Healthy Outlook for Pharma Services

This article is part of a special issue on Outsourcing Resources

Bio/pharmaceutical companies are expecting significant growth in their contract-services spending in 2011, but it may not be enough to satisfy service providers. That's the sense we get from the 2011 edition of the PharmSource–Pharmaceutical Technology Outsourcing Survey.

PHOTO: BURAZIN / GETTY IMAGES

Among bio/pharmaceutical company respondents to the survey, 64% indicated that they expect their spending on contract services to increase in 2011 compared with 2010 (see Figure 1); that percentage is up substantially from the 2010 and 2009 surveys. In fact, 44% of respondents expect their spending to grow by 10% or more this year, versus just 36% in the previous two annual surveys. We haven't seen these levels of expected spending growth since the middle of the last decade, which represented a high watermark for the contract-services industry.

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

Increased activity by bio/pharmaceutical clients is reflected in the responses of the contract-service providers, 80% of whom indicated that they expect 2011 to be "good" or better (see Figure 2) than the previous year. However, that percentage is up only slightly from 2010 results, and there was no increase in the share of respondents expecting 2011 to be "very good" or "extremely good" compared with 2010.

Figure 2 What will business be like for your company this year?

In spite of this apparent market improvement, contract-service providers were expecting even better. Only 26% of survey respondents rated their 2011 activity as "better than expected," and 34% felt that way a year ago (see Figure 3). Furthermore, 27% of contract-service provider respondents rated 2011 as "worse than expected" compared to 22% who thought things were worse in 2010. It seems that after the blood bath of 2009, service providers had muted expectations for 2010, but the better results for 2010 inflated their expectations for 2011.

Figure 3 How has 2011 been relative to your expectations?

Disappointment among service providers may also reflect where the new business is coming from. Asked which customer segment has performed best, 24% of service providers said that mid-size/specialty bio/pharmaceutical companies have been their best performers, which is double the response received in the 2010 survey (see Figure 4). Both the small and global bio/pharma segments fell from the top performer ranks: in our 2008 survey, 43% of respondents named small bio/pharma companies as their best performing customer segments, but that was down to just 17% in our 2011 survey.

Figure 4 Best-performing customer segment

PharmSource's analysis has shown that research and development (R&D) spending by the mid-size bio/pharma companies has continued to grow during the past three years even as spending by small and global bio/pharma companies has dropped. This change is not surprising considering that the mid-size companies have been able to fund their R&D activities out of revenues rather than depending on outside investors.

Also, mid-size companies have not gone through the painful restructuring experienced by larger global bio/pharmaceutical companies. Nevertheless, the overall opportunity of the mid-size pharma segment is not great: there are far fewer mid-size companies than small companies, and the spending per company is a small fraction of what global bio/pharma companies spend.

Intensifying competition

Although the overall level of outsourced development and manufacturing activity may be growing, competition for available business is increasingly intense. Service providers therefore must work harder for new business opportunities. Bio/pharmaceutical company sourcing practices and the rise of service providers in emerging markets, especially in India and China, are key challenges for contract-service providers.

It has become increasingly difficult for service providers to get new clients. More than half of bio/pharmaceutical companies reported that less than 25% of their bids have come from new service providers. In addition, bio/pharma ceutical companies continue to limit the size of their vendor base, with 47% of survey respondents indicating that they have reduced or plan to reduce the number of service providers they work with and only 22% indicating plans to increase the number of vendors they work with (see Figure 5).

Figure 5 How have you managed the number of contractors you work with?

Even when service providers can get their foot in a new client's door, competition for the new business remains intense. Bio/pharmaceutical companies are not reluctant to pit service providers against each other: more than half of respondents from bio/pharmaceutical companies reported that they get three or more bids for each project they advertise.

The competitive market is taking a toll on pricing. More than half of respondents from bio/pharmaceutical companies reported that services providers are actively seeking their business and are willing to cut price to get it (see Figure 6). In 2006 and 2007, when investment capital was flowing easily to bio/pharmaceutical companies, only 34% of respondents indicated that service providers were willing to cut price.

Figure 6 How badly do contractors want your business?

However, as new funding dwindled during the global financial crisis, price competition increased, and the number of respondents indicating contractors' willingness to cut prices jumped above 50% in 2009, where it remains today.

Interest in sourcing from service providers in emerging markets, especially China and India, continues to grow at a slow but steady pace (see Figure 7). The share of respondents from bio/pharmaceutical companies who indicated they are actively sourcing in India or China rose to 32%, up from 31% in 2010, and from just 20% in 2006. Companies with no plans to source in India and China dropped to 36% in 2011, compared with 41% in 2110, and 51% in 2009.

Figure 7 Plans for sourcing in India and China

Business risks

Not surprisingly, contract-service providers are concerned about competition from India and China. Among respondents, 29% identified competition from India and China as the biggest single risk their companies will face in the next two to three years (see Figure 8). In our 2010 survey, only 18% were most concerned about offshore competition, and in 2009, that figure was only 11%.

Figure 8 Biggest risks to contractor businesses

Funding for early-stage companies remains a top concern for service providers, with 16% citing it as the biggest single risk facing their companies in 2011, versus 12% in 2011. The increase in concern over funding is a bit surprising because industry data show that investments into early-stage companies have improved this year, but the experience of the 2008–2010 period has made service providers aware that the funding environment can change quickly.

Service-provider concerns over cuts in R&D spending at global bio/pharmaceutical companies declined in 2011 compared with 2010. This change is somewhat surprising because global bio/pharmaceutical companies continue to trim their spending and portfolios. The decline probably reflects the fact that fewer service providers have exposure to the global bio/pharmaceutical companies because those companies are reducing the number of vendors they work with.

Positive outlook

Responses to the 2011 PharmSource–Pharmaceutical Technology Outsourcing Survey indicate that the positive momentum should continue into next year. Acceptance of outsourcing seems to be growing: 37% of respondents from bio/pharmaceutical companies indicated that their spend on outsourced services is growing faster than their total spend (see Figure 9). That's the highest percentage choosing that response since 2006.

Figure 9 Outsourced spend versus total spend

Among respondents from bio/pharmaceutical companies, 64% expect an increase in spending on services in 2012 versus 2011 (see Figure 10). This change is slightly less positive than the 2010 survey, when 70% expected growth in the following year. However, only 6% of 2011 respondents expect a decrease in next year's spending, which is down sharply from the 14% in the 2010 survey.

Figure 10 How will your contract services spend change next year?

The "higher highs" and "lower lows" in the 2010 survey reflect the greater uncertainty of last year, when the industry was still buffeted by the difficulties of getting new financing and the restructuring of the R&D operations by global bio/pharmaceutical companies. The 2011 survey results reflect a more stable environment: among 2011 respondents, 30% expect 2012 spending to be about the same as 2011's.

Figure 11 Client and contractor views on contractor performance

Contract-service provider expectations for 2012 are similar to their clients'. More than 50% expect 2012 to be better while 33% expect next year to be about the same. The remaining respondents aren't sure what to expect.

What lies ahead

The results of 2011 PharmSource–Pharmaceutical Technology Outsourcing Survey certainly paint a positive picture for the acceptance of outsourcing as a business practice in the bio/pharmaceutical industry, and for the prospects of contract-services industry near-term. However, we would caution service providers about getting too enthused about their long-term prospects.

For one thing, looking at the survey results over the past five years, it is clear that the prospects of the pharmaceutical-services industry are tied less to the acceptance of outsourcing (which seems to us to be well-established) than it is to the overall industry business environment, and that business environment is still less than robust. Funding for early-stage companies is still fragile and is increasingly contingent on achievement of short-term milestones that provide little basis for long-term spending expectations. Furthermore, global bio/pharmaceutical companies must still undertake bouts of restructuring to fully face the ramifications of patent expiries.

The other major challenge facing the industry is the glut of capacity available for almost every conceivable service category and capability. The overcapacity problem is reflected in our survey by the willingness of service providers to cut prices in order to get more business, a finding that has been corroborated in recent years by the publicly owned contract research organizations in their quarterly financial results. Interestingly, service providers don't seem to be willing to address the problem: only 13% identified overcapacity as the biggest single risk to their company.

An overall rising tide of R&D activity can lift all the players in the contract-services industry for a short period and mask the overcapacity problem, as it did in the 2004–2008 period. However, that period was marked by an excessive amount of funding going into the bio/pharmaceutical industry, something we don't expect to see again for a long time.

Overall, contract nonclinical services providers should take heart while they can at the improved market conditions for the industry, but should be mindful that the overcapacity problem is likely to continue to eat away at their profitability and chances for long-term survival. We have already seen some high-profile failures, and others are not far behind.

Jim Miller is president of PharmSource Information Services and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, info@pharmsource.com