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Integrated Services Providers



A viable business model?



By Enrico Polastro, Arthur D. Little



Published January 22, 2014
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The pharmaceutical product creation process — defined as covering the discovery up to the commercial scale supply of a NTE (New Therapeutic Entity) — is one of the most complex endeavors undertaken by man. It involves the daunting task of effectively conducting — either in parallel or sequentially — and combining in a seamless way a large number of modules requiring a diverse set of activities and steps.

A major complicating factor and challenge is represented by the extremely diverse array of skills and bodies of competences required to perform these tasks — some at the leading edge of science while others are fairly routine. The execution of these various tasks is handled by different people, most often organized in distinct departments. This multiplies the number of interfaces and hand-over steps, bringing a corollary risk of delays and recycling.

Additional issues are associated with the long timelines for development, spanning several years, and the massive resources (be they financial or in human talent), regulatory and ethical requirements intrinsic to the pharma industry that contribute extra layers of complexity.

The risk of failure or setbacks is substantial, reflected in the major attrition rates characterizing pharma R&D, as well as the delays encountered by an increasing number of companies in the development and launch of new products.

Within this framework, a distinction needs to be made between two types of risks:
Exogenous — These risks are intrinsic to every new product creation process, and largely outside the developer’s own span of control. Examples include unforeseen problems associated with the pharmacological or pharmacodynamic properties of the NTE that can be found out only through testing and experimentation. Sometimes these only come up in late-phase clinical trials involving large patient cohorts.

Endogenous — These risk are associated with factors that are within the span of control of the developer and hence can be controlled and effectively managed. Examples of endogenous risks are legion in the pharma industry; they include:
  • Stifling bureaucracy that discourages entrepreneurial behavior and leads to the “analysis/paralysis” syndrome
  • Poor scheduling and synchronization of the different activities, be these performed in house through own resources or by third-party vendors
  • Absence of alignment and/or bottlenecks in terms of access to required resources
  • Ineffective hand-over of some activities because of inadequate interface between the departments/organizations responsible for each individual activity, resulting in wastage, recycling, loss of time, and perhaps even outright failures.
Until recently, pharma companies have insisted on conducting most, if not all, activities associated with the new product creation process in house. Such a setup is in sharp contrast with the extensive outsourcing to third-party vendors of a substantial share of the development and product supply activities observed in many other industrial sectors, including automotive or aerospace, which are also characterized by complex product-creation processes involving the integration of multiple tasks and components.
There are many reasons to delegate tasks to external vendors, including:
  • Risk mitigation by reducing or avoiding investments in own capacity or inflating own fixed cost base
  • Capacity management
  • The realization that even for the largest companies it is impossible to master and excel in all disciplines, tasks and operations involved in the product creation process, and some third-party vendors are often better positioned and equipped to perform these.
The implementation by the automotive and aerospace industry of such a “virtual” model has led to fundamental changes in the relations and mode of interaction between customers engaged in new product development and third-party vendors. To those industries, the traditional transactional model — where customers tended to simply purchase from vendors standard ready-out-of-the-shelf products shopping from a long list of suppliers and where low delivered prices were one of the main selection criteria — has increasingly proved inadequate and unsatisfactory for both parties.

It has been superseded by more collaborative models, where customers delegate discrete parts of the product development and supply process to a handful of “strategic” suppliers — often referred to as Tier 1 — acting as extensions of their own R&D and supply chain activities. Properly implemented, such a setup potentially provides for a win-win:
  • The customer teams up with the best qualified and equipped vendor, entrusting it with the mission to provide the “input” — be it a service or a product — with the vendor taking an active role in its development — a sort of “open innovation” scheme.
  • The vendor has the opportunity to achieve economies of scale while being guaranteed a certain base load, providing him with enhanced visibility on the business.
In sharp contrast with several other industrial sectors, the pharma industry has only recently started to become open to “virtualize” its product creation process.

This stubborn resistance to changing the status quo reflects a combination of factors, including the cozy environment that — until recently — characterized the pharma market, the peculiarities intrinsic to drug development, and entrenched mental models.
Let’s unspool some of those challenges facing the pharma industry:
  • Mounting financial constraints hitting healthcare budgets, with the basic laws of finance and economy eventually taking their toll on healthcare-related issues
  • Dismal R&D productivity and returns on the funds poured on R&D and innovation, reflected in the failure to maintain a steady flow of new products reaching the market required to offset the revenue decline associated with patent expiries and products reaching the end of their lifecycle
  • Escalating complexity of the science and technology base associated with the development of new products
  • The sunset of the blockbuster model, with an increasing shift towards specialist products targeting smaller patient cohorts
  • The emergence of new sets of players engaged in the development of new pharmaceuticals; startups, apply very different business models and largely limiting their role to project management, have led to a growing mismatch between business models, organizational structures and associated supporting systems traditionally applied by companies and the changing competitive landscape facing the industry.
As a result pharma companies have undertaken a number of moves in the quest of a new business model. These include waves of mergers and acquisitions, divestment of non-core activities, headcount reduction programs, and a redefinition of how companies operate. Their main objective has been to enhance efficiency and effectiveness while proactively reducing risks.

With this in mind, it makes more sense for pharma to move toward a more virtual model in terms of product creation process where some tasks are outsourced to third-party vendors.

This notion can be illustrated both by startups and by the “skunk works” offshoots that have been established by industry majors like Lilly or Roche. These offshoots are seen as as new product incubators free from the bureaucracy and organizational complexity typical of large pharma. Almost without exception, this set of players has embraced a fully virtual model where their role is limited to generation of ideas and project management, and all the activities associated with product development and supply are entirely delegated to third-party service providers. Parallel to this, larger pharma companies are becoming more open to outsourcing of selected tasks and steps. Some industry observers believe their transformation into more virtual organizations is just a matter of time!
As pharma companies move towards a more virtual model for handling their product creation process, it is logical to expect that the expectations and needs vested in their suppliers will also evolve, following a path already noted in other industrial sectors.

In other fields, we have witnessed developments such as a pruning of the vendor base and the emergence of Tier 1 suppliers taking an active role in undertaking entire segments of the product creation process, including development and commercial scale supply, acting as extensions of the customer’s own operations.

Such developments have triggered the question amongst vendors serving the pharma industry on the competitive advantage provided by ability to provide an “integrated service platform,” enabling them to handle discrete chunks of the product development process compared to competitors with a narrower focus on particular technologies.

What is the overall value-creation hypothesis behind this concept of combining a broad array of capabilities and skills under the same roof? If a provider can fully execute entire parts of the product creation process, it will be better aligned with the new approaches embraced by the pharma industry and, once gaining Tier 1 status, will be able to help customers to:
  • Facilitate alignment and create the intimacy between the vendor and the customer required to establish a true partnership
  • Reduce the number of vendors, with the Tier 1 supplier taking the responsibility to undertake discrete parts of the process, eliminating hassles for the customer associated with multiple interfaces and hand-over between different vendors, thus eliminating a frequent source of delays as well as the problems that often result in “finger-pointing” among various parties that do not have ultimate responsibility or full ownership
  • Avoid wastage and loss of time
  • Have effective access “at will” to leading-edge capabilities
Not surprisingly several service providers to the pharma industry have positioned themselves as “integrated service platforms,” “one-stop-shops,” or “single CR&DM services providers.” Examples include AMRI, Aptuit, Catalent and WuXi as well as — at one time — Next Pharma. The long-defunct Oread is probably the first vendor to pioneer such an approach.
For vendors, the transformation into “integrated service platforms” represents an appealing concept — at least on paper — to secure some form of competitive edge and tame the numerous challenges they face:
  • Leverage applied by customers (pharma companies), which, given their tighter margins and funding constraints, try to offset these by asking pricing concessions to vendors. A broader service provider would be in a better bargaining position, as the customer will depend on it for important — if not essential — parts of his product creation process, creating thereby a stronger mutual interdependence situation
  • Mounting rivalry amongst vendors, as a plethora of suppliers, invariably competing for the same pieces of business, act on the low delivered price dimension. Here an integrated service model potentially provides an edge; a vendor could argule that its ability to compress timelines supersedes the price argument
  • As new sets of players make inroads, including Asian vendors whose value proposition most often revolves around a reported lower cost base, having Tier 1 status with the ability to provide a broader range of services can ensure some protection against these competitors, which tend to lack credibility as true strategic partners
  • Increasingly elusive differentiation in terms of service or technology offerings: the once-unique selling propositions of various vendors tend more and more to converge, so a broader service provider’s ability to act as integrator and extension of the customer’s own operations can create a value proposition more difficult to match and copy.
However, despite these touted benefits and apparent congruence of the integrated service provider model with the on-going developments noted in the pharmaceutical industry, to date little evidence exists whether such a model effectively works in practice and can be of benefit to customers and service providers, witness the setbacks suffered by players having attempted such an approach. Oread, one of the precursors of the integrated service platform concept, fell into oblivion years ago, while Next Pharma — a cluster of companies originally combining commercial scale API and dosage form supply service capabilities — and PCAS — having attempted through the acquisition of Creapharm to assemble a comparable platform — both eventually narrowed their scope of activities, focusing respectively on formulation and API synthesis.

Pharma companies remain reluctant to rely on a single vendor for a suite of services or more than small discrete chunks of the product creation process. By and large their preference is to continue to cherry-pick among various vendors for each step, slicing and dicing projects and tasks, irrespective of the well-documented inefficiencies and drawbacks that associated with such an approach. In light of these elements, can it be concluded that the integrated service model is fundamentally flawed and poised for continuing failure?

The answer to this question is NO. The limited success to date of the integrated service model stems from questionable execution, not an intrinsic flaw in the model. Some of these problems include:
  • Limited understanding of customer requirements, in terms of failing to realize that not all pharma companies are at the same stage in their transformation into a more virtual mode of operations. Some still have a long way to go before being ready to partner with integrated service providers and delegate critical parts of the product creation process, while others (i.e. startups) are already in this mindset.
  • Failure to define a crisp value proposition for their offerings as — to make sense and provide scope for value creation — an integrated service platform has to combine “adjacent” as opposed to unrelated parts of the product creation process. Otherwise, synergies — both from the vendor and customer perspective — are elusive.
  • Assembly of an overly broad range of services, leading to both loss of focus and the perception among customers of being generalist vendors or “Jacks of all trades, masters of none.” This will undermine credibility, as no one can realistically have the capabilities of mastering and exceling in all steps of the pharma product creation process.
  • Clustering of unrelated assets and activities not followed by proper integration, leading to “silos,” poor interfaces between the various activities. This is the very problem most frequently encountered by big pharma, preventing the delivery of a seamless service and defeating the main value proposition of the integrated service platform concept. Absence of proper integration and alignment is a can’t-miss ticket for failure, particularly when these assets and activities are located in different countries and their origins and development path differ. For example, the practical problems associated with combining a service provider located in Asia with a development center divested by a large pharma company cannot be stressed enough. The risk of cultural  clashes and misalignment is daunting.
  • Vendor pursuit of the service business and of its own product development activities at the same time. These are two oft-incompatible activities can create conflict of interest and of priorities in the allocation of resources.
  • Vendors’ insistence on forcing customers into deal structures that they do not want or are not ready to contemplate, such as combining multiple offerings even though the customer is just interested in a narrower, a la carte scope of services.
  • “Trojan horse” strategies aiming to leverage some services like early development work as loss leaders in order to “hook” the customer into feeding commercial scale production assets, leading to cross-subsidization of distinct activities.
  • Attempts to combine weak players active at different stages of the product creation process in the hope of assembling a stronger integrated service platform. In reality the strength of the construct depends on its weakest component!
To be successful a vendor with an integrated service platform approach, one must avoid these pitfalls. The successful integrated vendor will:
  • Assess thoroughly what type of skills and operations can be meaningfully combined as a single service platform, providing for particular elements — adjacencies within the product creation process, opportunities to reduce number of interfaces and handovers allowing to make the process more efficient, shared equipment/skill base, and common stakeholders within the customer organization — as opposed to unrelated activities. For example, assembling a platform combining drug substance and drug product process development has more chances to succeed that bundling together full-scale drug substance and drug product supply capabilities.
  • Be selective in terms of breadth of services offered, perhaps expanding these over time once one’s credibility in the marketplace has been established.
  • Ensure that the quality of all services provided is at par with best industry standards, nothing standing to be gained by combining together mediocre capabilities in various fields under the same umbrella.
  • Recognize that ultimate success and ability to effectively act as an integrated service provider for the benefit of the customer hinges as much on “soft factors” relating to staff attitudes and behavior than on the quality of human talent and equipment base deployed. This stresses the imperative to deploy and organize the various skills and resources for optimal alignment — a key to ensure the effective execution of an integrated service through a seamless transition and hand-over of tasks between different groups. While tools such modern IT systems represent useful facilitators for achieving such an objective, by far the most critical feasibility trigger is the ability to make different sets of people work effectively together as a team. Too often this is hindered by factors such as cultural differences, different mental models, inadequate definition of organizational boundaries as well as lack of shared values or mechanisms to reinforce the desired behavior. This underpins the imperative for vendors trying to assemble an integrated service platform by clustering together parts stemming from different organizations to test and ensure the affinity and compatibility between these through an effective integration process as alternatively the construct is doomed for failure.
  • Manage the various activities and individual service offerings as distinct Profit & Loss centers, avoiding cross-subsidization. While this represents a key for long-term competitiveness and staff motivation, it is important have systems and procedures in place to prevent fights between the different P&Ls by establishing a subtle balance between centralization/coordination and autonomy. Here too, the importance of proper organization design and of associated supporting systems can’t be overemphasized.
  • Realistically evaluate the value that the customer effectively vests in an integrated service offering, tailoring customer approaches accordingly, carefully refraining from trying to force customers into deal structures that are not aligned with their requirements.
While only time will tell, a possible example of an integrated service provider appearing to match the six traits described above may be represented by the recent clustering of CML (Cambridge Research Laboratories), a provider of drug substance-related development and supply services, with AAI, a U.S.-based vendor active in analytical services and dosage form development and manufacturing. We see potential benefits to this pairing:
  • The combination of the two can yield a coherent platform of services associated with Chemistry, Manufacturing and Controls (CMC), providing opportunities to effectively build on synergies and adjacencies and offer value-added solutions leveraging know-how at the interface between synthesis and formulation, which can position the entity as a credible partner for pharma companies eager to virtualize parts or all activities associated with the development and access to the drug substance and drug product.
  • Both companies are recognized as players in their own field of activity, fully focusing on the service business.
  • AAI and CML also share comparable values and cultures, geographical proximity and U.S. roots, boding well for the ability to ensure effective alignment and realization of synergies.
  • Management has clearly expressed its intent to continue to offer to customers the choice between an integrated service or to cherry pick just selected services.
The recently announced merger (and de-listing) of Patheon and DSM Pharmaceutical Products (DPP) yields some similar benefits. It too provides an integrated service model, combining drug substance and drug product services, albeit on a much larger scale than CML/AAI, which means they’ll have much work to do to integrate the number of operations. The two companies may also have much different cultures than CML and AAI do.

The integrated service provider model is certainly appealing. Using subcontractors or multiple providers makes these arrangements more complicated, as opposed to having a single service provider. Time will tell, but reducing the number of interfaces a client must manage should certainly reduce complexity. In practice, this model will work, but the devil is in the details! CP


Dr. Enrico T. Polastro is a vice president and senior industry specialist of the Global Pharmaceutical and Fine Chemicals practice of Arthur D. Little. He can be reached at polastro.enrico@adlittle.com.


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