Industry Outlook: Down But Not Out

There has been an atmosphere of doom and gloom over much of the contract services industry this year. Early development outsourcing has been hit hard by funding cuts to small biopharmaceutical and pharmaceutical companies and restructuring at the major companies. Late-stage development has maintained some momentum, but a feeling of uncertainty has overtaken the confident swagger of contract services providers.

ILLUSTRATION BY M. MCEVOY. IMAGES: DON FARRALL, CREATIV STUDIO HEINEMANN/GETTY IMAGES

The 2009 PharmSource–Pharmaceutical Technology Outsourcing Survey suggests that the sense of gloom is overblown. Although the positive responses are somewhat fewer and the negative responses somewhat greater compared with previous surveys, the overall picture is still one of a healthy level of activity at contract manufacturing, contract development and manufacturing, and contract research organizations (CMOs, CDMOs, and CROs). Competition has intensified at the margins, but there is a core level of activity sustaining the industry.

Figure 1

Current level of activity

The healthy image of the industry is reflected in the spending patterns reported by respondents from biopharmaceutical and pharmaceutical companies (i.e., the "buy side" of the outsourcing equation). The number of respondents reporting double-digit increases in outsourcing spend dropped sharply, while the number reporting an absolute decrease in spending more than doubled (see Figure 1). Responses from contractors mirrored these results, with a sharp drop in those expecting 2009 to be "very good" and a quadrupling of those expecting the year to be "not very good" (see Figure 2).

Figure 2

Still, more than 50% of biopharmaceutical and pharmaceutical respondents expect at least some growth in their spending this year, and another 28% expect it to remain level. Among contractors, nearly 75% expect business to be "good" or "very good" in 2009. These responses indicate a slow growth year, but certainly not a disaster.

Other survey questions illustrated just how different the current market is from the recent past. The number of contractors pointing to large biopharmaceutical and pharmaceutical companies as their best-performing customer segment has jumped sharply, while the number singling out small firms fell sharply (see Figure 3). This change reflects the reduced means of early-stage companies that depend on the crippled financial markets for capital to fund their development activities. It suggests that companies that have been disproportionately dependent on small biopharmaceutical and pharmaceutical companies have been disproportionately hurt by the downturn.

Figure 3

Another big difference in this year's survey is that, for the first time in three years, more respondents report that outsourced spending is growing more slowly than total spending (see Figure 4). Con-tractor respondents also noticed this development. This may reflect efforts by major pharmaceutical companies to use internal capacity freed by the cancellation of many development programs, as well as the reduced funding available at many small companies.

Figure 4

Tougher competition

As expected in the soft business environment, competition for new business has intensified. The clearest indicator of this move is the big jump in the number of biopharmaceutical and pharmaceutical respondents claiming that contractors are willing to cut prices to get business: 52% of biopharmaceutical and pharmaceutical respondents indicated that contractors are willing to cut prices, versus 42% last year, and just 34% as recently as 2006 (see Figure 5).

Figure 5

Competition has been intensified by companies' ongoing efforts to consolidate the number of contractors they use. Respondents indicating that they are reducing their vendor base increased slightly, from 27% in 2008 to 31% this year, while the number of respondents with plans to expand their vendor base continued a two-year decline (see Figure 6).

Figure 6

There are still new opportunities, however, for contractors with biopharmaceutical and pharmaceutical companies: nearly half of the survey respondents indicate that they continually identify and test new vendors, while most others are looking for contractors to fill special needs or replace poor performers. Getting on the "short list" of bidders for a project, though, is becoming more difficult according to our survey. Both the number of bidders per project and the share of bids accepted from new vendors declined somewhat over past years.

One trend that seems to have slowed slightly is sourcing from India and China. The share of biopharmaceutical and pharmaceutical respondents indicating that they have no plans to source from India and China rose from 45% last year to 51% in 2009 (see Figure 7). This minor growth does not necessarily imply a lessening of interest in sourcing from Asia, but rather a lull reflecting the overall uncertainty in companies' development programs.

Figure 7

Contractor performance

Clients and contractors continue to view contractor performance differently. Contractor respondents are downright immodest in judging their own performance: more than 90% rated their technical and operational performance as "excellent" or "good," and 88% gave themselves "excellent" or "good" ratings on customer service (see Figure 8).

Figure 8

Clients graded contractor performance on a much tougher curve. Only 57% of biopharmaceutical and pharmaceutical respondents rated contractors' customer service as "excellent" or "good," and only 53% think contractors' project management skills are "excellent" or "good." Contractors fare better on technical and operational performance with 67% of respondents considering them to be "excellent" or "good." On the bright side, only 8–10% of biopharmaceutical and pharmaceutical respondents grade contractors as "poor" or "fair" in these performance categories.

Uncertain outlook

Perhaps the biggest sign of the changing times revealed by the 2009 PharmSource–Pharmaceutical Technology Outsourcing Survey is the change in which market factors worry service providers the most. In past years, service providers were most concerned about competition from CROs and CMOs in India and China, and about too much capacity in the industry. In 2009, their concerns are more fundamental: they worry about whether the biopharmaceutical and pharmaceutical industries will be able to maintain their historic levels of research and development (R&D) expenditures (see Figure 9). In light of the business-model changes occurring among major companies and the pullback of venture capital, these are very valid and real concerns.

Figure 9

Despite that uncertainty, respondents to this year's survey are signaling that 2010 could still be a good year. Spending growth is likely to be slower than in past years, but half of biopharmaceutical and pharmaceutical respondents expect increases in their outsourcing expenditures in 2010 (see Figure 10). Among the ever-optimistic contractor respondents, more than half expect 2010 to be somewhat better, and relatively few are expecting a bad year.

Figure 10

A maturing industry

Although the 2009 survey paints a picture of an overall healthy industry, contract services providers are right to be concerned about future levels of R&D spending. These concerns reflect fundamental changes taking place in the biopharmaceutical and pharmaceutical industry as the increasing challenges of commercial success are reflected in the level and nature of new drug development.

For providers of formulation and manufacturing services, the silver lining is that there is still plenty of opportunity for growth—outsourcing has not penetrated as deeply into physical product development as it has into clinical research. Clinical CROs have already grabbed as much as 70% of the clinical research spend available to be outsourced, and that segment's growth curve is likely to flatten. Formulation and manufacturing service providers have achieved about half of that level of penetration, so there appears to be additional opportunity to grab more of that spend.

Respondent profile

The opportunity will not be an equal one for all participants in the business, however. CDMOs can no longer depend on a rising tide to lift industry participants. The increase in outsourcing penetration in the clinical segment has been accompanied by a sharp consolidation of business among a relative few CROs that offer global scope, economies of scale, financial stability, and management maturity. The same is likely to be true for formulation and manufacturing services. The highly fragmented nature of the industry will change, and many smaller CDMOs will fall by the wayside as larger participants consolidate their market shares.

The key to capturing the opportunity will be performance—that is, the ability to deliver products and services dependably and at lower costs. The gap between how buyers and sellers view CDMO performance continues to be one of the more striking findings of the PharmSource–Pharmaceutical Technology Outsourcing Survey.

Service providers must improve their understanding of client needs and expectations and figure out how to provide the levels of service clients expect. The 2009 survey suggests they aren't doing a terrible job now, but the CDMOs that can close the gap will capture the lion's share of the business in coming years.