Positive Outlook for Outsourcing: Contract Services Ride High as Funding Floods Bio/Pharma
Early-stage and mid-size bio/pharmaceutical companies have enjoyed an embarrassment of riches over the past 18 months. The window for initial public offerings (IPOs) re-opened, at least for a while; global bio/pharmaceutical companies continued their frenzied pace of partnering and acquisition activity; and venture capital spiked up as the prospects improved for rich exits.
Because the contract services industry floats on the tide of external funding to a large degree, one would expect the bio/pharmaceutical contract services industry to be doing well in this robust funding environment. The results of the 2014 edition of the PharmSource-Pharmaceutical Technology Outsourcing Survey, conducted in June, confirm that expectation.
Bio/pharmaceutical company respondents reported strong growth in spending on contract services this year (Figure 1). Among that group, 19% said their company’s spending on contract services in 2014 is at least 20% higher than in 2013; the comparable figure in the 2013 survey was just 12%. Another 17% of 2014 respondents said their company’s spending is up at least 10%, about the same as last year. Only 9% indicated that spending had declined year-over-year.
As in past years, bio/pharma respondents reported that contract services expenditures are growing at the same rate as total spending, but that trend is more pronounced than in past years (Figure 2): 52% of bio/pharma respondents indicated that outsourced spending is growing at the same rate as total spending versus 42% last year and 39% the year before. Only 20% indicated that expenditures on contract services are growing faster than total spending, down from 29% in 2013.
Very good year for CDMOs
As expected, responses from contract service providers confirmed that they are enjoying a strong 2014. Of the total responses from that group, 32% characterized 2014 as “Very Good”, up from 20% in 2013. Further, only 5% of contractor respondents characterized this year as “Not Very Good” compared to 15% in 2013.
Most contract service providers were expecting 2014 to be a good year but those expectations may have been somewhat muted after disappointments in 2013. In our 2013 survey, 25% of CMO/CDMO respondents indicated that the year’s activity was “Worse than Expected” but only 12% have been similarly disappointed this year. 50% said this year’s performance has been “As Expected” while 38% indicated it was better than expected.
As in past years contract service providers singled out mid-size and specialty bio/pharma companies as the main drivers of business success for this year (Figure 3), but there has been a big surge in the performance of small bio/pharma companies: 23% of contractor respondents identified small bio/pharma companies as their best-performing customer segment versus just 5% in 2013. This is consistent with what we would expect from the robust funding environment: smaller companies have been beneficiaries of improved VC and partnering funding, while mid-size and specialty companies benefit from improved public equity markets and partnering.
The significance of generic companies declined: only 18% of CDMO respondents identified them as their best performers, versus 28% last year.
With demand for their services strong, service providers have not been as aggressive in soliciting new business as they have in past years. Among bio/pharma respondents, twice as many indicated that service providers “Are not asking for new business:” 27% in 2014 versus 13% in 2013. Further, bio/pharma respondents indicated that service providers are less willing to negotiate prices than in past years: 34% indicated that service providers “want new business but will not cut price to get it” up from 30% in 2013.
For service providers, the risk of losing clients as bio/pharma companies consolidate their supplier base remains high: 43% of bio/pharma respondents said they have reduced or plan to reduce the number of vendors they work with, the same as 2013. Interest in working with CMOs and CDMOs in India and China, in particular, continues to decline. Fully 50% of bio/pharma company respondents indicated they have no plans to source from those countries, up from 41% in 2013 and 33% in 2012 (Figure 4).
Interestingly, while bio/pharma companies say they are less interested in sourcing from India and China, service providers still see that as the biggest risk to their business (Figure 5). However, their concern about continued funding for development activities has drawn almost even with the India/China concern: 20% identified cuts in spending at global bio/pharma companies as the biggest risk to their business, double the number in 2013, while 23% focused on the risk of reduced funding for early stage companies. Clearly, the service provider respondents understand that the external financing environment and global bio/pharma’s need for new products are what is driving their success.
We continue to poll the industry on perceptions of service provider performance. In 2014, as in past years, there is a significant gap between how customers see CMO/CDMO performance and how they see themselves (Figure 6). The big gaps continue to be in the “soft” areas of project management and customer service, but there is greater satisfaction with levels of technical and operational performance.
Customer expectations indicate that 2015 should be another good for the contract services industry (Figure 7). Fully one-third of bio/pharma company respondents expect their spending to increase by 10% in 2015, the same percentage as in our 2013 survey. Only 11% expect spending to decrease while most anticipate spending to be the same or slightly higher in 2015.
What it means
Overall the 2014 edition of the PharmSource-Pharmaceutical Technology Outsourcing Survey paints a very positive picture of the contract services industry: spending is up, pricing has firmed and the risks of low-cost overseas competition have diminished.
However, a closer look at the data suggests some red flags that CMOs and CDMOs should heed carefully. In particular, the survey respondents suggest that the contract services industry’s success is largely a result of the improved financial environment, rather than an increased acceptance of outsourcing. This is borne out by the fact that for the majority of bio/pharma company respondents, their contract services spending is growing at the same rate as their total spending; and by the big surge in the importance of small bio/pharma companies as drivers of growth for service providers.
The reliance on smaller companies is concerning for three reasons. For one, funding for early-stage companies tends to be highly cyclical, with periods of robust financing followed by periods of relative drought, so it cannot be a driver of consistent performance. Further, since the preferred early stage bio/pharma business model is to be totally or highly virtual, i.e., nearly all of their development activity is outsourced, there is little or no room for growth by getting them to outsource more than they already do. Finally, since investors in an early stage company are generally looking to sell the company or out-license its candidates to larger companies, most early-stage companies do not offer long-term revenue streams.
In the clinical research sector the largest and best-performing CROs are those that have formed strategic sourcing relationships with global bio/pharma companies, which have the biggest pipelines and deepest pockets. Those relationships have been harder to create for CDMOs and CMOs because global bio/pharma companies continue to show a preference for in-house manufacturing and development, especially for high-margin products like biologics. A recent PharmSource study found that between 2010 and 2013 bio/pharma companies spent $114 billion on new facilities and equipment, despite the global financial crisis and demand for cash to fund acquisition and licensing deals.
CMOs and CDMOs should enjoy this unusual, central-bank driven tidal wave of industry funding, but must remain aware that they can’t expect it to go on forever. In particular, they need to make sure they continue to cultivate client relationships and battle for new business, and not just answer telephone and e-mail inquiries. As many pundits before me have noted, the real story is told when the tide goes out and we see who is wearing what.
Social Media Use Limited
The 2014 edition of the PharmSource-Pharmaceutical Technology Outsourcing Survey asked about use of social media in sourcing activities. We found that social media have not caught on in a big way as yet: 77% of bio/pharma respondents said they don’t use social media at all in their sourcing activities. Those that do use social media appear to use multiple services, mostly 22% LinkedIn (22%) and Facebook (9%). Those are both important peer-to-peer networking tools and peer referrals are very important in sourcing decisions, especially for smaller companies that have less experience shopping for services and working with service providers.
This article is reprinted from the August 2014 issue of Pharmaceutical Technology magazine.