Mergers and acquisitions in the pharmaceutical industry have made major headlines in the business pages in recent years. From completed mergers (Astra and Zeneca, HMR and RPR) to recently announced deals (Monsanto and Pharmacia & Upjohn), from aborted attempts (Abbott Labs and Alza) to rumors (GlaxoWellcome and SmithKline Beecham, perhaps?) to the yet-to-be-played-out mega-menage of Warner-Lambert, American Home Products and Pfizer, the big pharma landscape is undergoing a diastrophic change.
The outsourcing industry has arguably benefited from sponsor consolidation, primarily by gaining facilities and personnel deemed redundant by the newly merged entities, but contract service providers are hardly sitting on their hands and waiting for opportunities to fall into their laps. Both CROs and CMOs have hit the M&A trail, expanding their services and geographical bases by acquiring smaller (typically niche) providers.
For big pharma, mergers and acquisitions are a means of boosting drug pipelines, improving efficiencies and enhancing R&D. The rationale is somewhat different for outsourcing companies. For CMOs, consolidation can help boost early entry in a drug's discovery and development. The earlier a provider is involved with a drug, the more likely that company will remain connected to the sponsor up through the drug's bulk manufacture (provided it achieves commercial approval, of course). In fact, a recent report by Deutsche Banc Alex Brown concluded that CMOs must pursue some form of early entry strategy to ensure their future survival.
Is pharma and biopharma outsourcing headed toward an era of one-stop shops, in which contract service organizations handle nearly every aspect of a drug's development, from preclinical services to clinical trials to bulk manufacture? Contract Pharma spoke to a number of sponsors, vendors and consultants to find out how consolidation is changing this growing industry.
The Great Chain of Development
While it's true that outsourcing mergers are nowhere near the size of the pharma company deals, their pace has quickened and they seem to be dedicated to expanding services, not simply adding size. Steve Sullivan, the recently appointed president of clinical development and support services for Covance, commented that the merger trend is "all about niche marketers." He said, "There isn't a mega-merger trend in outsourcing. Instead, companies are targeting specific providers that can fill a niche they currently lack." In this way, he argued, outsourcers build a presence throughout each link in the drug development chain.
For Covance, this involves an internal growth initiative. The company recently underwent a restructuring, establishing management groups for each area of drug development it services: early development, clinical development and support services, commercialization, biomanufacturing and technology services.
However, Covance's plan for internal development wasn't the company's first option. Ironically, the company was ready to pursue a $2.5-billion mega-merger with Parexel that would have combined the second- and third-largest CROs and out-sized the ever-expanding Quintiles Transnational. It's not exactly Pfizer's $70 billion-plus offer for Warner-Lambert, but the announcement was regarded as a sea change for the CRO industry.
The One That Got Away
In some respects, the best deals might be the ones that fail. Josef H. von Rickenbach, president, chairman and chief executive officer of Parexel, contended that the aborted merger with Covance has helped his company develop a clearer view of the outsourcing industry. "At the time we announced the merger [April, 1999] there had been a revaluation of outsourcing companies by Wall Street. We believed that growing our mass and scale by merging with Covance would help," Mr. von Rickenbach said.
Reaction to the merger was "pretty negative, both from Wall Street and from our own clients," he admitted. "In truth, we underestimated the extremely high costs of the merger. Also, the synergies to be created were not so obvious to outsiders."
The merger would have made Covance/Parexel the largest CRO in the world. Mr. Sullivan commented, "Combining Parexel's Phase III business with our existing structure would have boosted our presence across every aspect of clinical development and enhanced our global stature."
Already buffeted by an announced earnings shortfall, Parexel's stock price plummeted following the announcement of the deal; the merger collapsed two months later. This led both companies to engage in corporate introspection, prompting each to reorganize its operations. Mr. von Rickenbach said, "We discovered that our clients were not happy about the merger plans because they felt that we'd lose our focus. We have a reputation as a specialized company for clinical research and there were fears that we'd dilute ourselves in the merger."
The lesson Parexel learned, he said, was that the company's narrow focus, which it initially perceived as a weakness, was actually a strength to be leveraged. "When the chips are down," Mr. von Rickenbach commented, "you have no choice but to go up. In the aftermath of the merger, we were able to be brutally honest about where we stood in the industry. We rethought our entire nature."
Parexel chose to separate its technical/skill groups from its operational ones, creating Client Research Units. Mr. von Rickenbach explained, "Under our old structure, it used to be difficult to differentiate properly between big pharma and biotech companies. We didn't have the flexibility required to treat each type of client correctly." He added, "We discovered that we needed to provide the benefits of a small CRO, with the Resources , geography, expertise and critical mass of a large company."
Possibly the biggest proponent of one-stop shopping is David Kimbrell, chairman and chief executive officer of Oread. The company offers development, manufacturing and clinical services in what Mr. Kimbrell calls "a true one-stop shop for drug companies." He remarked that Oread was built to accommodate vertical integration. "Clients are attracted to one-stop shopping if the option is available very early in the drug development process," he said. "By building ourselves like a drug company, Oread's purpose is to move each drug from one stage to the next seamlessly, saving time and expense on technology transfer."
Mr. Kimbrell contended that outsourcing a la carte can involve as many as six instances of technology transfer for a single drug. "Anyone who's been through one tech transfer knows what a pain it can be," he said. "Six tech transfers can be ridiculous, especially when you run the risk of different data formats from vendor to vendor."
Contract Pharma asked Mr. Kimbrell if the idea of vertically integrating Oread was a flawed concept. If vertical integration didn't work out for the major pharmaceutical companies, why would it work for a contract services provider? Mr. Kimbrell argued that vertical integration itself was not flawed. "Rather, it was the degree of integration that was at fault. The major pharma companies built massive structures at a time when they had little or no price pressure. They were prepared to accommodate peaks in demand, but the valleys left them with underutilized staff and equipment." In addition, he said, pressures from generic drugs and HMOs, as well as the uncertainty of President Clinton's health care initiative from 1992-1994, contributed to the growth of outsourcing.
"Vertical integration itself isn't wrong," Mr. Kimbrell emphasized. "I conducted market research in 1994 that totally opened my eyes to the fact that potential sponsors would favor one-stop shopping over a la carte outsourcing, if given the choice."
… Or Horizontal?
Lancaster Labs lies on the other end of the spectrum, according to the company's director of pharmaceutical sciences, Wes Neu-mann. He remarked, "Lancaster has struggled with the two approaches to outsourcing, and we've elected to focus on our strengths. We know labs and analytical services, and that's what we're sticking with." Mr. Neumann admitted that clients may be tempted to give multiple phases of the process over to a single provider. "There's certainly an appeal with one-stop shopping," he said. But, Mr. Neumann contended, the reality is that one-stop shopping hasn't proved practicable. "If it was easy to implement," he remarked, "everyone would be doing it."
Representatives at a number of sponsors tended to agree with Mr. Neumann. Susan Mitchell, sourcing manager for third party contract manufacturing at Eli Lilly & Co., said her company has yet to work with a one-stop provider. "This concept is relatively new to our field," she said, "and we do not yet believe that anyone has demonstrated the ability to do this well over an extended period of time."
Marie Skrilec, Ph.D., director of project outsourcing at Warner-Lambert division Parke-Davis, commented that her company is exploring the use of single contract service organizations for projects, but has had its best outsourcing experiences with small analytical labs. "Parke-Davis is trying to establish a strategic approach to outsourcing," Dr. Skrilec remarked, "and part of that would include using one-stop shops for projects where this would make sense. We have a relatively small sample set of outsourcing experiences, but the consensus so far has been to go with focused providers on an a la carte basis." She added that there is some fear of tasks "getting lost" by a large, one-stop provider.
"That's certainly an issue," said Sandy Hatten, director of scientific affairs for Beckloff Associates, a pharmaceutical R&D consulting firm based in Overland Park, KS. "Especially with rapidly growing organizations, there are client fears about slipping through the cracks. The larger an organization gets, the more it has to subsist on larger jobs, particularly commercial manufacturing. When you get to a point where an organization has 200 clients and 500 assignments, you have to wonder how well they can handle it. With smaller clients, especially virtual companies in the biotech field, we tend to be wary about committing to a one-stop shop."
Walter Hetrick, the director of manufacturing services at Hoffman-LaRoche, said that his company's outsourcing choices are based on more than convenience. "Financial stability is a big issue when you're committing to outsource a project. You have to make sure the company you're working with will stay in business. A broad-based company may be more stable, but it can also be stretched beyond its means. There's an awful lot of due diligence necessary on the part of a sponsor."
For some drug companies, one-stop shops simply don't offer the necessary services. Alexion, a biotech company with 100 employees, has recently boosted its outsourcing dollars, but continues to work with providers on an a la carte basis. Said Jim Wilkins, Ph.D., vice president of process sciences and manufacturing, "It's a matter of default with us, because there aren't a whole lot of guys out there who can handle all the aspects of what we're doing. If the situation fits, then using a single company would be great." But, he added, the particular expertise Alexion requires is typically available from smaller organizations.
Mr. Kimbrell of Oread contended that it's only a matter of time before one-stop outsourcing can satisfy the needs of companies like Alexion. "We can provide any number of specialty technologies," he remarked. "We've acquired specialty pro-viders for that very purpose. If we see a need, we're willing to incorporate the technology."
Some industry sources believe that consolidation among major pharma companies may lead to a cutback in outsourced manufacturing. As drug companies combine, they may pare off similar or redundant drugs, reducing the overall amount of manufacturing. Research, on the other hand, should tend to benefit, or at least not decline, in this scenario.
Others argue that manufacturers will not go hungry as a result of big pharma's consolidation. According to Thomas D'Ambra, Ph.D., chairman and chief executive officer of Albany Molecular Research, Inc., as pharma companies merge, they're going to be looking for areas to cut costs. One means of achieving that is by sourcing out manufacturing and selling off costly facilities." Dr. D'Ambra's company recently invested in a manufacturing site spun off from Nycomed Amersham.
Patheon has also acquired sites from merging companies. The company recently took over a pair of European plants from Hoechst Marion Roussel, which has merged with Rhône-Poulenc Rorer. Dan Ruch, Patheon's vice president of business management and commercial sales, "Patheon has had a plan for organic expansion, but we've also benefited from purchasing established sites." The company began as a commercial manufacturer, then branched into drug development, which helps sponsors avoid scale-up headaches, according to Mr. Ruch.
So are we headed for an era in which pharma and biopharma companies will use vertically-integrated vendors to handle all aspects of a drug's development?
Mr. Sullivan of Covance contended that, while manufacturers will get more involved in the development process, the combination of CROs and CMOs is a pipe dream. "Those two fields are like two different planets," he commented. "After all CROs provide a service, while CMOs provide a product. To fully integrate those two modes into one business would be unfeasible."
Mr. Sullivan admitted that Covance does engage in manufacturing, but only on pre-scale levels, generally for clinical trials. "We recognize that this is a niche area for us. Covance has no plans to purchase a major manufacturing facility and start competing with the CMOs. It wouldn't make sense, given our organizational structure."He also remarked that the CRO industry is facing some changes. "The tendency in big pharma is to use fewer suppliers for outsourcing," he remarked. "Large companies develop master service agreements and, where they used to have six or seven CROs on the list, they're cutting down to two or three. To do well, it's critical to focus on the skills that will make you the best in class."