Why outsource? It is a question to which there have been many answers during the past 40 years, as trends and necessities have changed within the pharmaceutical industry
Cambrex has researched the many changes that the market has seen in that time to evaluate whether history can be used to anticipate future needs.
Assisted by some of the leading industry figures who had been both witness to and participants in the evolution of (what we now call) the contract manufacturing sector, the history can be broken down into four distinct chapters.
These periods can be reviewed with hindsight to predict the challenges and potential direction of the fifth and future stage of the active pharmaceutical ingredient (API) industry.
The birth of outsourcing came about with contract manufacturing organisations (CMOs) offering services to the large pharmaceutical companies to undertake individual steps within a chemical synthesis that were difficult or hazardous. The unexpected rise of blockbuster drugs also led to a shortfall of in-house capacity within pharmaceutical companies, and so some early steps — often to produce an intermediate within an API process — were done externally. These were then brought back in-house for the final production steps.
This period saw a huge increase in R&D spending across the pharmaceutical industry, fuelled by the blockbuster model. New technologies were implemented, including biotechnology, computational chemistry, high throughput screening and combinatorial chemistry, which explored more and more of the small molecule drug space.
Plant capacity was full, and a shortage of GMP capacity saw investment in new facilities, investment in older plants to handle the needs of the fine chemical market and an influx of new CMO entrants across the United States and Western Europe.
As pharmaceutical companies’ plants filled, this heralded the beginning of multistep outsourcing; but, initially, the barrier to entry of investment and expertise meant that only a small number of CMOs were able to offer this service. However, as demand continued to rise, the opportunities became more numerous and the number of service providers boomed.
Many CMOs were bankrolled by investors who saw the industry as an opportunity to get rich quick, unaware of the slow development timeframes in the pharmaceutical industry. In the United States especially, many investors were lured in by what they saw as a profitable environment in the rapidly expanding market, only to pull out when the timeframes proved to be too lengthy, leading to a decline in the number of new US entrants at the start of the 2000s.
Enter Asia and low cost competition. The result of this was a decade of uncertainty, challenges and unpredictability. This was at a time when the pharmaceutical companies were facing the end of the blockbuster drug era and had to embrace a changing environment and adapt the way that they worked.
In many ways, it was inevitable that the expanding economies of India and China were attracted to the growth potential of the CMO market, and the rise in outsourcing companies and the cumulative growth of overall global capacity saw a shift in supply that far outweighed demand. Predictably, this led to a race to the bottom on prices for manufacturing. For the pharmaceutical companies, who were coming to terms with reduced blockbuster revenues after patent expirations, increased failure rates in clinical trials and soaring R&D spending, this opportunity to save money was widely welcomed.
Undaunted by quality and experience issues, the risk/reward factors in saving vast sums of money were seen as too great to ignore; Chinese and Indian firms could typically offer up to 50% price reductions compared with Western competition because of lower labour costs, simpler and cheaper manufacturing assets, lower depreciation and lower cost of capital. Established relationships between the pharmaceutical companies and traditional suppliers were severed as cost savings were prioritised instead of quality concerns.
What also drove the influx of Chinese and Indian companies to the CMO industry was the rising need for manufacturing to support their own local drug industries and the growing demands of the domestic populations. When the companies had excess capacity because of troughs in domestic drug product demand, it was only natural to turn their own captive manufacturing towards the open market and offer API production on a fee-for-service basis.
There are numerous factors that have combined to lead to a stabilisation and resurgence of the CMO industry. Healthcare spending in Western markets has increased in line with the increasing number of new chemical entities (NCEs) approved by FDA, notably in high-value disease targets such as oncology and orphan indications.
China and India have suffered. A rise in labour costs within China, which relies on low automation/intense resource operations, now makes that market less attractive, and the regular reports of warning letters by FDA towards Asian CMOs have diminished the trust that pharmaceutical companies have in them. Indications from regulatory authorities are that standards are only going to become tighter, so infractions will likely persist and become more frequent, eroding trust even further.
New entrants to the CMO market from India and China have reduced, and now the trend of “reshoring” — returning manufacturing processes to US and European suppliers — is increasing. However, it should be noted that the companies in the greatest demand are those with specific assets and capabilities — just having capacity in plant is not enough. The “right” assets, facilities and experience are key drivers when placing projects. What can be concluded, however, is that low cost is no longer good enough, and cost is no longer the highest priority when selecting a CMO partner.
The result in China has been an increase in domestic manufacturing regulation; the Chinese Food and Drug Administration (SFDA) has aggressively tightened up on drug product approvals, as well as CMO quality and compliance levels. As a result, a significant number of Chinese CMOs have left the market, many drug master files (DMFs) have been deregistered, which has contributed to the reshoring of pharmaceutical companies’ supply chains back to Western CMOs.
The research undertaken suggested there are five key trends that could determine the direction that the CMO industry takes.
Capacity planning: No one is suggesting that the future is risk-free. There are signs that growth prospects continue to be positive; however, blindly investing in capacity to meet perceived increased demand is undoubtedly unwise. Overcapacity within the industry would return CMOs to the past and a potential boom and bust scenario, culminating in slashing prices to ensure assets are utilised whatever the cost. Cambrex research indicates that the average annual US demand for small molecule APIs has reduced from around a hundred metric tonnes to tens of metric tonnes.
Additionally, the risk of the current trend of NCE approval rates being high and increasing could be temporary. If the opposite were to happen and approvals rates drop, coupled with increased market capacity, this could also lead to a scenario wherein capacity outweighs demand once more and we are back to the era of the 2000s and the competitive years.
Technology: A lack of investment in innovation amongst CMOs has deprived the industry of core differentiators, which increases the perception of companies purely being seen as “capacity for hire” by pharmaceutical companies.
Again, with the risk of overcapacity becoming an issue, there is little motivation to outsource and the case for it becomes less compelling unless a CMO can offer a specialism, or an expertise such as undertaking hazardous chemistries, or has the capability to handle highly potent or controlled substances.
A CMO must find a differentiator to stand out in this widely populated industry. In times of full order books and high capacity utilisation, new technologies should be sought and investment is crucial to maintain a standout offering to customers seeking expertise. The most successful CMOs in the industry are those that continue to adapt and invest, and to answer the needs of the customers; however, it goes without saying that delivery of expertise overrides all. It is paramount that the service lives up to the claims.
Customer focus: History shows that CMOs with an over-reliance upon one customer can end up in a perilous position. Having a balance of customers and, crucially, the correct type of customer, is the most desirable position for a CMO to ensure risk is mitigated. Finding key customers who value success and need a CMO to work and grow symbiotically is important; times have moved on from the practice of beating down prices by using low-cost providers, and quality is now recognised to come at a price.
To attract new business, especially from Big Pharma companies, having a stable and sizable portfolio of clients gives credibility to a CMO. However, a balance must be struck between having sufficient capacity and size to offer services, technologies and manufacturing capacities to satisfy customer demand, and not being so large that internal company bureaucracy results in — or has the perception of — inflexibility, such that partnering and collaboration becomes difficult.
Business models may need to vary between clients for CMOs as the demand for flexibility becomes greater still, and it is only through balancing the needs of all clients and carefully choosing new projects that come with an element of risk/reward that growth can be achieved. Filling capacity and taking on new clients with deals that are not beneficial to the CMO is not a long-term strategy for success.
Market intelligence: Forecasting is, and never has been, straightforward within the CMO industry. Market intelligence and data analysis tools can help to predict the next industry trend, and using data to assess and evaluate pipeline opportunities is crucial … compared with the approach of doing nothing and waiting for the next large-scale product to emerge.
New markets and opportunities: The trend for regulators to push back the registered starting materials within a chemical process means the opportunity for CMOs to move back down the supply chain increases. This has the benefit of not only filling capacity, but also affords a greater chance for process development to improve customer processes.
Similarly, by moving further up the supply chain towards finished drug product manufacture, own product manufacturing can absorb excess capacity and smooth out some of the variability and unpredictability of CMO capacity utilisation.
And what of the once revered “one-stop-shop” strategy? The research shows that pharma companies do not put an increased value on API and drug manufacture being under the same roof. The real value comes from CMOs sticking to the knitting, and rather than claiming expertise in everything, the key is to deliver and be competent in the areas that they do focus on. The market has evolved, but not changed. The upshot is that customers still want high quality products, delivered on time and in full. Customers want experts that they can enjoy working with.