Magazine Article | May 6, 2010

The Cost Considerations Of Outsourcing Vs. Internal Deployment

Source: Life Science Leader

By Scott Clark

Outsourcing in the clinical development area accelerated rapidly in the last 25 years, fueled mainly by five main factors: (1) difficulty in aligning the varied clinical functional needs with multiproduct and multiphased developmental pipelines, (2) increasing domestic internal costs, (3) globalization to reduce overall development costs, (4) harmonization efforts to facilitate globalization, and (5) technology advancements. The impact of technology in gathering and disseminating information is a primary driver of this expansion, which allows low-cost labor providers in developing countries to do the work more cheaply than domestic workers.

But, the cost reductions from outsourcing can be lost if you don’t have a strategic plan addressing critical deployment issues. Let’s take a look at the main cost factors companies need to assess to make an informed decision on whether to outsource or to do the services internally.

Fixed Versus Variable Costs
One of the drivers of clinical services outsourcing is the ability to convert normal fixed costs that absorb available capital to variable costs. This adds significant economic value to the company employing this tactic. Instead of using scarce capital to employ potentially underutilized resources (and the facilities needed to support them as a fixed asset), you can employ a variable cost for the functional service when you need it. The impact on your burn rate if you are a biotech company can be significant, and for pharmaceutical companies the economic value is boosted.

Employment Costs
A reduction in labor costs is another leading driver for choosing to outsource clinical development services. It is important to analyze the true cost of the outsourced service compared with your internal cost. The overall cost of the labor is made up of several components. To evaluate the true wage cost difference between internal resources and the CRO, the following items must be considered:

  • Hourly wage
  • Benefit cost
  • Federal income taxes
  • State or provincial income taxes
  • Local or city income taxes

CROs will typically roll all of these items into their hourly wage cost in their rate cards to come up with a fully loaded wage rate. Pharmaceutical and biotech companies typically look at only the hourly rate without the employment costs, which run around 34% in the United States. Therefore, many internal cost analyses are understated by 34%. When considering the employment costs in developing countries, the difference can be significant. The difference between the United States and developing countries like India (16.75%) and China (20%) can be as much as 17%. The hourly wage rates in developing countries (Table B) are much lower than in the developed countries, and this presents one of the major cost advantages for offshoring labor in addition to lower employment benefit taxes and facility costs.

Overhead (General & Administrative) Costs
A critical analysis of the true cost of a service for internal consumption requires you to look into your internal overhead costs. CROs will add overhead costs to their labor costs, which internal analyses rarely consider. The CRO overhead costs can range from 10% to 27%. Pharmaceutical companies’ general and administrative costs often run between 20% and 60%. Once you have your company’s G&A costs, you can apply this to your available labor costs. So, if your hourly wage for a full-time principal statistician is $56 an hour, you would add 55% to that cost to come up with your fully loaded cost of $86.80. In some instances, the G&A cost difference may be small if choosing between a global full-service CRO or doing it internally.

The following are some overhead costs that impact total cost:

  • Legal services
  • Accounting services
  • Marketing services
  • Sales services
  • Executive management
  • Facility costs
  • IT costs
  • R&D costs
  • Training
  • HR
  • Quality assurance
  • Finance
  • Purchasing

CROs are typically lower priced (compared with your internal costs) due to their low overhead and labor and employment costs (depending on where they are located). The important criteria for a full-service approach employed by a sponsor company require that the overhead cost for each functional area of expertise be rolled up into the overall G&A cost. In the case of full-service, global CROs, the difference could be less pronounced, since they have similar organizational structures to the manufacturer, with the exception of R&D costs. The difference between the CRO and manufacturer’s costs could be as high as 40%.

Time Estimation
When determining outsourcing costs, you also need to estimate the amount of time needed to complete the task. To do so, you need a well-written protocol that limits the interpretation of what is needed and how long it will take. The sponsor and CRO must be in agreement on the outcome to be achieved and the time associated with meeting that outcome. Once this agreement is reached, a true comparative cost can be attained.

If your company has a detailed time reporting system or sophisticated financial/CTMS (clinical trial management system) operating software based on clinical trial tasks, then you can determine the time associated with that general task as a starting point. However, utilizing benchmarking as a tool to estimate costs has some inherent problems associated with it. For instance, since it is based on historical data, it does not take into consideration new approaches and technology or seasoned project managers who may be able to get the project running and finished faster.

Professional negotiators reducing initial estimates, reverse bid options, benchmarking, and the internal pressure to underestimate the project scope to get funding all present a challenge to develop a true cost estimate of a particular task without agreement up front.

Scale Of Management
The amount of time required to manage resources — especially when quality issues arise — also needs to be quantified. When a sponsor decides to develop a particular functional service, it will need to employ a project manager and/or an alliance manager to work with the selected CRO. Depending on the scale of the project and the service required, this could include a team of individuals to ensure quality. Typically the scale of management within CROs is larger (meaning more people and projects are managed per person) than in pharmaceutical and biotech companies, which reduces the cost. It is not unusual for a CRO to have one project manager for multiple projects, whereas the sponsor will typically have one project manager for each project and will have layers within each supporting department reporting into them.

When evaluating the cost of management against whether to outsource or not, you also need to assess the internal management costs associated with each department that affects the project. Typically this area of cost is undervalued in the internal development assessment. And don’t forget to consider any resulting quality and time delays if the scale of management is too large.

Support Services
The fourth cost-related issue relates to the support services you will have to increase to bring additional resources on board: mainly the IT and facility requirements to employ the needed resources. If you consider the option of employing SAS programmers, for instance, you will have to provide a desk, computer, software, email, Internet access, and IT support. You may even have to rent additional space. Typically, CROs build into their cost models the support needed and offer different choices on where and how they interact with your assigned project manager. Conversely, if you are not at full capacity with your facility and have more efficient IT support services than the CRO, then this cost difference could be minimal.

Recruitment Time
When comparing outsourcing with internal resources, many sponsors often overlook what it costs to recruit and hire personnel. To fill an open internal position typically can take up to six months. A CRO with recruitment staffing can typically employ and train a person in one to three months. Many CROs keep a pool of readily available candidates to fill positions as they come up.

The shorter the recruitment time, the faster you can get a product to market. Depending on the drug developed and the size of the market, saving one to three months can equate to millions of dollars, which easily can justify outsourcing a particular service.

Utilization Cost
Another issue to consider is the utilization cost associated with carrying essential employees who are underemployed. Timing the utilization of the needed resource amongst all of your trials can be daunting, especially when you consider the number and different phases that have to be aligned with functional needs.

Having enough critical clinical staff on hand for when you need them is the main driving factor why many companies choose to outsource in the first place. Conversely, keeping certain clinical support staff around when you have only a few products in the pipeline will result in underutilization of the employee and drive up your costs. For instance, timing exactly when you will need a statistician among multiple clinical trials is challenging due to the feast and famine nature of their role during the trial. A lot of work is done up front creating the format of the tables to be used. Then, they have to wait for the data to come in to analyze it. Medical writing also follows much the same routine in regard to the clinical development process, but can be utilized in other areas like publications to maximize utilization. CROs offer the opportunity to smooth out these utilization gaps when they occur.

At first, CROs’ services may appear more costly when compared on an hourly basis. However, if you consider the utilization cost of that internal person, the cost can be substantially less. To calculate the utilization rate of internal staff, you need an accurate time reporting system and/or a CTMS system which identifies actual tasks associated with that position. The counterbalance to underutilization of resources is the reduced training time it takes to get new resources up to speed. So when analyzing this cost, both areas need to be assessed.

Get Control Of Your Trials
Several important cost factors need to be considered to determine whether or not to outsource some or all of your clinical development and operational needs. Once you have calculated all of the cost factors, you are ready to evaluate the different outsourcing approaches and the strategies to maintain control of your trials. After evaluating all of these areas you will be ready to make an informed decision on whether to internally develop or outsource your needs.

About The Author
Scott Clark is head of business development for North and South America for Quanticate. He has more than 25 years experience in the pharma and healthcare industries. He has worked in sales, marketing, business development, operations, IT, software development, Web development, and management for pharmaceutical manufacturers and CROs.