Biopharmaceutical Contract Manufacturing: Consolidate or Break Up?

Sam Venugopal, Frost & Sullivan

Although biopharmaceutical contract manufacturing is a relatively young phenomenon, it has experienced rapid growth over the past few years as both pharm and biotech companies have become more comfortable with outsourcing. As the industry has matured, two tiers have developed within the biopharmaceutical contract manufacturing organization (CMO) arena:

• CMOs that take on the whole spectrum of the drug development manufacturing steps (multiservice CMOs)
  
• CMOs that specialize in one or two segments of process (single-service CMOs)

As the biopharmaceutical contract manufacturing industry continues to mature and develop, greater demands from its clients, coupled with the need for better efficiencies within CMOs themselves, will force the industry to undergo consolidation. Influencing this movement will be the increasing economic and financial pressures pharmaceutical and biotechnology companies will begin to impose on CMOs to help develop and manufacture potential drug candidates at a faster rate. Improvements in software, manufacturing, and process technologies will also stimulate the move towards more efficient, vertically integrated companies encompassing the whole spectrum of upstream and downstream drug development manufacturing operations.

Although relatively large players such as Lonza Biologics, Primedica Inc., and Patheon, Inc. have become leaders in third-party biopharmaceutical manufacturing by supplying customers at every stage of the manufacturing process, the outsourcing market has proved large enough to accommodate quite a few players, both large and small. Some smaller players include Goodwin Biotech and Paragon Bioservices, both of which have built up a customer base of smaller biotechnology companies.

However, the outsourcing market has also given rise to another type of market competitor: the single-service manufacturer. These companies tend to focus on one narrow manufacturing segment, whether it be process development, early clinical trial supply manufacturing, dosage, or vialing operations. It is these players that have moved the industry towards what senior analyst Enrico Polastro of Arthur D. Little Inc. calls the "cafeteria-self service" model. This model is based on the notion that pharmaceutical and biotech companies will obtain the best deals by "leveraging different suppliers and relying on distinct vendors for their manufacturing activities." [Chemical Market Reporter, 9/27/1999].

As a result, CMOs face lower margins and greater risks as competition for business increases and long-term relationships between CMOs and customers shorten over time. These pressures will make sustaining the current contract manufacturing model difficult, especially for smaller, single-functional firms who must compete against larger, vertically integrated CMOs.

In all likelihood only CMOs that offer a whole range of specialized services will become the marketplace winners in the biopharmaceutical contract manufacturing arena. In fact in his article Polastro describes this scenario as the "strategic preferred partner" model.

Many factors give rise Polastro's opinion. First and foremost, the rapid growth exhibited by not only biotechnology companies but also, pharmaceutical companies have led to an increase in the number of manufacturing activities contracted out to CMOs. While this rise has helped expand the contract biopharmaceutical marketplace, success has created an environment that Vish Rai of the Collaberative BioAlliance Group describes as having become "commoditized."

"Pharmaceutical companies do not look at us not as essential partners in the system of drug development but instead, as tools used to achieve the final goal," Rai states. While this attitude may seem difficult for some CMOs to swallow—that is, for CMOs hoping to receive credit as value-added partners in the drug development process—it serves to validate the strategic preferred partner model suggested by Polastro. The increased activity in terms of not only volume but also, in terms of the number of services required by pharmaceutical companies has led to more efficient economies of scale within multi-service CMOs; efficiencies that mirror that of a standardized product. This is more likely to occur within a multi-functional facility as the processes become even more standardized and CMOs are subsequently able to attract more companies.

Avigen's Alan McClennan validates this point suggesting that while his company does not currently use a CMO, it would "consider it in the future once processes and procedures have been perfected in-house and we feel confident that the CMO will be able to handle and meet our needs."

Further influencing the emergence of strategic partner model as the most effective choice, clients are starting to demand speed and flexibility in their manufacturing services. Multi-service CMOs have the ability to meet these demands and, more importantly, offer customers attractive value-added services that help improve customer relationships and fuel long-term collaborations. Patheon's vice president of marketing, Laura MacDougal, suggests "One of the strong points of Patheon is that we provide fully integrated solutions to a client's needs, providing them with a complete solution from the early stages of product development right through to the commercialization of a product."

Is MacDougal's view the model of the future? Will this paradigm make it impossible for the smaller single-service players within the market to survive and in turn, cause a new wave of consolidation within the industry?

The biggest argument in favor of large CMOs suggests that the larger, multi-service companies produce larger gross margins based on simple economies of scale. In addition, the larger CMOs ability to offer "extra" services such as process development and more effective project management programs help forge better results with clients and in turn, have the potential to add more value to each step of the manufacturing process. Expressing the importance of being able to capture the revenues associated commercial manufacturing.

Scott Wheelright of Calydon Inc. stresses, "The higher margins are associated at the commercial stage of development, not with the process scale-up functions associated in the early stages of drug development." With the capital investments needed in order to establish a reputable CMO, a business model focusing solely on a particular segment of the manufacturing process—those outside of commercial, large-scale contracts—will be difficult to maintain the competitive edge needed in order to stay in business.

Another driving force behind consolidation and the formation of larger more multi-functional CMOs involves the inherent risks these organizations must face when dealing with early stage drug products. "The CMO stands to lose a lot if a drug is pulled from the manufacturing process in terms of lost revenue and more importantly, in terms of lost opportunity costs associated with turning down business that had been reserved for a compound that ultimately ends up being canceled," says Alan Moore of Primedica, a medium sized CMO which offers a variety of different manufacturing needs to its clients. While this problem is not insignificant to larger CMOs, the smaller, more fragmented niche players within the industry will not as easily absorb the interruptions in cash flow.

"The gaps in revenue streams would be too difficult to fill and subsequently replace in a time-effective manner," continues Moore. By merging together and vertically integrating different production functions, smaller players will be able to help minimize this inherent risk faced by all third party manufacturers.

Perhaps the biggest factor behind the predicted movement away from niche CMOs will come about as a result of the efficiencies created through improved development of more powerful supply chain management software packages such as Enterprise Resource Software programs. These packages will further improve the ability of multi-service CMO to meet the demands of their customers. It will better able CMOs to manage and execute more effectively a number of different jobs—all which may require different processes performed—at the same time. Not only will this please the drug and biotech companies, but also, will improve efficiencies making it easier for CMOs to fill as much capacity as possible. Firms will have more opportunities to improve operations through better management of inventory as well as process and materials management. Margins and profits will increase for these CMOs and will most likely, continue to force any existing single-service manufacturers to form strategic partnerships and consolidate their services.

As drug development enters into the 21st Century, it becomes essential that multi-service CMOs emerge as the dominant business model within the biopharmaceutical outsourcing market. Companies that currently only serve one stage of a drug's manufacturing process will be forced to consolidate with competitors that offer complimentary services to their own. It is the only way in which they will be able to compete effectively within the growing biopharmaceutical CMO market. Even smaller multi-service CMO will need to consolidate with other companies in order to increase capacity such that they will be able to meet the future demands of the industry.

This attitude is likely to infect more and more companies in the future as the processes and procedures for many pre-developmental compounds become standardized and the amount of business increases over time. "Smaller companies may find it more difficult to get the ‘big bang' results that large manufacturers achieve in adopting cycle-time reduction initiatives," states Industry Week editor John Sheridan. Larger, multi-segmented firms will be the ones able to balance the issues of speed, flexibility, control, and quality better than their single service competitors.

Sam Venugopal is an analyst with the Biotech/Pharmaceutical group at the market research firm, Frost & Sullivan. His focus is on the Silicon Valley Biotech Industry.

For more information: Sam Venugopal, Frost & Sullivan, 2525 Charleston Ave., Mountain View, CA 94043. Tel: 650-237-6588. Fax: 650-961-5042.