Sizing the Market for Contract Manufacturing

How big is the market for contract- manufacturing services? PharmSource gets that question more than any other. Published estimates of market size vary widely and often seem to be exaggerated or inflated.

Jim Miller

Measuring the market

Determining the size of the contract-manufacturing market is a methodological challenge. The biggest obstacle is the fact that most CMOs are either privately owned and do not report their financial results or are part of larger corporations that usually do not break out their CMO revenues in their financial reports. Although good research can overcome some of these problems, determining market size ends up requiring some amount of "guesstimation."

Another methodological problem is defining what is included as "contract manufacturing." Many published reports are unclear about what they are measuring, which can lead to widely divergent market-size estimates. Understanding a given market size estimate requires that the reader and user fully appreciate what is being measured. Some of the dimensions that must be considered are discussed below:

• Which products are included in the market? The definition can include prescription products, over-the-counter (OTC), and nutritional products. Although prescription and OTC products are both governed by drug GMPs, nutritional products often are not, so the market dynamics and participants tend to be different, albeit with some overlap.

• Is the product being manufactured proprietary to the client or is it generic? Some estimates of the contract-manufacturing market appear to include generic APIs, which are really commodities that can be bought by any company looking to manufacture a generic or OTC drug. There also are generic or OTC drug products that the manufacturer licenses to a customer to be packaged under the customer's name, the so-called "private label" business. By contrast, pure contract manufacturing involves a CMO manufacturing an API or drug product using the client's proprietary process or proprietary formulation.

• What regulatory standards must be met? Many manufacturers in emerging markets offer contract manufacturing, but they do not operate under North American, Western European, or Japanese regulatory standards. These companies are competing in a different market and under a different set of terms than manufacturers that meet higher regulatory requirements.

Given the potentially broad dimensions of the CMO industry, users of market-size data must be clear about the applicability of the data they are using. PharmSource recently published its own estimate of the size of the dose CMO market, Dose CMOs by the Numbers—2012 Edition. We measured the market for contract manufacturing of a client's formulation under FDA, Western European, or Japanese GMP standards and built our estimate based on extensive research of company revenues and revenue modeling.

We (PharmSource) arrived at a contract-dose manufacturing market size of $13.7 billion in 2011. That was up 7% from 2010, but that growth rate includes revenue from facilities that became contract-manufacturing sites during the year after they were acquired by CMOs from biopharmaceutical/pharmaceutical companies. The organic growth rate (i.e., the growth of revenues at facilities that were in CMO networks in 2010) was 6%. We estimate that overall, dose CMOs accounted for 22% of the biopharmaceutical/pharmaceutical industry's dose-related cost-of-goods in 2011.

Of course, size and growth are not the only dimensions that matter for the health of the industry. Contract-dose manufacturing suffers from overcapacity, especially for solid-dose forms, and the intense competition to sell capacity means that only a minority of dose CMOs make reasonable profits. Further, global biopharmaceutical/pharmaceutical companies continue to show a strong preference for building captive manufacturing, shutting CMOs out from some of the most attractive segments of the market.

We continue to believe that a consolidation of the industry will happen sooner rather than later, driven by developments in the broader economic and financial environment. When that happens, the industry may not be so big or growing at the same rate, but it will be getting healthier.

Getting paid

A recent analysis of working capital management practices ofbiopharmaceutical/pharmaceutical companies has some mixed implications for the contract-services industry. The report from financial services giant Citi claims that the global biopharmaceutical/pharmaceutical companies could release $33 billion in cash by managing their working capital better. Working capital is the difference between current assets (which include accounts receivable and inventories) and current liabilities (which include accounts payable and short-term debt). Companies use cash when they build up inventories and receivables and pay their bills; they increase their cash when they run down their inventories, slow payments to suppliers, or collect receivables more aggressively.

Companies could free up that cash by reducing inventories and taking longer to pay their bills, according to the Citi report. The additional cash resources could be used for licensing and acquisition deals or could be returned to shareholders as dividends and stock buybacks.

Having to wait longer for their money is not something that CMOs and CROs want to hear. Service providers are already getting squeezed on prices and profit margins, and a slowdown in payments will eat further into their profits by forcing them to borrow more against their lines of credit or to forego discounts they might get from paying their own suppliers. In the worst cases, CROs and CMOs could be forced to delay hiring or purchasing materials and equipment, which would hurt the quality and reliability of the services they provide.

On the other hand, helping their biopharmaceutical/pharmaceutical clients to reduce their inventories could be a big opportunity for CMOs. Managing inventories is about managing production schedules, cycle times, and supply chains. These are skill sets at which CMOs are supposed to excel because they are at the core of modern manufacturing practice. CMOs that are able to reduce schedule lock-in times from the traditional three months for dose forms and six to twelve months for APIs could increase their share of business from key customers and probably earn somewhat higher margins.

The working-capital challenge raised by the Citi report is further proof that success for CMOs will go beyond traditional measures of quality and cost of goods.

Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, Twitter@JimPharmSource, info@pharmsource.com, www.pharmsource.com.