract services expenditures.

Outsourcing spending

Fastest growing client segment

Nearly 50% of the 193 pharmaceutical company survey respondents expect that their 2005 outsourcing spending will increase by 10% or more, compared with 2004 expenditures. Sixteen percent of respondents anticipate their spending will increase by 20% or more.

The expected growth in spending is especially high among small pharmaceutical and biopharmaceutical companies. Overall, 56% of respondents from those companies expect to see their spending grow by 10% or more, while less than 45% of respondents from other segments anticipate that kind of increase. Expectations of spending increases are largely the same for buyers of development services and of commercial manufacturing services.

The increased spending by pharmaceutical companies is translating into even faster revenue growth for contract services providers. Overall, 62% of contractor respondents expect their revenues to grow by 10% or more in 2005, including nearly 70% of commercial manufacturing contractors. Contractors cite small pharmaceutical companies as their fastest-growing segment, especially for development services, but contract manufacturers are getting a bigger boost from Big Pharma.

Respondents profile.

Respondents from pharmaceutical companies indicate that the 2006 spending growth should rival that of 2005, with 48% expecting increases of 10% or more next year. Certainly, there seems to be plenty of opportunity for pharmaceutical companies to expand their use of contract services: Only small companies are outsourcing a substantial portion of their development and manufacturing activity. Among Big Pharma and Mid-size Pharma companies, which account for nearly 80% of industry R&D expenditures, only a few companies are outsourcing more than 50% of their chemistry and manufacturing (CMC) activities. 

Preferred-provider status critical

Share of respondents outsourcing 50% or more of activity spending

This year's survey again underscores the importance of contractors achieving "preferred-provider" status with major clients. Among pharmaceutical company respondents, 45% report that half or more of their 2005 services spending will go to formally designated preferred providers, and only 18% say preferred providers receive less than 10% of their business. Overall, 33% of contractor respondents report that half or more of their revenues will come from formal preferred-provider relationships.

Share of pharmaceutical company outsourced spending going to preferred providers in 2005

Interestingly, the responses indicate that the preferred-provider trend may be leveling off. In fact, the responses for expected preferred-provider share for 2007 are largely the same as for 2005.

Other procurement innovations also are working their way into sourcing practices. Sixty percent of pharmaceutical company respondents report using electronic procurement technology for sending and processing at least some of their requests for proposal (RFPs), including 90% of Big Pharma respondents. Among contractor respondents, 85% respond to at least some RFPs electronically, although electronic procurement represents less than a quarter of RFP activity at most contractors.

Online reverse auctions, in which vendors bid against each other in real time, are used in less than two-thirds of cases, and are especially uncommon in Small Pharma companies. Still, 46% of Big Pharma respondents say that at least some bids are awarded using reverse auctions. Less than 50% of contractor respondents have participated in reverse auctions.

The growing role of procurement has been an often talked-about trend in sourcing, and this year's survey partially validates that trend. Only 15% of pharmaceutical company respondents say that procurement groups control the sourcing process today, but another 13% say procurement groups are likely to control the process in the future. Nearly half of respondents characterize the procurement group as influential in the sourcing process but not controlling. As one might expect, the effect of procurement groups is greater in large pharmaceutical companies and cost-sensitive generic pharmaceutical companies. But, the effect is less in small companies that have smaller bureaucracies.

Offshore sourcing moves slowly

Share of contractor revenue coming from preferred provider relationships in 2005

Perhaps the survey's most surprising result is the low expectation for offshore outsourcing. Overall, 53% of respondents indicate they have no current interest in outsourcing to India or China. The low level of interest by small companies is to be expected (63% of small company respondents say they have no current interest in sourcing from India or China) because they lack the scale to find and supervise offshore vendors. Nonetheless, the lack of interest was high even among Big Pharma respondents (54%). The lack of interest is greater among development services buyers (60%) than it is among manufacturing services buyers (45%).

Contractor view of India and China competition

Still, our survey shows that offshore sourcing is making in-roads into the pharmaceutical industry. Overall, 16% of respondents indicate they are actively sourcing from India or China, and 27% say they are looking for vendors or are developing a strategy for sourcing in those countries. Not surprisingly, generic pharmaceutical companies seem to be the most active offshore sourcers: 32% of respondents from generic pharmaceutical companies report that they are actively sourcing from India or China.

Clearly, respondents expect offshore sourcing to proceed slowly: only 11% expect that India or China will account for a quarter or more of their spending in five years. Nonetheless, respondents indicate that as they move in that direction, they will be quite willing to work with Indian and Chinese suppliers directly, not just with US companies that have offshore operations.

Status of pharmaceutical company sourcing activity in India and China

Most service providers fully expect to face Asian competition. Among contractor respondents, 21% report they are now feeling competitive pressures from India or China, and 42% expect to face that competition within the next 5 years. Providers of development services are much less concerned than manufacturing services providers: 42% of development services respondents view India or China competition as "not an issue," but only 21% of manufacturing respondents take that view.

Among service providers concerned about Asian competition, most respondents expect to take action by emphasizing less price-sensitive services (57%). Others are considering establishing facilities or joint ventures in Asian countries.

Growing sophistication

The 2005 edition of the PharmSource–Pharmaceutical Technology outsourcing survey portrays a pharmaceutical outsourcing industry that is firing on all cylinders. Thanks to the rejuvenation of new product pipelines, pharmaceutical companies' need for services is expanding rapidly, and contract service providers are reaping the benefits.

The survey indicates that pharmaceutical companies are accompanying their increased expenditures with heightened attention to receiving the most value for their dollars spent. The preferred-provider concept is now well-established, and companies are turning to more-sophisticated technologies and strategies to manage their spending. In fact, respondents probably have understated the growing role of information technology and the effect of procurement professionals on the sourcing process: Those developments are mandated as much or more by efforts to comply with the Sarbanes-Oxley Act as they are by the quest for sourcing efficiencies.

Influence of procurement group in sourcing process

Similarly, it is likely that respondents have underestimated how the emergence of vendors in India and China will affect drug development. Development and manufacturing costs are under pressure throughout the industry: Big Pharma must cut costs to preserve margins while increasing the flow of new products, and Small Pharma is under pressure from venture capitalists and public equity investors unwilling to commit the growing sums required for drug development. Pharmaceutical companies will find business models that allow them to access lower-cost development and manufacturing resources offshore.

Pharmaceutical company preferences for working in India and China

During the past five years, the PharmSource–Pharmaceutical Technology outsourcing survey has been a bellwether of trends in the pharmaceutical contract services. On the basis of this year's edition, contractors can look forward to another strong year but increasingly demanding customers.

Jim Miller is the president of PharmSource Information Services, Inc., and the publisher of Bio/Pharmaceutical Outsourcing Report, 9868 Main Street, Fairfax, VA 22031, tel. 703.383.4903, fax 703.383.4905, jim.miller@pharmsource.comwww.pharmsource.com. Mr. Miller also is a member of the Pharmaceutical Technology editorial advisory board.