Western CMOs Rise Again, Face New Challenges

After many years of stagnant or even declining revenues as a result of lackluster sales in the pharmaceutical industry, the global contract manufacturing market is growing steadily again. Toward the end of 2011, CMOs started seeing a positive change. Growth of approximately 11% per year brought global revenues for CMOs to nearly $30 billion by the end of 2012, and that figure is predicted to double by 2018 (1). Furthermore, a report by London-based consulting firm Frost & Sullivan suggests that nearly 80% of the top 15 pharmaceutical companies are expected to grow their biologics portfolio over the next four years (2).

Yet even as many CMOs stabilize and grow, it is no guarantee that every CMO will be able to experience the same level of growth. In fact, today’s CMOs may find themselves challenged by a multitude of variables that have not previously existed.

Internally, CMOs will find that certain aspects of their business—including their geographic location, the types of products and services offered, and the partnerships created—will play a bigger part in determining their ability to find success. Externally, CMOs will have to pay close attention to the market they are working in and remain flexible regarding the “new dawn” in the industry.

Product launches, updated technologies, and scientific breakthroughs are driving growth for the foreseeable future, but the abandonment of big pharma’s traditional pursuit of “blockbuster” drugs presents a challenge. Experts forecast that cost-control measures, changes in R&D spend, introduction of novel technologies, and the increase in competition and patent expirations (better known as the patent cliff) are driving the proliferation of specialized—in some cases, “orphan”—drugs and generic drugs (3).

Upswing in approvals: the paradigm shift
The change toward specialized medicines has also led to an upswing in new drug approvals to keep up with market demand. Demographics, increasing life expectancy, and the fact that the “pharmerging” countries will double their spending on drugs within the next five years have all spiked global demand for pharmaceuticals. In the mid 2000s, approvals hovered in the low to mid 20s, but in 2011 and 2012, new drug approvals reached their highest level in 15 years. The approvals of new molecular entities (NMEs) jumped to 30 in 2011 and 39 in 2012 from 21 NMEs approved in 2010. Approximately 70% of these are small-molecule drugs (4).

The rise in the rate of drug approvals reflects a paradigm shift in the industry. Because pharmaceutical companies are no longer able to rely on multibillion-dollar selling blockbuster drugs for most of their revenue, they must now develop and launch more agents aimed at multiple niche markets with considerably smaller patient populations. In their report, Frost & Sullivan estimates this loss of revenue from diminishing blockbuster patents to be $100 billion over the next six years (2). Therefore, the transition to more specialist-care types of drugs is one of the most notable changes observed in the market, but there are other important factors driving change in the industry.

The generic challenge
In today’s market, Western CMOs are undoubtedly seeing increased competition from CMOs in Asia, which makes it more crucial than ever to understand the fundamental cause of change. By remaining focused and informed, Western CMOs will find new ways to address potential barriers, as well as maximize many advantages leading them to success.

The increasing use of generics has presented a particular challenge. With healthcare cost-saving programs becoming progressively more important in developed countries and a large number of drug patents expiring, the use of generic drugs has been growing quickly, with no signs of letting up. Industry analysts predict that by 2015, 85% of all drugs by volume will be generic drugs (5).

Patent expirations on remaining blockbuster drugs and the growth of generic drugs have also led to a wave of mergers and consolidations of big pharmaceutical corporations with prolific drug-production facilities. The influx of unused reactor capacity in these facilities has driven some large pharma companies—Sanofi, GSK, Pfizer, and Merck, to name a few—to use that capacity to directly compete with independent CMOs.

A comprehensive analysis of the overall pharmaceutical and biotechnology outsourcing industry shows that by making this capacity available, large pharmaceutical companies have contributed to an estimated 40% reactor overcapacity for the manufacture of high-volume, small-molecule APIs. At the same time, a number of these companies are shifting parts of their own high-volume, small-molecule API-manufacturing operations to Asia for lower costs, thus adding further to the overcapacity in Europe and the US.

Interestingly, overcapacity does not seem to be an issue for CMOs involved in innovative APIs. This observation is supported by the fact that 2012 saw a 5-10% growth in activity in Europe and the US for innovative, highly potent APIs, orphan drugs, biologics, and critical raw materials used for the manufacture of biologics. In some cases, there has even been a capacity shortage, with some specialist capabilities underserved. Understanding the cause of this phenomenon is crucial if CMOs want to be successful.

Changing customer bases
The observed growth is partly triggered by a change in the customer base. As in-licensing projects for biopharmaceutical products rapidly pass the proof-of-concept stage, large pharmaceutical companies are driving significant growth in demand from smaller players. These smaller companies have rather different requirements than the traditional big pharmaceutical corporations, whose outsourcing needs are often driven by cost, capacity constraints, or a need for specific technical expertise. Hence, today 82% of innovation takes place outside of the top 25 companies of Big Pharma, with 54% of the originators of highly potent APIs having only a limited number of drugs in their development pipeline (6).

Smaller companies aspire to boost productivity to expedite their proof-of-concept development. The security and support needed comes generally through close partnerships with CMOs. The notable difference between Big Pharma and smaller biotech companies often creates a challenging environment for CMOs. Even so, the demand for productivity from smaller companies is now also spreading to some of the larger players in the industry. Therefore, to successfully meet customer needs, CMOs must be fast and flexible and employ highly skilled and educated workers.

Global workforce costs
The need for a skilled workforce is further amplified by an increase in approval pathways for the next generation of biopharmaceuticals, making workforce one of the key drivers of innovation and progress in the drug development process. This is particularly true for CMOs operating in Asia, where the workforce continues to meet with changing demands and needs.

At first glance, highly educated postdoc chemists in the US or Europe appear to earn a higher salary than their counterparts in India or China. Labor costs in 2013 were estimated to be $83,232 in the US and $104,040 in Europe, as compared with $36,675 in India and $30,106 in China. However, it is important to note that while salaries are noticeably higher in the US and Europe, Asia is witnessing rapid growth in remuneration, as double-digit increases are quickly bringing employees up to the same level as those in the West. In the US and Europe, the standard salary increase is approximately 2% a year, compared with 15% in India and 12% in China (7-9).

In contrast to rapidly rising employee costs, productivity in most Asian countries is often considerably lower, estimated to be only two-thirds of that in the West. This is primarily due to much higher employee turnover. In China and India, the rate of labor turnover is estimated to be between 10-20% per year. And for every skilled worker who leaves, a new one must be trained as a replacement, which takes time and can result in a temporary loss of productivity Therefore, unless a CMO is designing its business to serve the Asian market, there is now far less rationale for building a facility in Asia that handles sophisticated chemistry (10).

Yet for chemical manufacturing that requires less-skilled workers, the global salary gap is closing far more slowly. In fact, it is estimated it will take at least a decade or two before parity is reached with Western counterparts. For example, in 2013, the labor cost for a chemical operator in the US was $53,045, with an average salary increase of 3%. In Europe, those numbers are very similar—$72,828, with a 2% standard salary increase. These numbers are substantially lower for India and China: $9000 per year with an approximately 15% salary increase in India, and $7900 for China, with an approximately 12% standard salary increase (10).

This difference means that it takes 7-12 years for an Indian operator and 8-14 years for a Chinese operator, to “break even” with counterparts working in the West. Any decreased productivity becomes offset by the drastically lower wages--to the tune of a 70% cost advantage remaining for the manufacture of high-volume products in Asia. As such, many Western companies will continue to outsource this type of work to Asia for the foreseeable future (11).

Breaking dawn
As the CMO market continues to evolve, the shift from blockbuster drugs to specialist-care drugs has undoubtedly changed the game. The increasing complexity of new biopharmaceutical agents creates real opportunities for companies that are able to offer specialized, innovative chemistries that are being carried out by skilled workers.

Biologics and highly potent APIs are projected to grow by more than 60% during the next five years, giving CMOs an incentive to truly invest in developing their workforces. Furthermore, successful CMOs will be recognized by their ability to deliver high-quality, customized manufacturing materials and services designed to drive the performance of their customers’ end products. In addition to a strong workforce, offering differentiating technologies and services leveraging their capabilities in biologics and highly potent APIs is crucial.

While focusing on these strategies, successful CMOs should also consider expanding in Asia, because the production of high-volume generic drugs will—for the foreseeable future—be owned by Asian companies. Such a strategy, however, should not just be driven by cost savings. Rather, globally operating CMOs should look to Asia as a hub to serve local Asian markets’ growing populations and demands.

Big and small pharma companies have drastically different key drivers in today’s market, which requires greater flexibility from CMOs than ever before. Such greater flexibility—reinforced by an understanding of novel technologies, the competence to offer specialized chemistries, and the ability to meet undercapacity in some specialized niche areas—highlights the potential for Western CMOs to continue to win business and find success ahead of their Asian rivals. The new dawn has broken.

References
1. GBI Research, Contract Manufacturing Organizations to 2018 (April 2012).
2. Frost & Sullivan, Competing in the Global Contract Manufacturing Market (October 2013).
3. S.S. Dewan and K.A. Setia, BCC Research, Global Markets for Contract Pharmaceutical Manufacturing, Research and Packaging-—Focus on Contract Manufacturing (August 2013).
4. E. Palmer, “FDA Approvals 2012” , accessed Jan. 8, 2014.
5. IMS Health, Competition in the API Market, Generic Association (May 2011).
6. I. Lloyd, Citeline, Pharma R&D Annual Review 2013, June 2012.
7. S Morrissey, Chem. and Eng. News, 90 (23) 36-38 (June 4, 2012).  
8. J. Sincavage, C. Haub, and O. Sharma, Monthly Labor Review 133 (5) 3-22 (2010).
9. A. Badrot, “When the Unexpected Happens,” accessed Jan. 20, 2014.  
10. P. Pollak, Chem. Weekly (Feb. 24, 2009) p. 183.
11. P. Pollak, Fine Chemicals: The Industry and the Business, (Wiley, 2nd ed., 2011).

About the Author
Andreas Weiler is global head of strategic marketing, SAFC Contract Manufacturing Services for Life Science Products, and a member of the Pharmaceutical Technology Editorial Advisory Board, andreas.weiler@sial.com.