How small CROs can survive and thrive in a shaky economy
In a shaky economy where demand from sponsor companies is slack, small contract research organizations (CROs) may want to consider various partnership strategies to improve stability and profitability—or be forced to liquidate.
Examining current industry, economic and political trends will help CROs determine the best strategy and even thrive in the months ahead.
R&D spending decline offers pitfalls and opportunities
After Q1 2008, pharmaceutical industry revenues declined steadily throughout the rest of the year. Limited United States Food and Drug Administration (FDA) approvals of New Drug Applications caused many pharma companies, particularly small companies, to focus on their latest stage drug candidates, shelve early-stage projects and minimize R&D spending. In past years, these projects would have been outsourced to CROs.
If you look at R&D spending growth among the top 20 U.S. pharma companies, it slowed to just 5 percent year-over-year in Q3 of 2008, and to 1 percent year-over-year in Q1 of 2009. Thus, smaller CROs offering pre-clinical and early-stage clinical research services such as toxicology, process development and small-scale manufacturing of clinical trial materials have shouldered the brunt of the economic downturn.
Now, CROs are competing for fewer projects and R&D dollars while trying to achieve the same scale as in years past. As the absolute number of compounds in development falls further, smaller CROs are increasingly at competitive disadvantage compared to larger companies, which have diversified expertise and greater ability to leverage price and weather the storm. Small and mid-size CROs will need to act quickly to survive. One popular option gaining momentum in 2009 is to follow what their bigger CRO cousins are starting to do: engage in preferred partnership and strategic alliances.
Benefits of preferred partnerships
Preferred partnerships happen when pharmaceutical companies agree to outsource research or development services to select CROs for a predetermined amount of time. These agreements, which are becoming more sophisticated in scope and depth, allow pharmaceutical companies to limit the number of CROs used in return for discounts for an increased volume of work.
Big Pharma is especially drawn to preferred CRO partnerships because they gain competitive advantage with access to exclusive technology, know-how, guaranteed delivery timelines and preferential pricing. Conversely, CROs are guaranteed work volume over an assured amount of time, giving them the stability they crave and the efficiencies their sponsors want.
These types of partnerships occur both in the U.S. and abroad. For example, large and small pharma have established relationships with CROs in India and China, particularly for early stage discovery and chemical synthesis projects. One example is the fairly recent three-year collaboration between Pfizer and WuXi PharmaTech for Absorption, Distribution, Metabolism and Excretion (ADME) services. Spurred by the recent development of India’s regulatory processes and government support, clinical trial organizations in India are also being used by many pharma companies for their high quality staff, infrastructure and low cost.
Benefits of short-term mergers
Pharma/CRO short-term or “alternative” mergers not only provide benefits of preferred provider relationships, but result in evolutionary jumps in costs savings for pharma. They allow CROs to take over and make efficient large pieces of pharma drug development machinery. Pharma can then focus their resources and talent on their core competencies.In this way, “alternative mergers” are gaining popularity within large CROs and pharmaceutical companies. Small CROs are looking to gain these advantages as well.
As with Covance’s purchase and takeover of Lilly’s development facilities in Greenfield, Indiana, a similar deal involving Pharmaceutical Product Development (PPD) and Merck occurred earlier this year. Called a “short-term merger,” the five-year agreement provides benefits similar to preferred partnerships and establishes a strong, flexible relationship in a short amount of time. Under their agreement, PPD purchased Merck’s 130,000 square-foot facility in Wayne, Pa., as well as 80 contract employees. In return, PPD will provide Merck with range of assay development and immunogenicity testing services as well as traditional central laboratory and sample storage services over the next five years to primarily support Merck’s vaccine pipeline.
These broad-based partnerships help accelerate drug development programs, drive enhanced productivity and flexibility and most of all provide stability for both companies involved. However, the alternative merger also brings threats to small CROs along with opportunity.
How smaller CROs can compete in a buyer’s market
Because of a recent decrease in demand for general CRO services, commoditization of many CRO services and a large emergence of CRO capacity over the years, pharma companies looking for CROs are in a buyer’s market. However, as pharmaceutical companies look to establish strategic outsourcing partnerships with larger CROs, smaller CROs may be overlooked because of their fewer service offerings and inability to provide the price leverage found with their larger counterparts.
Therefore, smaller CROs must continue to distinguish themselves as leaders in their areas of specialty and turn out quality research in those niche areas to retain clients, while being sensitive to price. Small CROs in niche areas have advantages, as large CROs may be slow to adapt to new technologies fully validated and accepted, which is especially true in areas of early discovery and development. By concentrating services in these unique areas, a smaller CRO could stay afloat until better times arrive.
Smaller, non-clinical CROs are least attractive to sponsor companies when their services overlap with their larger counterparts. However, if these smaller CROs can distinguish themselves by becoming market leaders within niche research areas, they will have an advantage in weathering the economic storm. Unique areas within early stage discovery and development will stay in demand as pressure remains on pharma to produce quality candidates for development.
CROs looking to gain strategic advantage may find a small niche CRO attractive in order to access a specialized area of drug R&D. For example, Charles River Laboratories acquired Molecular Imaging Research in part for their in vivo imaging expertise. Now would be a good time for small CROs to round out their service offerings to corner a niche market or add strategic advantage to larger CROs and become more attractive to pharma companies looking for strategic alliances.
There are a lot of opportunities for small U.S. CROs to align not just with US-based CROs, but with foreign CROs. There has been a trend of partnering with Asian CROs over the last few years (e.g., Charles River Labs and Shanghai BioExplorer; MPI Research and Shanghai Medicilon), which will only increase as Chinese markets and expertise grows. An example of a smaller CRO with traditional services making inroads into China is Frontage Laboratories, a bioanalytical/analytical laboratory with the guts to make the move. On the flip side, European and Asian CROs are still looking to enter the US market. The recent acquisition of Prevalere Life Sciences by ICON is a case-in-point. One caveat of cross-culture partnerships, however, is that a time lag is often incurred before real value is realized for the pharma sponsor companies.
Mega-mergers like Pfizer/Wyeth also provide opportunities for smaller CROs by forcing pharmaceutical companies to reexamine their current CRO agreements. These mergers give smaller CROs with strong service offerings and competitive prices new opportunities to be noticed. Mergers can also create subdivisions within existing organizations that did not exist before. For example, large companies may split by therapeutic areas or by disciplines creating separate outsourcing groups and thus greater opportunity for smaller CROs for working within a given mega organization. As companies shift in all areas of the sector, reorganization and project expansion will create additional new business opportunities for smaller CROs.
Obama administration: Good or bad for the CRO business?
The Obama administration is enacting policies that will affect the CRO industry. The long-term, likely expansion in public health care to capture the estimated 15 percent of the population who are uninsured would grow future drug revenues. However, if patent protection legislation weakens and inexpensive generic drug companies effectively compete, the pharma industry will be hurt.
Short-term, the National Institutes of Health (NIH) budget and funding for basic research, which includes translation medicine grants, are both expected to double over the next 10 years. This funding will be good for CROs working with the emerging biotechs spawned from the universities. For example, there has already been a tremendous increase in grants to universities working on therapeutic targets, particularly those involving Homeland Security (e.g., anthrax vaccines) and antiviral agents. As monies to academic institutions increase, you’ll see Technology Transfer and Commercialization groups within these universities grow which will be good for CROs equipped with the capability and expertise to ensure these projects meet their important milestones.
On the downside, small CROs are likely to be hit hard as business taxes will increase and employee health insurance costs go up. These increases could seriously affect profitability and thus success of a small CRO. On the other hand, small-business legislation may positively impact small and mid-size CROs. Increases in amount of capital written off have already given many CROs additional equity. The industry is hoping President Obama will simplify and make permanent the research tax credit, providing an incentive for businesses to invest in R&D.
As weak as the economy is now, the health care industry, particularly the pharma industry and the CROs that support this industry, are on solid footing. As the world economy emerges from this dark period and as the demand for new medicines continues, pharma will undoubtedly be one of the market’s strongest performers.
The CROs with strong performance records, solid financing and established specialty capabilities will be the survivors in the coming years. Those too exposed to commodity services and unable to obtain preferred vendor status or strategic alliances due to experience and scale of services may be more at risk for failure.
Michael Schlosser, Ph.D., is founder and president of Midwest BioResearch LLC (MBR), a contract research organization providing outsourced drug disposition and toxicology services. MBR was recently acquired by WIL Research Laboratories. Schlosser has more than 20 years of experience within the pharmaceutical industry and 27 years of experience in toxicology. Prior to founding MBR, he was senior director of Safety Sciences at Pfizer/Pharmacia (formerly Searle/Monsanto). Prior to that, he served as the director of Experimental Toxicology and Pathology at Astra Pharmaceuticals. Schlosser was also head of Experimental Toxicology at Ciba-Geigy Pharmaceuticals. Schlosser holds a Ph.D. in toxicology and pharmacology and is a Diplomat of the American Board of Toxicology (DABT).