Finding alignment opportunities and obstacles in the pharma CRO relationship

Finding Alignment: Opportunities and Obstacles in the Pharma/CRO Relationship explores the increasingly critical role of contract research organisations CROs in the transformation of the

Pharma/CRO Relationship

A report from the Economist Intelligence Unit

Sponsored by Agilent Technologies

Preface 2

Interviewees 3

Executive summary 4

Introduction: rapid growth, evolving challenges 6

The rise of a bifurcated market and its strategic implications 8

Making the most of new relationships 12

Information technology will be part of the evolution 13

Conclusion 15

Appendix: survey results 16

Contents

Finding Alignment: Opportunities and Obstacles in the Pharma/CRO Relationship explores the increasingly

critical role of contract research organisations (CROs) in the transformation of the drug discovery and development (D&D) process at pharmaceutical and biotechnology companies

The Economist Intelligence Unit conducted the survey and analysis and wrote the report The fi ndings and views expressed in this report do not necessarily refl ect the views of the sponsor The author was Paul Kielstra Gilda Stahl edited the report, and Mike Kenny was responsible for layout We would like to thank all of the executives who participated in the survey and interviews for their valuable time and insight.January 2012

Preface

President of Strategic Partnering

Chief Commercial Offi cer

Pfi zer

John RatliffPresidentChief Operating Offi cer Quintiles

Dr Ajit NairPresident, India SIRO Clinpharm

Dr Robert Ahlbrandt Senior Vice-presidentGlobal development operations for the Pharmaceutical Development Division Takeda International

Interviewees

After years of painfully diminishing return on investment (ROI) from discovery and development (D&D) programmes, pharmaceutical and biotechnology companies are taking a calculated risk at the heart

of their businesses with the production of their most valuable asset—intellectual property Within the last decade, outsourcing to contract research organisations (CROs)—companies that offer the industry a wide range of research services—has grown to such an extent that it now encompasses over 40% of the entire sector’s D&D More than one-half of drug makers conduct their Phase I, II and III trials primarily through CROs

This is no longer outsourcing at the margins, but a fundamental shift away from the industry’s tradition

of strong vertical integration In making this change, however, biotechnology and pharmaceutical companies are betting on a model that is not only unproven, but is still being defi ned The ability of this approach to deliver improved innovation at a reduced price will require strategic vision rather than simple cost cutting

Finding Alignment: Opportunities and Obstacles in the Pharma/CRO Relationship, an Economist

Intelligence Unit report sponsored by Agilent Technologies, draws on a survey of 251 senior executives from the life sciences industry, as well as in-depth interviews with corporate leaders and industry experts Its key fi ndings include the following:

l The interest of biotechnology and pharmaceutical companies in global alliances with contract

research organisations has reshaped an important part of the CRO market Pharmaceutical

and biotechnology companies are increasingly entering into global alliances with CROs as they seek to improve their ROI in D&D; in the last two years, 22 such major alliances have been formed

Executive summary

About the survey

A total of 251 senior executives from the life sciences industry participated in the September 2011 survey, including respondents from pharmaceutical companies (44%), biotechnology fi rms (22%) and contract research organisations (15%), with others in the industry comprising the remainder (19%) In terms

of seniority, 51% of respondents are members of the C-suite, with the remainder drawn from senior management positions Thirty-fi ve percent are based

in North America, 28% in Asia-Pacifi c, 27% in Western Europe and the others in the Middle East, Africa, Latin America and Eastern Europe Forty-eight percent of participants represent companies with more than US$500m in annual revenue; 26% work for companies with more than US$2bn

According to Economist Intelligence Unit survey respondents, although the most common client-CRO

relationship remains one that involves ad-hoc contracts, the preferred relationship on both sides

would be global alliances or partnerships that are regional or disease-specifi c

Yet smaller biotech and pharma fi rms—defi ned here as those with annual revenue of less than

US$100m—lack the volume of business to make such arrangements worthwhile These fi rms prefer

continued arm’s-length relationships with CROs with local operations John Ratliff, president and

chief operating offi cer (COO) at Quintiles, an integrated biopharmaceutical services company, says,

“You almost need two different types of service for two different types of client.”

l CROs and their potential clients have different expectations of the shape of partnerships

A striking perception gap exists between CROs and their clients as to the direction of the market

in future In order to become more attractive partners and tap into the potential market such

relationships provide, many CROs are expanding services across the D&D spectrum, particularly in

the earlier stages Forty-eight percent of CRO respondents, for example, intend to begin or expand

assay development services and 64% screening services Other companies in the life sciences industry,

however, expect to increase their use of CROs largely in fi elds in which they are already most frequently

used, such as drug trials It appears that the dominant model in the industry has yet to be defi ned

l CROs will continue to consolidate and gravitate towards becoming either all-purpose partners

or niche specialists Contract research remains a fragmented industry ripe for further consolidation:

74% of CRO survey respondents say that the trend towards alliances with biotechnology and

pharmaceutical companies will drive consolidation in the short term Moreover, 41% say that in

the next three years they will expand their range of services to become better potential partners

Highlighting the industry’s duality, the same percentage will focus on a small number of specialised

areas (29%) or a single niche (12%)

l All sides still have work to do in shaping partnerships and alliances to their own broader

interests As the nature of alliances and partnerships is redefi ned, CROs will need to demonstrate

to biotechnology and pharmaceutical companies the value of working with the former as partners

rather than as sources of cheap labour John Watson, president of strategic partnering and chief

commercial offi cer at Covance, a US-based CRO with global operations, says, “Supplier consolidation

can create short-term value It is up to the CRO industry to put forward a broader value proposition.”

Pharmaceutical interviewees indicated that companies within the industry are open to new ideas Such

fi rms, however, need to approach the use of CROs as an opportunity for strategic renewal rather than

mere cost cutting

A striking perception gap exists between CROs and their clients as to the direction of the market in future

Contract research organisations (CRO) are an integral part of drug development According to Contract Research Annual 2011, a yearly study of the pharmaceutical industry, the market for CRO services

increased to US$28bn in 2010 This represents over 40% of the approximately US$68bn the industry spent

on D&D that year

CROs have attained this position only recently In 2000 the market for their services was US$5.2bn and

in 1993 a mere US$1.6bn During these years spending on internal pharmaceutical and biotech D&D also grew, albeit more slowly The Tufts Center for the Study of Drug Development (TCSDD) notes that spending

on CROs over the last decade increased on average by 13.4% per year, while global D&D spending rose by 9.1%

The CRO market looks set to continue to grow The reason is straightforward Kiran Mazumdar-Shaw, CEO of Biocon, an India-based biotechnology company, says that a lack of productivity is creating “serious concern about return on investment in R&D” Respondents to an Economist Intelligence Unit survey of senior industry executives worldwide conducted in September 2011 agree: 71% of non-CRO respondents say their companies will increase the use of CROs in the next three years, against just 7% who foresee a cutback

Even while the industry grows, client-service provider relationships are changing Previously, sponsors would typically contract out specifi c work to CROs on an ad-hoc basis Such arm’s-length relationships offer fl exibility but they also have drawbacks For example, the purchaser of services may not be able to draw on the CRO’s expertise in shaping the requested service, eg, helping to design a trial strategy The sponsor also might not be able to benefi t directly from the specifi c knowledge of a compound a CRO may have gained as the drug underwent the development process

Increasingly, therefore, pharmaceutical and biotech fi rms, especially the largest ones, seek closer links with CROs in alliances or strategic partnerships These involve, in some cases, provision by the CRO

of a wide range of D&D services for all of the sponsor’s products globally, or may be restricted to certain types of disease or geography The relationships require much closer integration of the CRO with the sponsor, providing the former with a steady stream of work and the latter with ongoing access to the CRO’s expertise, potentially across the D&D spectrum In the last two years, 13 big pharmaceutical companies have announced 22 such pacts with CROs, such as Pfi zer’s agreement with ICON and PAREXEL and Sanofi ’s with Covance

Although the focus is on big pharma’s adoption of these arrangements, John Watson, president

Introduction: rapid growth, evolving challenges

of strategic partnering and chief commercial offi cer of Covance, expects mid-sized pharmaceutical

companies to favour alliances as well, to avoid being frozen out by larger competitors “There is a limited

amount of high-quality services from stable, fi nancially sound CROs,” he says

While the number of fi nancially secure CROs may be small, the industry is experiencing intense

competitive pressures goBalto, a global directory of CROs, lists 1,122; the total number may run higher

The industry is concentrated at the top—the leading ten companies boast a 75% market share However,

fragmentation is affecting profi ts even at the biggest companies, where overcapacity has squeezed

margins In 2009, JP Morgan estimated that excess physical capacity in certain preclinical areas had

reached 20-25% Since then toxicology in particular has seen signifi cant facility closures and price

discounting

“We expect further consolidation,” says Tycho Peterson, an industry analyst at JP Morgan “It is still

a fragmented industry.” The number of mergers and acquisitions (M&A) is growing, with the biggest

recent example being INC Research’s purchase of Kendle for US$232m in July 2010 However, Dr Jason

Hwang, executive director of healthcare at Innosight Institute, a social innovation think-tank, warns that

consolidation will be diffi cult With low barriers to entry, new companies may come into the market as

quickly as old ones disappear

“We expect further consolidation It is still a fragmented industry.”

Tycho Peterson, Industry analyst,

JP Morgan

Headline-grabbing global alliances are only part of the evolving CRO marketplace The strategy is most appropriate for big pharmaceutical and biotechnology companies: indeed, 66% of CROs polled say their relationships with large and small clients are increasingly differentiated Ajit Nair, President Global Operations at SIRO Clinpharm, an India-based, multinational CRO, sees “two major markets Big pharma will go towards preferred relationships, but mid-size and smaller pharma and biotechs will look towards working with partners that can do so in a cost-effective manner and provide individualised attention.” Smaller biotechnology and pharmaceutical companies—those with annual revenue of less than US$100m—lack the volume of business to make broad alliances attractive to both sides Facing greater resource constraints, these companies are more likely to list low costs as a leading attribute when selecting a CRO (47%) than are larger companies, those with annual revenue over US$2bn (38%) The opposite is true of global reach: 47% of larger companies say this is among the top attributes they look for

in a CRO compared with 27% for smaller companies

CROs still have a large market with smaller pharmaceutical and biotech companies, many of which may

be virtual Ms Mazumdar-Shaw says that Biocon’s two CROs—Syngene and Clinigene—seek to create a

“hybrid” model that meets the differing needs of both types of clients Worldwide partnerships, though, are the bigger prize, bringing a steady stream of potentially high-margin work CROs in our survey are even more interested in pursuing global alliances than are pharmaceutical and biotech respondents (26%) Only 9% of CROs prefer arm’s-length arrangements

To tap into the growing partnership market, CROs should make a strategic decision: expand so as to engage in wide-ranging partnerships or focus on one or several niche areas Mr Peterson of JP Morgan predicts “a bifurcated market At the high end a handful of large global CROs with a substantial geographic presence and, at the low end, niche providers (in areas such as oncology) should be OK Those in the middle tier that are not unique enough or do not have appropriate breadth or scale will have difficulty.” Profitability is feasible using either approach Indeed recent research conducted by the TCSDD found that small, niche providers experienced higher average growth over the last five years than other CROs When asked directly about their strategy, CRO respondents are divided: in the next three years 41% will expand their range of services, while the same percentage will focus on a small number of specialised areas (29%) or a single niche (12%) A closer look at the findings, however, shows that companies that speak of specialisation will not shed certain capabilities to focus on others Only a small number (14%) intend to reduce their service provision on any part of the discovery and development spectrum, while

“Big pharma will go

Disruptive innovation: are CROs

agents of change?

The life sciences industry, and big pharma in

particular, has long favoured an integrated

approach to D&D because of the importance

of intellectual property to the company In

moving rapidly towards outsourcing, is it

possible they are actually enabling future

competitors rather than partners to grow up

around them?

The possibility certainly exists

Forty-fi ve percent of survey respondents believe

the largest CROs are developing suffi cient

competencies to become competitors of

traditional pharmaceutical businesses in the

near future; only 37% disagree Moreover,

40% of respondents from potential CRO

clients believe that a signifi cant risk of

outsourcing is that it allows a potential

competitor to develop capacities; only 16%

think this risk is not signifi cant

Life sciences companies are not the

fi rst science-based business to outsource

important functions and the PC industry

offers potential lessons In The Innovator’s

Prescription, Jason Hwang, Clayton

Christensen and Jerome Grossman explore

the parallels of transformation in life

sciences to other technology industries that

experienced what the authors call “supply

chain disruption” In this process, sectors

with highly integrated production—such

as traditionally practised by big pharma—

outsource more and more functions because, once such activities can be commoditised, buying in makes more economic sense than retaining them in-house

One danger of this process is that, by outsourcing enough functions, a company

might create a competitor The Innovator’s

Prescription describes how PC-maker Dell

contracted out more of its operations to the Taiwanese manufacturer ASUSTek, which assimilated these skills and began producing its own machines, thus becoming a direct competitor to Dell

The authors see CROs as a potential source of supply chain disruption in the life sciences industry As they develop integrated capabilities across the entire D&D value chain—and as margins on their existing work are squeezed—some will move into higher-margin areas, thereby becoming competitors

of biotech and pharmaceutical companies

How likely is this, though? Currently, only 18% of CRO respondents say their companies plan to create and market their own pharmaceutical products Almost all

of these companies have annual incomes under US$500m These seem to represent small CROs transforming themselves into biotechs rather than ones that have grown substantially and are disrupting the supply chains of former clients

Bigger CROs do not appear interested in making this shift Mr Peterson of JP Morgan warns that such a move is “very risky This

is what happened to several CROs in India

that moved into generics They burned a lot of bridges, and you can’t necessarily go back.” Similarly, John Watson, president of strategic partnering and chief commercial offi cer at Covance, acknowledges that his company is about the same size as the D&D function of a major pharmaceutical fi rm Yet Covance has consistently said “it is not in the best interests of our shareholders to compete with our clients We’ve seen it backfi re on some of our competitors.”

Dr Hwang, who was also interviewed for this study, stands by his position On the one hand, “it is still a bit early to see the disruption we describe,” he says “The waves

of consolidation in the last decade indicate

an industry that is ripe for disruption, but the prevailing business model is still trying

to consolidate its power and there are still plenty of pharma players in the industry.”

On the other hand, he continues, whether in alliances or not, pharmaceutical companies are turning to CROs to do low-margin work that is “a very commoditised form of R&D

If traditional pharma passes on its cost pressures to CROs, they will eventually seek higher ground.”

The threat of disruption lingers, not because of current intentions, but because of how other industries have evolved Dr Hwang therefore advises CROs to consider how they will adjust if margins become unsustainably squeezed He also suggests that life sciences companies retain in-house the likely core competencies of tomorrow rather than those

of today

can cover the entire spectrum from the lab to the patient, it will be a big advantage.” Risks can also increase with partnerships Mr Ratliff of Quintiles says, “[in partnerships, CROs] are in the middle of what they [clients] are attempting to do in terms of drug development You have the heart of their portfolio in your hands If one CRO fails, we all get tainted.”

Ms Mazumdar-Shaw points to a more fundamental issue: the industry is betting on an untried approach “CROs have aspired to move up the value chain from services to product development,” she says, “and pharma looks at alliances in order to reduce risks and costs, but still retain commercialisation rights On the face of it, it sounds like a great model Yet it remains to be seen how long it can deliver on cost and performance efficiency.”

Not only is the model unproven, our survey indicates CROs and their clients have mismatched expectations The CRO industry as a whole will expand its capacity across the D&D spectrum, hoping to lure clients into more integrated partnerships Respondents from the rest of the life sciences industry, however, may have different ideas Although a majority say they will expand their use of CROs, only 37% say they will do so “greatly” Moreover, most of this increase will be in the areas where CROs are already frequently used, such as pre-clinical and phase I through III trials

More often than end-to-end partnerships, which are certainly being created, pharmaceutical and biotechnology firms expect to partner with CROs on development, not discovery Potential clients do not appear to be looking to depart from their current D&D strategy: only 11% say they will use CROs to restructure how they engage in drug discovery and development Moreover, companies that are looking to use CROs more in the area of discovery tend to rank their financial performance as poorer than those that are not This suggests that successful firms see less need to evolve in that direction

Internally By CROs Other

Target discovery Target validation Assay development Screening Lead optimisation Pre-clinical testing Phase I & II testing Phase III testing D&D overall

At your company, which of the following stages of D&D are conducted primarily internally, primarily by CROs,

or primarily through some other means?

Please select one for each row.

Does the trend towards alliances represent merely a wave of supplier consolidation and is some

of the capacity expansion of CROs misguided? That is possible, but so too is the likelihood that some

biotechnology and pharmaceutical companies do not understand the implications of the path they have

chosen Dr Hwang of Innosight Institute explains that when talking about suppliers in most industries

companies “would never believe that they are fundamentally changing their model” The dominant shape

of the CRO-client alliance is still malleable as both sides learn how best to work together

Greater proportion done internally

Greater proportion done by CROs

Greater proportion done

Phase I & II testing

Phase III testing

D&D overall

Do you expect a shift in the next three years so that a greater proportion of work in these areas will be done internally,

by CROs, or through some other means?

Please select one for each row.