The biopharmaceutical industry faces many challenges. Patent cliffs, increased generic competition, a diminishing pool of promising compounds, payee pricing pressures and increasing costs associated with research and development (R&D) all are factors significantly impacting pharma’s bottom line. As for skyrocketing R&D costs, frequently quoted estimates from lab discovery to approved drug are $1.2 billion, over 10-15 years, and recent cost estimates are much higher. Outsourcing, or moving certain aspects of R&D from a fixed to a variable cost structure, can generate significant R&D savings, which, in turn, frees up valuable dollars for much-needed discovery efforts. However, even in outsourced models, increasing regulatory scrutiny and trial complexity coupled with growing competition for patients and sites create an environment where clinical trial costs continue to rise.

In this article, we will briefly discuss the origins of the vendor outsourcing model and its associated contractual structure, as well as some emerging trends in the vendor commercial framework. We also propose changes to contract structures that can drive innovation and contribute additional R&D savings.

How Did it All Begin?
The basic scientific model to conduct clinical trials had long been established: A study protocol developed, project lead assigned, sites selected, clinical monitoring team assigned, investigator training held, database built and deployed, and so on. Rules and regulations continue to evolve in an effort to ensure patient safety and data integrity.4 The vendor industry was born in the mid-1980s as pharma began to explore outsourcing of clinical trials tasks such as site monitoring and management, database programming, and drug safety monitoring.

Historically, pharma companies chose to support the whole of R&D efforts, including clinical trial conduct, with their own staff—an insourced model. However, the fixed nature of this model limited pharma’s flexibility to expand or contract its workforce in response to the needs of its development pipeline. The solution was to outsource the functions—clinical monitoring, data management, drug safety, etc.—of a specific clinical trial or program, i.e., the variable labor efforts. Outsourcing to vendors allowed for a more efficient use of resources and reduced expenses associated with trial conduct. Over the last 30 years, pharma has gradually increased its annual outsourcing spend from an estimated $3.7 billion in 2001 to $12.9 billion in 2011. In terms of percentage of R&D expenditure outsourced, spend started at virtually nothing in 1985, but has grown steadily to an estimated 33.4%, 46.3%, and 58.6% for large, medium and small pharma, respectfully, today. 

Throughout the 1990s, pharma and its vendors typically negotiated fixed-priced contracts, often without flexibility to renegotiate (change orders) unless the study design fundamentally changed. Payment schedules were based on milestones such as “20% of study subjects enrolled” or “50% of site monitoring visits completed.” In this contracting model, if a trial ran longer than planned or required more vendor effort to complete, the vendor lost money. In contrast, if a study’s timelines were reduced or the vendor found ways to complete the work more efficiently while still protecting patient safety and data integrity, then the vendor would make more money. Thus, there was a powerful financial incentive for the vendor to innovate and deliver ahead of schedule, which in turn could make that vendor more competitive and over time reduce costs for its pharma clients.

However, by the early 2000s, pharma began to grow dissatisfied paying full price on a fixed-price contract when the trial was completed ahead of schedule. Thus the vendor industry started moving toward unit-based contracts, in which CROs were paid based on units achieved, such as monitoring trip reports written, data queries processed and so forth. There was wide familiarity with the necessary tasks to conduct clinical trials, and unit pricing was established based upon the hours needed to perform each task, along with the rates for the personnel performing the various functions of the trial. A unitized model of contracting can be very transparent when all parties are aware of the level of resources required, the rates associated with those resources and the time necessary to complete the tasks. This model has not evolved in any great degree over the last 15 years and remains the main method of contracting used today. However, a consequence of the unitized model is—when a trial can be completed in less time and/or with fewer units than originally planned—the vendor may earn less revenue. Therefore, unlike the original fixed-price/milestone-based contracts of the 1990s, today there is less direct financial incentive to complete a study ahead of schedule or find more efficient ways to deliver quality data.

In that light, process innovation in the current environment is left solely to the vendor’s desire to remain competitive and increase market share. This indirect pressure to innovate has produced some significant advancements in the ways we conduct clinical trials, such as electronic data capture (EDC). However, we believe additional innovations can be brought to the surface via creative commercial constructs.

How Do We Leverage Contracting to Drive Innovation?
The need to reduce trial timelines and research costs has to be matched with a new means of incentivizing innovation in order to be successful. Moving away from hours, rates and unit-based negotiations to value-based conversations is a likely next step in the evolution of contracting.

Output-based contracting is a broad industry term used today for grouping units to match specific, desired client outputs. In an output-based delivery model, the vendor charges the client based on a complete set of tasks that are aligned with the long-term, operational goal of that client. A general example of outputs occurs within automobile manufacturing. When we purchase a car, we expect to negotiate one price and drive it off the lot, not individually negotiate the rate and time required to build and assemble each part. We leave it up to the manufacturer to manage the pieces and parts, and then deliver to us what we want—a fully functioning, dependable, fuel-efficient and fun-to-drive car.

Within the clinical trial industry, the definition of these outputs remains a challenge. Because the industry negotiates primarily activity-based units, we do not have a common language to help define value-driven outputs.

How Do We Define Value-driven Outputs?
An example of activity-based units versus a value-driven output is study site activation—when a site is ready to receive the study drug and begin screening potential study subjects. Site activation requires that all essential regulatory documents have been collected, ethics committee/ministry of health approvals have been obtained, and an executed contract is in place with the site. In many current contracts with activity-based units, each of these steps can drive billable activity-based units. In other words, a vendor can charge a client for each of the steps required to achieve site activation—even if the site is never activated.

In a value-driven output model, the contract establishes that payment will be made to the vendor when a site is activated. Enhanced productivity and higher quality are encouraged in this model since the vendor profits if the work is done efficiently. If startup is protracted and requires more effort, the vendor loses money. If a vendor “cuts corners” and does not maintain high quality, the vendor faces rework and resulting budget overruns. For the client, this represents a simple option based on the status of when the site is ready to participate in the trial, but it also incentivizes process optimization and high-quality performance by the vendor. The client will capitalize on sites being able to enroll as quickly as possible (process innovation), along with reduced costs. A vendor will become more competitive when it can innovate its technologies and processes to reduce the effort or overhead costs to accomplish any given value-based output. Over time, improved efficiency and reduced costs can be measured and tracked easily.

What’s the Commercial Leverage?
As noted in the site activation example, the leverage to drive innovation is in the separation of activities from value-driven outputs. By paying a vendor for an output that the client desires, the vendor receives a natural and strong incentive to invest in innovations and process improvements. The vendor’s investments can be clearly valued against the contract in terms of the return on capital or expense investment. Additionally, strong financial incentives encourage the vendor to continually drive down the cost of services.
In the near term, value-driven outputs represent a model in which the vendor has the opportunity to make greater margin. By reducing the timelines or effort required to deliver an output, the vendor will decrease internal costs while maintaining a fixed-unit payment, enabling the vendor to expand profits. Although this may seem counterintuitive to the industry’s needs for reducing costs, these financial incentives will drive more innovation into our industry than the current activity-based unit model. At the same time, market pressures will force vendors to pass on savings to clients in order to remain competitive.

How Do Volume and Operational Excellence Factor In?
In the sites activated example, it is commonly understood that, on average, at least 10% of study sites that are approved to screen study subjects never enroll, yet under the current model vendors are paid the same amount to initiate sites whether or not the site enrolls subjects into a study. Vendors support this model because, after all, it requires the same amount of effort and costs to activate a study site regardless of how the investigator performs later.

In a value-based output model, perhaps vendors would not be paid as much, or at all, for sites that do not recruit subjects. The risk that vendors undertake expending effort in study sites that do not recruit subjects and fall out of the process is part of both the financial model and the opportunity for improvement within the vendor’s process. Although a vendor can model this risk within the scope of an individual trial, this model works best in large-scale, multi-study partnerships and functional service provider (FSP) contracts in which a client outsources large volumes to a vendor. In a large volume contract, the vendor risk is distributed over a larger portfolio of labor, which reduces the impact of a single failure, but encourages a strong solution delivery that results in making the end unit costs lower and offering a model more apt for success.

Another distinct advantage of a value-based output model is that it rewards vendors with operational excellence. In the outputs model, the vendors that will be rewarded are those that can perform the task most efficiently at the highest level of quality while leveraging innovation, industry knowledge capital and process improvements. In contrast to the activity-based model, this method does not reward the vendors that do not invest in innovation. Given the continuing needs of the industry to reduce costs and timelines, we need to invest in and incentivize those vendors that have the operational excellence necessary to move the needle.
The value-driven outputs model is specifically designed to push vendors to invest more in innovations so the broader industry can benefit.

The Path Ahead
Ultimately, we propose a path forward in our industry to move away from rate negotiations and toward output and value negotiations. When vendors cut rates, lower margin expectations and reduce overhead costs, those actions may not convert to a value return nor are they aligned with client goals of obtaining safe and effective therapies approved as quickly as possible. To maximize investments, pharma needs a vendor community built on operational excellence, which is best unlocked by way of an incentivized contractual structure. 

References

1. J.A. DiMasi, R.W. Hansen, and H.G. Grabowski. “The Price of Innovation: New Estimates of Drug Development Costs.” Journal of Health Economics 2003; 22(2): 151–185.
2. J.A. DiMasi and H.G. Grabowski. “The Cost of Biopharmaceutical R&D: Is Biotech Different?” Managerial and Decision Economics 2007; 28(4–5): 469–479.
3. Herper M. The Cost Of Creating A New Drug Now $5 Billion, Pushing Big Pharma To Change. Forbes 11 August 2013. Online at http://www.forbes.com/sites/matthewherper/2013/08/11/how-the-staggering-cost-of-inventing-new-drugs-is-shaping-the-future-of-medicine accessed 10Oct14.
4. Pharmaceutical Research and Manufacturers of America. 2013 Profile: Biopharmaceutical Industry. July 2013.
5. Clinical Services Outsourcing. CenterWatch Clinical Trials Data Library. Tufts Center for the Study of Drug Development.
6. Reported Percentage of Annual R&D Budget Spent on Outsourcing. William Blair & Company, 2011; n=133 companies. CenterWatch Clinical Trials Data Library. Tufts Center for the Study of Drug Development.
7. Typical Site Enrollment Performance. CenterWatch Clinical Trials Data Library. Tufts Center for the Study of Drug Development.