CRO Market View

What lies ahead of the curve?

By Brad Anderson

As industry observers report, the contract research market is growing. Indeed, the Tufts Center for the Study of Drug Development predicts this market will continue expanding 16% per year for the next five years.1 Despite this growth, however, there are clues that segments of this market will mature in the near- to mid-term. This has vital implications for managers of contract research organizations (CROs).

While terms like “growth phase” and “industry maturation” are commonly used, many people do not fully understand the impact these concepts have on their business. Let us take a moment to review what competitive implications these terms have for CROs. To do this, we must briefly review the concept of “industry lifecycle.”

The evolution of revenue growth for an entire industry follows a predictable pattern. Figure 1 shows this pattern.

In the introductory stage, the industry is new. There are few customers and only a handful of companies selling the service. Thus, industry revenues are low.

However, as the market expands, the number of customers grows. So do the number of firms providing the service. During this growth stage, increasing customer demand causes revenues to increase rapidly. The CRO industry is currently in this stage.

During the maturity stage, the number of customers enters a steady state and supply of service reaches equilibrium with demand. Many companies find they are unable to differentiate themselves from competitors. Customers then search for the lowest price. As a result, industry revenues level off.

Finally, services become commoditized as the industry ages, driving prices down. Revenues, in turn, decline — hence the “decline stage.”

Each phase has unique challenges and opportunities. Importantly, the transition from one phase to another can be traumatic. Why? Because the challenges and opportunities that managers face will change. Old strategies no longer work and firms must develop new ones.

There is a growing body of evidence suggesting the CRO market is approaching just such a transition, and many owners are starting to sense changes in the industry. Firms that anticipate these shifts and prepare themselves accordingly can do very well. Firms that fail to prepare themselves, however, can find themselves out of business.

The CRO industry: Still Growing

Contract research is a multi-billion dollar industry. With demand for CRO services expected to increase by 16% annually over the next five years, the future appears rosy.1 The rise in foreign studies plus the increasing complexity and size of clinical trials fuels this growth.

Figure 2 presents historic revenue growth of the CRO market. The rapidly rising revenues observed characterize an industry in a growth phase.

Rapid revenue growth encourages the formation of new CROs. As this trend continues, the market becomes highly fragmented, with hundreds of CROs vying for market share.

However, building a fully-functional CRO takes time. Thus, growth of the customer base tends to outstrip CRO capacity. Consequently, incumbents have no difficulty finding new customers. Their biggest challenge, typically, is managing rapid growth and maintaining cash flow needed to sustain capacity development.

In 2005, there were 269 CROs in the U.S., and 462 more in Europe. The top five CROs by market share laid claim to 36% of total industry revenues.2 This suggests that a few dominant CROs are arising, which is typical of an industry in the late growth phase.

Clues That the CRO Industry Is Maturing

There are three indicators suggesting the industry is maturing:

1. Slowing revenue growth
2. Reduction in the number of CROs
3. Fewer new customers

Looking back at Figure 2, the rate of revenue growth has slowed. In 2006, industry revenues grew about 15% from the year prior. Although this is still a respectable growth rate, it is very different from the heyday of the mid-1990s, when rates of 50% occurred. This pattern of slowing growth is a classic indicator of an industry in the late growth phase before it undergoes maturation.

Turning to the number of CROs, there were 731 companies combined in the U.S. and Europe in 2005.3 This represents a slight downward trend from the peak of 736 in 2003. Moreover, there is geographic variability within this number. Looking at North America, which accounts for 60% of the global CRO market, the number of CROs has decreased by 2% per year since 2001.

Although not dramatic, this shows the growth in the number of CROs has at least stopped and is trending downward in some regions. Regarding availability of new customers, no formal study exists to assess this parameter. There is, however, indirect evidence new customers are harder to find.

The first is anecdotal. Through conversation with many owners of CROs, we have noticed a change in the challenges they face. Whereas once managing growth was the main difficulty of respondents, now “getting new leads in the door” is becoming their major issue.

Secondly, Figure 3 shows the proportion of clinical studies with CRO involvement has reached a plateau. This suggests the drug-development industry is outsourcing as many of its clinical projects as it intends to.

These findings hide differences between various segments of the CRO market. Some areas are still in an early growth phase, others have already matured. Taken together, though, it suggests the industry as a whole is approaching a period of transition. This, in turn, has a profound effect on the competitive landscape of the CRO market.

What Will Maturation Mean to CROs?

Shifting from a growth stage to maturation is especially traumatic. Growth in the customer base slows and capacity of CRO services finally catches up with demand. As a result, pricing power shifts from the CRO to customers.

To compound this, the experience customers have gained working with CROs in the past gives them greater savvy when negotiating contracts. This, in turn, puts further pressure on CROs’ pricing. Thus, rivalry between CROs intensifies as firms compete for market share. Increasingly, CROs gain new customers by taking them from competitors.

Inevitably, some CROs start slashing prices to win new customers and retain old ones. Consequently, less competitive companies exit the industry and the number of companies declines.

The large players become larger by buying smaller firms and claiming the market share left by exiting companies. In fully mature industries, it is common for the top five companies to claim more than 50% of industry revenues. Surviving niche players split the remaining market share amongst themselves.

Now is the time for prudent managers to take action to prepare their companies for this transition.

Surviving & Thriving in the Near- to Mid-Term

As the industry matures, price competition intensifies. Competing on price is a valid competitive strategy. Thus, the goal of management is not necessarily to avoid price competition. Rather, it is to avoid competing on price because the competition forced you to.

We shall explore both the overarching strategies and operational tactics executives and managers can use to position their companies to avoid the trap of price competition.

Survival Strategies

There are a few broad survival strategies in a maturing industry. These include:

• Sell the business
• Gain scale
• Find a niche
• Enter new growth markets
• Appropriate combinations thereof

Sell the business

The late growth phase of an industry’s life cycle is an excellent time to find a buyer for the business. Revenue growth is still robust, and many companies are looking to grow through acquisitions. Strong revenues plus a large pool of buyers puts owners in a strong negotiating position when selling a CRO.

If owners plan to sell, then waiting until the industry fully matures is not a good idea. By then, industry revenues have slowed. This makes the company look less marketable and limits the capital buyers can draw on to make acquisitions. This, in turn, weakens the owner’s negotiating position.

Gain scale

The natural evolution of many markets as they mature is to move to an oligopoly. That is, a few companies emerge that dominate the industry with a number of smaller, niche firms. The CRO industry is trending this way. Therefore, quickly growing in size to become one of these dominant firms is a viable strategy.

Gaining size provides companies with the capacity to capture larger shares of the market. In addition, they benefit from economies of scale, allowing them to lower their cost structure.

Moreover, in the CRO industry, bigger companies have a larger geographic footprint. This allows them to offer valuable, global access to larger drug companies seeking to enter multiple countries. However, planning to gain this scale through organic growth is generally not a viable option. Opportunities to capture markets evaporate quickly.

Therefore, owners should expect to acquire or merge with other companies to capture the market share needed to become a major player. This is a capital-intensive strategy, so companies will likely require investor or debt financing to pursue it.

Find a niche

As stated above, the CRO industry is trending towards a market with a few dominant companies and a number of smaller niche firms. Another viable option as the industry matures, then, is to position the company to become one of these niche firms.

To do this, managers must evaluate their company’s abilities and the marketplace to identify a profitable niche they can fill. Niches can be geographic (i.e. many services in a local area), operational (i.e. few services in many geographical areas), or both (i.e. few services in a local area).

Once managers have selected their niche, they must design and implement marketing programs targeting the selected niche. Moreover, managers must modify operations to deliver services these niche customers value.

Enter new growth markets

A CRO can maintain revenue growth by entering into rapidly growing markets. Although the CRO industry as a whole is maturing, growth segments exist. These opportunities fall into two categories: geographic and new markets.

Geographically, there are regions experiencing rapid growth in pharmaceutical sales, including South & East Asia, India and Latin America. This is driving growth in clinical trials in these regions and subsequent demand for CROs.

Geography aside, technological, procedural and regulatory advances in the clinical-trial process create new markets for enterprising CROs. Such opportunities include microdosing trials, electronic data capture (EDC) and electronic patient recorded outcomes (EPRO). Additionally, the battle waging between generic and pharmaceutical companies is creating great opportunities in the bioequivalence sector.

Appropriate combinations thereof

Naturally, CROs can combine the above strategies. Managers should not limit themselves to choosing one strategy, but rather combining applicable strategies when developing their plans.

Survival Tactics

Tactically, managers need to find new sources of sales, demonstrate the CRO’s distinct value to customers and brace for price competition. Firms can do this by focusing on three areas. These areas include:

• Marketing
• Differentiation
• Operations

Marketing

During the growth phase, managers focus marketing activities on attracting new customers and creating a distinct brand. As the industry matures, however, new customers will increasingly come by luring them from competitors.

Marketing managers, therefore, need to prepare defensive and offensive action plans. Defensively, CROs should develop programs to foster customer loyalty. Such programs will protect the company from competitors raiding your pool of clients. Offensively, CROs should look to creating compelling value propositions to attract competitors’ customers.

Because many CROs will be working hard to retain their current customers, the cost of winning new clients will increase. This, in turn, can erode profit margins and decrease the return on the marketing budget. It will be more profitable, therefore, to increase sales to existing customers.

In response, prescient marketing managers focus on increasing sales to current clients. There are two ways to do this. First, managers can focus on gaining a larger share of their current customers’ purchases. Second, they can develop additional services or add-ons sold to current clients.

Differentiate

If a CRO wants to avoid competing on price, it must be able to differentiate itself from the competition. That is, the CRO must be able to state how its services differ from those of its competitors and convince customers this difference is worth paying for.

To be effective, a CRO’s basis of differentiation must meet two criteria. First, it must add value to customers in a way that competitors cannot easily match. If it does not add value, customers will not pay for it. If competitors can easily match it, then it is not truly a differentiator. Either way, the company is back to price competition.

Second, the company must be able to deliver on the differentiated service. The CRO must align its operations with the promised differentiator. For example, firms should back a promise of exemplary customer service with programs implemented in house to deliver on that promise.

If managers do not consciously align operations with what salespeople are telling prospects, customers will quickly discover you are only paying lip service to your promises. This, in turn, undermines the firm’s credibility and brings the company back to competing on price.

Operations

During the growth stage, CROs should focus on establishing quality and reliability. Once the industry starts to mature, price competition becomes common.

Ideally, managers strive to avoid having to compete on price alone. However, customers will become used to seeing CROs lower their prices. As a result, their expectations of what activities cost will change.

Thus, even CROs with clearly differentiated services may face pressure to keep costs down. This can be extremely disruptive to unprepared companies. Operations managers, therefore, should focus on reducing costs to give them the flexibility to operate in an environment of falling prices.

Managers can do this by standardizing and automating functions where possible. When appropriate, CROs can consider outsourcing commoditized functions to low-cost providers. Some CROs have started to do this by, for example, offshoring data management activities to lower-cost Indian CROs.

Looking Ahead of the Curve

The CRO industry has experienced many years of growth. History has shown, however, that all industries eventually mature. For companies caught off guard, this change can be traumatic — if not terminal.

There are hints the CRO industry is approaching maturity. Some firms are already noticing changes in the air. There are concrete activities managers and owners of CROs can take to prosper as the industry matures. The time to act is now.

References

1. Tufts Center for the Study of Drug Development.  Outlook 2007.  (Boston, MA: Tufts CSDD, 2007).
2. BioWorld & CenterWatch.  (2006).  Clinical trials state of the industry report 2006.  Atlanta, GA:  Thomson BioWorld.
3. Thomson CenterWatch.  (2005). State of the clinical trials industry 2005.  Boston, MA:  Thomson Healthcare, Inc.

Brad Anderson is president of Integrative Consulting Services, a Vancouver, Canada-based management consultancy specialized in clinical development outsourcing issues.