Troublesome Signs for Bio/Pharmaceutical R&D

This year has been a good one for development-services providers, especially those that support late development (i.e., Phase II–III). CMOs and CDMOs report strong demand for late-stage clinical-trial materials and clinical-development services, and our PharmSource surveys indicate that the industry could experience growth of 5–10% this year.

Jim Miller

The buoyant conditions for late-development services may not last much longer, however, as there is growing evidence that discovery and early- development activity may be declining. CROs offering preclinical-development services, such as animal toxicology testing, have reported soft market conditions and weak revenues throughout the year. CMOs specializing in process development for small-molecule APIs note that demand for process development and early-stage clinical supplies remains weak even as late-development demand has been strong. This situation is a big concern for late-development services, of course, because a weak early-development pipeline means fewer Phase II and Phase III candidates in coming years.

Much of the blame for this state of affairs can be placed on the highly uncertain and volatile global financial environment. Investors remain risk-averse and are less likely to embrace investments that require long gestation periods and have a low probability of positive outcomes. Late-stage development candidates have a greater probability of success than candidates in discovery or early development and are closer to a payoff in the form of licensing or outright sale to a global bio/pharmaceutical company.

This state of affairs is reflected in venture-capital activity in the bio/pharmaceutical industry. According to US data provided by the National Venture Capital Association, the number of venture-capital investments in the bio/pharmaceutical sector is down 15% through the first nine months of 2011 compared with venture-capital investments in 2010. The actual dollar value of investments is up, but that is because of some large deals that supported companies with strong late-development prospects, such as the $300 million raised by Reata Pharmaceuticals from a single investor. Venture-capital support is crucial to early-stage companies, and the decline in funding is a clear warning sign for the industry.

European economic crisis

The European financial crisis is another cloud on the bio/pharmaceutical R&D horizon. As part of austerity measures required to get their sovereign debt situation under control, many European governments are slashing expenditures on drugs. In countries such as Greece and Spain, governments have cut the prices they will pay for drugs by as much as 25% or more and are forcing a conversion to generic drugs from branded drugs. (The southern-tier countries that have the greatest debt problems have lower generic-drug penetration than northern European countries).

According to a report by the investment firm Jefferies and Company, the top-line squeeze is likely to force small and mid-size companies in Europe to cut their R&D expenditures as part of overall cost-cutting measures. A recent article in the Wall Street Journal cites Spain's Almirall and Greece's Alapis as mid-size companies that are facing R&D cuts as revenues fall (1).

If European revenues are severely affected, even the global bio/pharmaceutical companies could end up reducing their R&D spending in Europe. Although those companies try to maintain global R&D networks to tap into the broadest array of opportunities, their R&D activities have typically been matched to the regions with the greatest revenue and profit potential. Over the past 10-plus years, the locus has been in North America, where the high prices and margins in the US market have funded most of the R&D budgets at global bio/pharmaceutical companies. More recently, the focus has been shifting to the high-growth emerging markets. Even though some of the largest global bio/pharmaceutical companies are headquartered in Europe, continuing sales and profit pressures could force them to move more R&D activity to other locales.

Implications

The global financial outlook is not likely to improve in the foreseeable future. The outlook in Europe remains highly uncertain, with further cuts in government expenditures likely and the survival of the euro zone at risk. Deep budget cuts are coming in the United States, where the aging population and the need to cut budget deficits will put severe pressure on Medicare, the large government-sponsored healthcare program.

These macro environmental challenges and uncertainties compound the bio/pharmaceutical industry's internal challenges, most notably the decline in revenues resulting from patent expiries. Under these circumstances, the outlook for bio/pharmaceutical R&D spending would seem to indicate little or no growth in coming years.

The difficult R&D environment will have a mixed impact on the bio/pharmaceutical services industry. Bio/pharmaceutical company efforts to control R&D costs have helped the contract-services industry, and the penetration of outsourcing is likely to grow, especially in the nonclinical-development segment. However, those benefits will not be equally shared among all industry participants. Thanks largely to the efforts of the global bio/pharmaceutical companies to reduce the number of vendors they work with, a select number of preferred providers is benefiting disproportionately from the outsourcing trend. The clinical-development services segment has already consolidated into a handful of major CROs with large market shares, and we are seeing evidence of a similar consolidation in the nonclinical-development segment although the pace is slower. CROs and CDMOs that don't achieve preferred-provider status will be left to fight over limited opportunities among small- and mid-size bio/pharmaceutical companies.

The pharmaceutical services industry has traditionally risen and fallen with the R&D spending tide. When the tide has been high, most of the companies in the industry have prospered, but when the tide has gone out, all the participants have suffered more or less equally. If we are going into another period of industry weakness, the pain is not so likely to be shared this time around.

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

Reference

1. J. Whalen, "Europe's Smaller Drug Firms Feeling Pain," Wall Street Journal, Oct. 28, 2011.