Implications of the Depreciation of the Euro
The sharp devaluation of the Euro (EUR) against the Swiss franc (CHF) in mid-January is a reminder that exchange rate movements can have a big impact on global industries like bio/pharma contract manufacturing.
The EUR declined by nearly 20% relative to the CHF in just a matter of hours, thanks to the decision by Switzerland’s central bank’s (SNB) to no longer cap the appreciation of the CHF against the EUR. The sudden devaluation threatens to play havoc for some period with the finances and operations of major CMOs based in Switzerland, including Lonza, Siegfried, Carbogen-Amcis and Dottikon, while having mixed impact on Roche and Novartis, the two very large bio/pharmaceutical companies headquartered there.
In trying to protect the competitiveness of Swiss companies by limiting the appreciation of the CHF against the EUR, the SNB was swimming against a very strong current of devaluation of the EUR. During the 12 month period from January 2014 to January 2015, the value of the EUR declined by 15% against the US dollar (USD) and 18% against the Indian rupee (INR), both important currencies in bio/pharmaceutical industry trade. In fact the finance community expects that, thanks to the European Central Bank’s (ECB) recently-inaugurated program of quantitative easing, the Euro will decline further in coming months, perhaps reaching parity with the US dollar (USD), i.e., EUR 1 = USD 1.
On the surface one would expect European contractors to gain at the expense of US and Swiss contractors following devaluation to EUR/USD parity, as the relative prices of goods and services manufactured in Europe are coming down considerably. As a practical matter, however, the risk of market share losses is much greater for Swiss CMOs than for US CMOs:
1. The US doesn’t offer many first tier options for custom manufacturing of APIs, so US CMOs probably didn’t take much market share away from European CMOs even while the USD was weak and the EUR strong. So it is unlikely that European custom API manufacturers will get much incremental benefit changes in sourcing patterns resulting from a cheaper EUR relative to the USD. However, Swiss CMOs are major players in the API business and they could lose share to the strong European API sector.
2. On the drug product side, Europe has an extensive network of underutilized dose CMOs that compete aggressively for business. It is unlikely that many products intended primarily for the European market have been sent to the US for manufacture. Aenova and Siegfried are the only major CMOs with Swiss operations.
3. As most contract manufacturing arrangements are subject to multi-year contracts, the opportunity to move products primarily on the basis of exchange rate movements is limited. Some contracts have provisions for adjustments in the event of large exchange rate movements.
While market shares among contract manufacturers might not shift, profitability will definitely be impacted:
1. American and Swiss customers whose contracts are denominated in Euros will gain because it will be cheaper to buy the Euros necessary to pay their contractor. For instance, an invoice of EUR 100,000 would have cost $130,000 a year ago, but just $114,000 today and perhaps just $100,000 in a year’s time. On the other hand, a European customer of an American/Swiss contractor whose contract is denominated in USD/CHF will see its costs go up by a similar degree.
2. European contractors whose contracts are denominated in USD/CHF will also benefit: an invoice of $100,000 would have converted into EUR 80,000 a year ago, but it will yield EUR 87,000 today and EUR 100,000 if the exchange rate goes to parity. Conversely, an American or Swiss contractor with a Euro-denominated contract will see its revenues drop by the same proportions.
Because the Swiss market itself is small, most CMOs in Switzerland depend heavily on exports. Some of the larger CMOs like Lonza and Siegfried have significant operations outside of Switzerland and therefore have a “natural hedge” by being able to match revenues and costs in the same currency. Smaller CMOs like Dottikon are more exposed, however.
The bigger impact of the devaluation of the Euro could fall on Indian API and drug product manufacturers. The rupee is getting more expensive in Euro terms just as other costs are going up for Indian manufacturers, especially the costs of GMP and EHS compliance. India and Europe are the pharmaceutical industry’s biggest sources of generic APIs, and the combination of higher prices and ongoing compliance concerns is likely to cause more European pharmaceutical companies to switch their sourcing to suppliers within the Euro zone. The same combination of forces could negatively impact imports of Indian-made drug product as well.
For an industry as global as the bio/pharmaceutical industry, exchange rates are of critical importance because they play a major role in determining the price of goods and services traded between countries. Under normal circumstances, it is unusual to have sudden moves in exchange rates between two major currencies, so the impact of exchange rates can be managed over time. Since the USD/EUR exchange rate averaged nearly $1.30/EUR1 for the past five years, devaluation to $1.00/€ 1.00 suggests that substantial changes may be afoot for the contract services industry.
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