Outsourcing's Evolution from Commodity to Partner

Increasingly pharmaceutical and biotechnology firms are starting to explore the effectiveness of their outsourcing strategies. Outsourcing the many different aspects of drug development is not a new phenomenon and over the past two decades there is tangible evidence of a change in the way in which both providers and outsourcers approach outsourcing.

PHOTOGRAPHY: GETTY IMAGES ILLUSTRATION: PAUL A. BELCI

The primary driver for this change in ethos and strategy is the need for the pharmaceutical industry to firstly understand the trends and forces within their own market sectors and then rethink their own approaches to both growth and cost management. This article reflects on the changes in strategic outsourcing and considers the mechanisms that have driven outsourcing from a commodity function to a model of partnership and risk sharing.

Outsourcing by the numbers

There are a number of varying estimates on the size of the outsourcing marketplace but it was estimated in 2006 that the value of the drug development sector for the outsourcing industry was more than $10 billion.¹ Another report proposes that the annual growth rate for pharmaceutical R&D outsourcing between 2001 and 2010 will be 16.3% per annum, resulting in a total market value of $36 billion by the end of this period.² Whichever set of figures is used, there is no doubt that pharmaceutical R&D outsourcing is big business.

There is, however, pressure on the manufacturers and owners of proprietary pharmaceutical and biotechnology medicines to reduce their costs while maintaining margins. This is becoming more pertinent, as rising R&D costs coupled with the large number of blockbusters that are losing their patent protection force an almost continual strategic and business model review. In its 2008 Outlook, Tufts Center for the Study of Drug Development quoted that the estimated cost to develop a new biopharmaceutical has surpassed the $1 billion mark.³ These costs are split⁴ evenly between the preclinical and clinical phases of drug development, both of which use outsourced service providers to facilitate progression of the product along the drug development pipeline.

While focus on shareholder value and increasing developmental costs are high on the list of forces driving the outsourcing market, they are not the sole factors. There are also perceived crises in both the sales and marketing and R&D function of the pharmaceutical industry, all of which are having an impact on how the sector responds. The consequence of all these factors coming together has resulted in a slow down in the productivity of pharmaceutical and biotechnology companies,² with a significantly reduced level of products entering the drug development pipeline.

To combat this, the strategy of choice during the early 2000s was mergers and acquisitions. This was seen as a key mechanism to improve research and development productivity; however, the result was a concerted period of consolidation among the top players. This has not been as fruitful as anticipated and the delta between where they are and where they wanted to be has not been sufficiently breached. Indeed, IMS Health reported in March 2008 that during 2007 the U.S. pharmaceutical market experienced its lowest growth rate since 1961. This has been attributed directly to the loss of exclusivity on branded products, the fewest number of new product launches, and increased safety issues and withdrawals of a number of products.

As the pharmaceutical and biotechnology industries evolve, there is a tangible influence being exerted on the role of the outsourcing market in the resolution of these drivers. With evolution comes a cultural shift in the attitude of the industry toward vendors such as CROs, who are becoming a far more integrated part of a product's development.

Drug development

Outsourcing has traditionally been viewed as a commodity, primarily due to the fact that there was little differentiation across the sector. To a degree this has been a consequence of the approach that the top tier CROs have taken toward meeting the perceived need of the customer through being "one-stop shops." The outcome has meant that there was very little differentiation in terms of both portfolio and quality of the end product. Coupled with the fact that scientific equipment required for high-end discovery carried with it an expensive cost price, it was traditionally the regulatory driven high resource, low technicality work that was outsourced. Sponsor companies wanted to control the amount of proprietary information that was available to the vendors and often the relationship was based around a-need-to-know basis.

Flipping to the barriers, it could be suggested that these are in the main more emotive than practical. It is human nature to hang on to what is tried and tested, and the thought of allowing someone else to have input into the development of the next big thing (and potentially a share of the profits) remains a significant hurdle that needs to be overcome. If we are to consider the perceived barriers to outsourcing R&D, it is easy to understand where this resistance is coming from.

It may be desirable to have an integrated pharmaceutical company, however, the current economic climate dictates that sustaining such an overhead requires a large portfolio of good revenue generating products. As we have already noted, the lack of products entering into the pipeline coupled with diminishing patent protection and the hunger of the generics marketplace to have their own products in the market puts a strain on these revenues. Since 2003, while global pharmaceutical sales increased year on year the level of growth has correspondingly decreased year on year from 10.3% to only 6.4% in 2007.⁵ It is inevitable that something has to change.

A shift in design

The classic model of outsourcing has been described as being a slave/master relationship—a description the pharmaceutical and biotechnology industry will possibly feel is somewhat harsh. In this model, the pharmaceutical and biotechnology sectors have utilized a nonstrategic and short-term approach of outsourcing on a fee for service basis. As dated as this concept may seem, it is popular. Data indicates that as recently as 2001, outsourcing was conducted in a nonstrategic, piecemeal fashion, simply outsourcing to meet a short-term resource shortage without considering the long-term perspective. It facilitates internal cost control and deals tactically with capacity requirements on a short-term focus that over time is supposed to provide cost reduction.

While providing a short-term fix, the fee for service approach does little to build effective lines of communication, nor does it seek to build any sense of a long-term relationship or loyalty between the two parties. And over time, the fee for service relationship ultimately becomes frustrating for both. On the side of the CROs, there is the lack of visibility of a long-term commitment and fluctuating capacities. On the side of the outsourcer, there are increased prices and long lead times.

In response, the biopharm industries have sought time to implement a more strategic approach to outsourcing. The aim: to promote an internal procurement approach that narrowed down the pool of possible vendors to a select few that would gain preferred supplier status. This would be based on a number of measurable criteria, including capacity, capability, quality, compliance, price, and culture. This approach has the potential for more strategic relationships that move toward a long-term understanding rather than a pick and mix approach involving multiple vendors that sometimes provide the same service but to different departments.

From the CRO perspective, preferred provider relationships provide an opportunity for longer term forecasting and opportunities to secure continued and repeat business. This in turn provides smoother cash flows and potential for investment in the service and new areas of interest.

With the vendor organizations focusing more and more on value added components, the dynamic of the agreement is changing and the transformation of the relationship to more of a partnership is becoming reality. The success of the model is contingent on the gradual erosion of the barriers that are noted in Table 1. When all parties involved share a common perspective on how partnerships work and have a strong commitment to making it work for the mutual success of both parties, the barriers become less of an obstacle.

Table 1. Factors understood to be the main drivers and barriers for companies when it comes to outsourcing.

Both parties should also be comfortable with the fact that a working partnership means sharing not just the risks but also the rewards and successes of the outcome. The systems and processes involved in the project will often be intertwined, and there may even be a sharing of resources in critical phases.

In reality, the shift from commodity to partnership has failed to gather as much momentum as would have been hoped. There is still continued mistrust and a lack of faith in the value that properly constructed relationships between the pharmaceutical industry and CROs can provide. On the other side of the fence, the CROs feel that while it is in principle a partnership arrangement, the terms and conditions of the actual contract are those of the client, information does not always flow as readily as hoped, and internal management resources at the sponsor's end are not always sufficient to effectively manage the relationship.

However, there are a number of strategic alliances and agreements between biopharm companies and outsourcing service providers that stand testament to the willingness of both parties to meet, share, and understand the dynamic of the relationship. The success in these alliances is the understanding that both parties come to the table with a clear area of expertise and capability and are afforded the latitude to control the processes that they are responsible for, focusing on their core competencies, and taking a back seat where and when required. Be it through risk sharing or facility for service arrangements, these arrangements work at the most basic level because there has been a mutual investment in the relationship by both parties.

With over 100,000 scientists estimated to be employed worldwide by contract outsource providers, there is no lack of experience or capability within the vendor community. The real value for the pharmaceutical and biotechnology industries will not be through seeking to place all their eggs in the same basket through the old one-stop shop approach. Nor will it be through the fee for service arrangement. Rather, they need to seek out both large and small service providers that understand the needs of their customers and that add value to services through innovation. Sponsors can begin to leverage synergies in areas such as bioanalysis, pharmacogenomics/pharmacogenetics, and bioinformatics, where additional information can be brought to the development process.

By working with each other rather than against each other, the shift from commodity to partnership will be truly realized and, as a consequence, both parties will see the benefit.

Dave Scott is general manager of Tepnel Research Products and Services, Appleton Place, Appleton Parkway, Livingston, West Lothian, EH54 7EZ, United Kingdom, email: dscott@tepnelscientific.com.

References

1. R.G. Hughes, The Contract Research Annual Review 2006 (Biopharm Knowledge Publishing, United Kingdom, 2006).

2. S. Birch, Pharmaceutical R&D Outsourcing Strategies: An Analysis of Market Drivers and Resistors to 2010 (Business Insights, London, 2002).

3. J.A. DiMasi and H.G. Grabowski, The Cost of Biopharmaceutical R&D: Is Biotech Different? Managerial and Decision Economics, 28 (4-5) 469-479 (2007).

4. Tufts Center for the Study of Drug Development, Outlook 2008 (Tufts CSDD, Boston, 2008).

5. IMS Health, Market Prognosis, Global Pharmaceutical Sales, 2000-2007, March 2008.