The reasons behind this change of mood are multiple, including a pick-up in both top and bottom line growth, more robust demand driven by a larger flow of new chemical entities (NCEs), lesser leverage as pharmaceutical companies seem to eventually embrace a more strategic approach to sourcing, as well as the sentiment that competition out of China and India, referred to as Chindia-based vendors, is facing increasing hurdles and is rapidly losing its edge.
But is this optimism justified? Are we witnessing the new dawn of the western pharmaceutical fine chemical industry where all its ills including overcapacity and inadequate returns on capital are durably solved? Or, is this situation simply a short-term reprieve? At this stage I lean in favor of the latter hypothesis.
Prepare for the future
Western players are now benefitting from a combination of favorable tailwinds that may be short lived, underpinning the imperative for these players to take advantage of the situation to prepare for the future if they want to continue to prosper.
This view is based on a number of observations. For one, the strength of the U.S. dollar—the reference monetary unit in pharmaceutical fine chemicals—compared to other currencies may not last forever. Should this be the case and the U.S. dollar to the Euro exchange rate revert back to the levels noted in 2013 it would spell bad news for several Western European-based producers.
Also, Chindia competition may be out only temporarily and may well emerge more formidable than before. Within this frame it is important to have a look at the root causes behind the fall out of grace of this set of players. This has been largely driven by high profile regulatory setbacks suffered by several Chindia-based vendors following inspections by western agencies casting doubts on the reliability of the entire sector.
Parallel to this, the value proposition provided by Chindia revolving around lower delivered prices has been challenged by rapidly escalating labor and environmental costs. It would be, however, a gross mistake to believe that Chindia is permanently out of the picture as a pharmaceutical fine chemical source. Instead, the most likely scenario calls for an accelerated restructuring of the supply structure leading to the pruning of weaker players and the emergence of a small number of vendors offering capabilities in line if not even exceeding those of western competitors. Such a pruning of the supply structure can already be observed in China as well as in India, though to a lesser extent. The declared intent in both countries is to proactively encourage the emergence of national champions able to compete at par with best in class western players without having to leverage the price dimension.
The price pressures facing the pharmaceutical industry—branded Rx or generics—are unlikely to abate anytime soon as health payers throughout the world try to keep expenditures under control. Quite logically pharmaceutical companies facing such pressures try to offset these by squeezing their fine chemical vendors, requesting from them some form of discount in the form of lower prices or some other “value” concessions. This strongly suggests that the much touted shift amongst pharmaceutical companies towards strategic as opposed to tactical fine chemical sourcing will be all but to provide to vendors a blank check. The quest for value amongst pharmaceutical companies is likely to continue unabated and could even accelerate.
Meeting client needs
Several western vendors remain ill prepared to compete and meet evolving customer expectations. They must have the ability to effectively act as sparring partners for pharmaceutical companies, providing to these support in terms of synthesis route research or process development. Many vendors are having a limited role, simply “renting” capacity and applying the process provided by the customer without providing any truly value added services.
Also, there must be a match between vendor capabilities and evolving customer requirements in terms of molecular structures and/or volumes. The trend is moving towards increasing complexity of the NCEs reaching the market. Parallel to this, volume requirements of individual products tend to become lower, driven by the increasing shift of pharmaceutical companies towards specialty drugs as opposed to general practitioner (GP) type of products targeting large patient cohorts. For fine chemical vendors the implications of this shift are far reaching as the hardware, equipment and skill base required for efficiently handling these new types of products are very different. Some players risk finding themselves unable to eventually effectively compete.
The major dependence of several pharmaceutical fine chemical companies on a handful of products and customers leaves them highly vulnerable to swings of fortunes. This situation is largely associated with the type of dynamics intrinsic to the pharmaceutical fine chemical business where the vendor supplying the drug substance for a NCE or a paragraph 4 ANDA can find himself unexpectedly facing short capacity or conversely with empty assets depending on the end product fate and/or the customers ultimate sourcing decision. It is interesting to note that larger vendors are not immune to high customer or product dependence levels as this set of players tends to focus on larger accounts and products, reflecting their drive to avoid business fragmentation and dilution of efforts.
Vendors must also avoid inadequately differentiated positioning. Most vendors on their sites and brochures tend to describe themselves as “leading” suppliers while most often invariably offering the same capabilities. This begs the question, how is it possible to have so many “leaders” when, by definition, in any given area there can be just one number one—all others are followers.
8 traits for success
At this stage it is critical for western pharmaceutical fine chemical companies to take advantage of the current window of opportunity and actively prepare to effectively meet eight traits that will increasingly differentiate the winners from the rest of the crowd.
- Achieve an adequate size—not too small but not too big. Within this frame the slogan applied in the early 90s by the now defunct Shell Fine Chemicals, “Big enough to matter but small enough to care,” remains fully appropriate and is worth meditating on. While size obviously matters in order to achieve acceptable economics and have a critical mass, it is important not to go overboard. Passed a certain size diseconomies of scale mainly relating to loss of flexibility and responsiveness rapidly start to take their toll.
- Assemble and maintain a diverse yet coherent business, product and customer portfolio where the key is to carefully manage and avoid dependencies on any given product or customer. Establish a subtle balance between own products such as off-patent API or intermediates where the vendor has an effective control on the business. Custom made/bespoke items supplied for the exclusive use of a single customer is a business where the customer rather than the vendor is in control.
- Eliminate inefficiencies and fragmentation in terms of industrial footprint. One of the root causes behind the inadequate financial performance of several fine chemical companies is having grown through acquisitions. Within this frame having a turnover of €30 million per site appears to be the minimum level required for ensuring critical mass and adequate fixed cost coverage.
- Ensure limited staff turnover at all levels within the organization to prevent loss of knowhow, experience as well as discontinuities in terms of customer relations. The latter factor is of critical importance when involving the decision made by a pharmaceutical company to outsource from a third party a critical input such as an API. It represents an act of faith hinging on the level of confidence that has developed between client and vendor. It is also equally important to have for key positions adequate succession plans in place—a particularly critical factor for family owned companies.
- Develop a “can-do-customer centric service approach.” Flexibility and reactivity are of paramount importance in pharmaceutical fine chemicals.
- Articulate a value proposition astutely combining soft skills such as project management, product and customer selection, the ability to establish effective rapport with customers, and hard capabilities like knowhow in certain chemistries and suitable hardware.
- Ensure total commitment to quality and customer satisfaction. The cost of failure is daunting for both the customer and the supplier.
- Set pricing in line with the value effectively provided to the customer favoring the long-term. Carefully avoid taking advantage of situations where the balance of power is for once in favor of the vendor.
Dr. Enrico T. Polastro is vice president and senior industry specialist of the Global Pharmaceutical and Fine Chemicals practice of Arthur D. Little. He can be reached at email@example.com.