The State of Outsourcing Partnerships

Preferred-provider relationships are transforming the bio/pharmaceutical industry. The largest clinical CROs are focused almost exclusively on gaining and implementing preferred-provider relationships with the global bio/pharmaceutical companies. The author examines the nature of these relationships and implications on drug-development activities.

FSTOP/GETTY IMAGES; DAN WARD

Preferred-provider relationships are the "new new thing" in the contract services industry, even though they have been around for almost five years now. The largest clinical CROs are focused almost exclusively on gaining and implementing preferred-provider relationships with the global bio/pharmaceutical companies. Josef von Rickenbach, CEO of PAREXEL International, recently described the trend toward these strategic sourcing relationships for clinical research services as "a once-in-a-lifetime industry transformation" of the bio/pharma industry.

The interest in strategic sourcing relationships is part of a total rethinking of the traditional R&D paradigm at global bio/pharma companies. The traditional model was built on a vertically integrated organization, usually housed on remote campuses that conducted all phases of discovery and development. That organization was meant to generate a large number of development candidates, often referred to as "shots on goal," and required a tolerance for high failure rates to produce a few commercially successful drugs.

The traditional R&D model was possible because of the spectacular profits generated by blockbuster drugs, but as those blockbusters have gone off patent, global bio/pharma companies have been forced to discard it. For one thing, global bio/pharma companies found that those isolated organizations were not effective at identifying promising new products. Following the lead of other high-tech industries, companies realized that innovation could come from anywhere. They have, therefore, begun moving their discovery operations to centers of medical research, such as in San Francisco and Boston, where they can interact with academic researchers and small bio/pharma companies to identify and acquire the most promising new technologies and candidates.

Global bio/pharma companies also have had to abandon the traditional model because of its, largely, fixed costs. With the revenues and profits from blockbuster drugs eroding, global bio/pharma companies can no longer afford to maintain such costly infrastructure. Reducing costs by reducing fixed overhead and making expenses as variable as possible have become major objectives.

This is where the strategic sourcing arrangements have become central to R&D strategies. Preferred-provider arrangements are enabling global bio/pharma companies to realize cost savings across a number of fronts:

Preferred-provider arrangements have enabled bio/pharma companies to reduce their fixed operating costs by transferring staff and facilities to their preferred providers.

They have made operating costs more variable by letting companies buy just the services they need when they need them.

They have leveraged the operating efficiencies and economies of scale of the large CROs, which generally have better operating skills than the bio/pharma companies themselves.

They have taken advantage of the CRO's expertise and investment in information technology. Information technology has become the differentiating capability in clinical research by enabling companies to collect clinical-research data more quickly and accurately from all over the globe.

They have given bio/pharma companies access to patients worldwide, including countries such as China and India, thereby enabling companies to complete studies more quickly and at lower cost.

They have reduced contract and vendor management costs because there are fewer vendors to manage and audit and because vendors and clients can establish processes that facilitate their cooperation.

Most of the major preferred-provider relationships involving global bio/pharma companies were announced in 2010 and 2011, so the past two years have been crucial periods of implementation. What has been impressive so far is the success that CROs seem to be having in making these arrangements work. The deals are remarkably complex, involving the transfer of dozens of trials, hundreds of staff, and sometimes, entire facilities from the bio/pharma company to the CRO. Typically, the transfers are staged to ensure that the process is orderly, and studies are not seriously delayed during the hand-off. Despite the complexity, there have been no reports of serious problems in the transfers, and CROs have not reported major unexpected costs or delays resulting from the hand-offs. The smooth transition is in part thanks to the governance structures that have been established to oversee these preferred-provider relationships, typically involving senior management from both sides of the relationships to ensure that the participants are aligned strategically and operationally, and potential problems are tackled quickly.

Implications for the business model

One of the most interesting aspects of the growth of these strategic sourcing arrangements is the impact on business-development activities at the large CROs. Senior executives at the major CROs believe that no more than half of the potential deals for clinical services have been done, and less than that for preclinical services. The greatest fear among these companies is that if they lose out on a strategic opportunity with a bio/pharma company, it will be a long time before they get to do business with that company again. As a result, the CROs are being aggressive in going after these deals. They are bidding them at fairly low prices to lock in relationships with the hope that lower sales expenses, greater visibility to workflows, and opportunities for add-on work will boost their margins over the longer term.

The big CROs also believe that the ability to offer a broad range of integrated services is important to winning strategic deals. The initial preferred-provider contracts often involved primarily data-management and site-management activities, but companies realize that being able to offer a broader range of services can make them more competitive. This increase in services has driven acquisition and alliance activity to add crucial services, such as bioanalytical testing, and to broaden geographic coverage.

Table I: Major preferred-provider relationships in clinical research.

Going beyond clinical research

Preferred-provider deals have primarily been struck (or at least announced) in the clinical-research arena (see Table I), but they are beginning to spread into other R&D activities. In a recent presentation at the JP Morgan Healthcare Conference in San Francisco in January 2013, the CEO of Charles River Laboratories, James Foster, said that strategic sourcing activity had "reached an inflection point" in the preclinical research area. Charles River had secured several such deals recently and has seen more such deals in the pipeline. Activities supporting drug discovery, which by most accounts have been only minimally outsourced to this point, is another area on the verge of considerable growth.

In the areas of developing and manufacturing APIs and drug products, few preferred-provider relationships have been established thus far. Outsourcing trends in these areas have traditionally lagged those in clinical research by as much as five years, and are complicated by the vast array of process and delivery technologies that are required to support a typical global bio/pharma company's portfolio. There have been a few noteworthy successes, especially in clinical packaging, where as many as half of global bio/pharmaceutical companies have established preferred relationships with one of the three major clinical packagers. Bio/pharma companies are also showing increased interest in models that hand-off all aspects of product development, from clinical through commercial, to a single CDMO.

This is a time of great experimentation with new business models at global bio/pharma companies, and we are likely to see many variations on the preferred-provider model in coming years. This new environment will call for a combination of vision and operating skill on the part of CRO and CMO executives as they help define the bio/pharma business model of the future.

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