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04 June 2004

Changing Trends in Pharmaceutical Outsourcing: The Allure of Emerging Markets

Across the industrialised nations of the world, the pharmaceutical industry has traditionally been considered one of

the most highly Research & Development (R&D) intensive sectors of technology. It has for over fifty years delivered a

stream of innovative scientific advances in the field of medicine, thereby earning above-average growth rates and

returns on investment. When compared with the R&D expenditures of other areas of technology, the

biopharmaceutical industry is ranked only second to that of information, communications and technology. The

industry also contains the highest research intensity of any other area of manufacturing with a ratio of R&D to sales of

17.7%.

Between 1990 and 2000 investment in R&D increased by 121% and in 2000 the global pharmaceutical industry invested

approximately $58 billion in the R&D effort. However although it is generally assumed that companies with the highestR&D expenditures will be the most innovative and productive, this relationship has proved to be much more complex thanpreviously supposed. In an increasingly competitive pharmaceutical market, players both large and small f ind themselvesstruggling to cope with innovation, cost containment and global competition. Thus after decades of rapid growth it can beargued that the causes of declining sales and weaker innovation are threefold: R&D, customer expectations and structuralchange.

R&D: A widening gap has appeared between the input costs to R&D and its output in terms of New MolecularEntities (NMEs) approved for marketing. According to industry research group CMR, although the inflation-adjustedindustry spend on R&D doubled between 1995 and 2002, the average number of NMEs approved per year duringthis period fell by more than half. In 2003, only 26 NMEs were launched onto the world market, and this waspreceded by equally disappointing results in 2002 and 2001.

Customers: Customers have become much more discerning in their assessment of the value of the choices opento them with purchasing decisions increasingly influenced, not only by considerations of clinical effectiveness, butalso by the pressure on healthcare buyers to contain costs.

Structure: The structural changes taking place within the pharmaceutical industry itself is leading to more intensecompetition on a global scale with increasing competition in areas of R&D such as therapeutic substitutes' andpatented products all competing for a share of the market. Taken within a global context, patents protecting 80% ofblockbuster drugs in 2000 will expire by 2007, thereby releasing $67 billion to generic erosion.

If benefits are to be derived from these R&D investments, long-term planning is required as well as consideration of thepossible changes to the commercial and technological environments in which the industry operates. Decision-making onprojects therefore need to take into account the increasing cost of drug development and the role of external alliances andpartnerships as a means of facilitating the R&D process. The technical problems experienced in clinical development,combined with the growing cost of the process suggest that few companies can develop all of their product offerings

in-house. Consequently many have turned to specialist Clinical Research Organisations (CROs) to carry out this function.This approach has enabled companies to spread the risks and costs involved in drug development; gain access to newtechnologies and expertise that drive innovation; as well as acquire the ability to concentrate resources for maximumeffectiveness while not compromising on productivity and quality.

Trends in Pharmaceutical Outsourcing

Outsourced research has historically evolved f rom the need of pharmaceutical manufacturers to supplement their in-housetesting resources through the contracting of CROs. The ability to specialise in certain aspects of drug evaluation, therebyachieving economies of scope and scale in the drug testing process, has meant that over the past few years CROs havecome to be viewed as a pivotal instrument in containing rising R&D costs and to shortening a product's time-to-market.This capacity to reduce a drug's testing time by as much as 30% is seen as particularly important since a manufacturercan lose as much as $1 million or more in sales for each day that a blockbuster drug is delayed on to the market. As a

result, about 19% of all testing is now outsourced, accounting for worldwide CRO revenues of approximately $7.8 billion in2002.

With an average annual growth rate of 14.6%, the competitive structure of the pharmaceutical R&D outsourcing marketcan be characterised as five major multinational players all of which have grown through Merger and Acquisition (M&A)over the last decade; mid-tier competitors which have developed a focus on particular segments of the R&D process,

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therapy areas or geographical markets; and niche competitors that are highly specialised, often possessing specifictherapeutic or geographical expertise .

The Allure of Emerging Markets

Although more than half of all drug evaluation revenues are earned in the United States alone, CROs continue to followtheir pharmaceutical clients in their quest to extend their global reach, thus enabling these companies to not only capture agreater proportion of potential business, but to also gain access to low-cost clinical testing areas such as India, China and

Eastern Europe. Since such cost savings can be passed on to pharmaceutical clients, the competitiveness of CROs canthereby be considerably enhanced. Consequently many contract research companies are expanding their presence inEastern Europe and Asia through alliances with, and acquisitions of, local providers thus allowing for rapid access to localexpertise and relationships which would otherwise take years to establish [11]. Examples include Quintiles, Covance,ICON Clinical Research, Kendle, Pharmaceutical Product Development, PAREXEL and Omnicare to name a few.

In the case of India, stricter intellectual-property protections are paving the way for a growing number of Indian firms totake over components of the drug discovery work traditionally conducted by American firms. Although the hub of suchactivity is currently located in Hyderabad, smaller Indian firms such as Shantha Biotechnics now produces enzymes forAmerican clients such as Calbiochem - an affiliate of Merck KGaA of Germany. In the case of Ociumum Biosolutions,which is also based in Hyderabad, the company has sold some of its software to Dow Agro Sciences, while recentlysetting up contract research operations in Indianapolis.

Although China lags behind India in servicing the American life sciences markets, it is striving to catch up and remains oneof the fastest growing pharmaceutical markets in the world. Over the past decade, there has been a steady influx offoreign multinational companies accompanied by the establishment of a large number of domestic pharmaceutical firms.Since intellectual-property protection still remains a concern in China, outsourcing has so far been inclined to revolvearound projects relating to the assembling of micro arrays, or the altering of formulations of existing drugs with a view topossibly extending patent life. Nevertheless, multinational companies such as Roche and Eli Lilly have awakened to thecommercial merits of highly trained, low-cost Chinese scientists. As a recent report Research & Development in thePharmaceutical Industry: Options for Success points out, with continued pressures on pharmaceutical companies toreduce the time and money it takes to develop a new drug - typically 7 to 10 years at a cost of $800 million or more - lowercost locales such as India and China are proving to be increasingly attractive.

The Future of Pharmaceutical Outsourcing

The R&D outsourcing market is predicted to grow from $9.3 billion in 2001 to $36 billion in 2010, representing an annualaverage growth rate of 16.3% compared with an average growth in global R&D expenditures of 9.6% over the sameperiod. This growth in outsourcing will continue to be fuelled principally by the demand for R&D enabling technologiessuch as genomics, high through-put screening and proteomics, all of which facilitate the discovery of more and more newtargets, thus reinforcing the need for further clinical testing and hence outsourcing.

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