In a year that has seen a perplexing continuation of the slowdown in customer demand for preclinical outsourcing, Covance recently announced a new strategic deal with Sanofi-Aventis. We'll explore the impact of this partnership on Covance, Sanofi, and the preclinical outsourcing industry at large.
The Deal
As widely reported in the financial press, Covance will become a primary provider of research services for Sanofi. It is important to note that the services provided by Covance will include clinical services and chemistry services, but this column will only focus on the impact of the deal on preclinical outsourcing. Covance will purchase Sanofi operations in France and the UK. Employees at these facilities will become Covance employees. The deal for Covance is valued as high as $2.2 billion over
10 years.
What Does the Deal Mean for Covance?
Once the deal is closed, receiving between $1.2 and $2.2 billion in guaranteed revenue over the next 10 years will help Covance temper the cyclic nature of customer demand for preclinical outsourcing. The Sanofi deal follows Covance's first asset transfer deal with Lilly, which was valued at $1.6 billion for Covance. Covance has since been able to commercialize the former Lilly site in Greenfield, IN to serve other clients in addition to fulfilling its Lilly service obligations. The Sanofi deal further differentiates Covance in the industry as having the ability to close deals of this magnitude. Locking in long-term guaranteed revenue would seemingly enable more strategic decision-making and help minimize market driven reactive decisions.
By acquiring research operations in France and the UK, Covance significantly improves its European presence. These facilities will join the existing Covance portfolio of European preclinical facilities in Harrogate, UK and Muenster, Germany. As Covance realized with the Lilly deal, one of the real benefits may be the acquisition of experienced Sanofi researchers. If managed effectively, the overall gain of research experience can only help to diversify Covance's existing scientific expertise. Like some other preclinical CROs, Covance has been adept at moving employees among its sites to address operational needs. Having additional experienced staff can only extend this flexibility. As I have stated in the past, facilities don't conduct research; people conduct research.
What Does the Deal Mean for Sanofi?
At a time when pharmaceutical companies are looking to cut costs, the Covance deal allows Sanofi to reduce some of its fixed overhead expenses. Transferring two research facilities and their employees to Covance helps to achieve this goal. As long as Covance performs to Sanofi's expectations, Sanofi could also benefit by reducing external service agreements and the subsequent costs associated with maintaining those relationships.
What Are the Challenges for Covance?
How will former Sanofi employees transition to CRO work? Working for a CRO is much different that working for a pharmaceutical company. The pace is faster and the expectations for customer service are much greater. Frankly, some individuals just aren't cut out for the CRO work environment. If Covance decides to maintain Sanofi's site management teams, these teams will need to deliver the level of research quality and service that Covance and Sanofi will expect. Again, this is easier said than done, as CRO work requires a different mindset than what is needed in pharmaceutical research operations.
Will Covance commercialize the newly acquired Sanofi research operations? By "commercialize," I mean, will Covance look to provide services from the former Sanofi facilities for clients other than Sanofi? While Covance has proven successful in commercializing the former Lilly facility in Greenfield, IN, it has been suggested that some potential clients will not place work there due to lingering confidentiality concerns arising from Covance's partnership withLilly. Furthermore, any clients that Covance may seek to attract to the former Sanofi facilities will need to be convinced that the employee concerns that were expressed above have been addressed.
Will Covance have too much global capacity? The preclinical outsourcing industry in 2010 is still experiencing the low customer demand that first started to decline in 2008. While it is reported that client requests for bids remain high, there has been no definitive evidence that we will see a marked improvement in demand for the immediate future. Over this timeframe, the preclinical CRO industry has cut costs through layoffs and, in some cases, reducing capacity. Despite its previous strategic deals, Covance has not been immune to these market forces. Some financial analysts have suggested that Covance may announce a cost-cutting initiative but no such news has been announced at press time. While the Sanofi sites will provide Covance with a greater presence in Europe, their management team will be challenged to balance workload across their operations. Despite best intentions and talk of teamwork, multi-site preclinical CROs can end up competing with their sister sites because individual site revenue generation is often a measure of management effectiveness. Finally, despite additional governmental scrutiny, animal liberation activities are still a significant concern for European preclinical CROs and their clients.
Will the Sanofi facilities conduct regulated drug development activities? With the Lilly deal, Covance made a strategic decision not to conduct GLP toxicology work at the Greenfield facility, a site focused on late discovery/early development non-GLP activities. This decision enabled Covance to commercialize this facility faster, since they did not have to build the infrastructure to support GLP work. If it is determined that the Sanofi operations acquired by Covance will conduct regulated work, Covance will need to make sure that regulatory compliance is consistent with its expectations and with those of its clients. The decision could be significant in that there seems to be growing scrutiny of CRO operations by the FDA. As reported in my October 2010 Contract Pharma column, "Regulatory Shock-waves," the FDA is seeking to prevent sponsors from commenting on or editing contributor reports from CROs until the contributor report has been finalized. If this enforcement action is maintained, sponsors may become even more selective in choosing preclinical outsourcing partners; they may be inclined to work with CRO scientists who are more familiar to them. This is pure speculation but if true, it may be more difficult for any new CRO operation to be embraced by the client community.
Is Covance's preclinical business too large to be managed effectively? There really is no standard to determine the "appropriate" size of a preclinical operation. Covance has been harmonizing multi-site preclinical operations since the mid-1990s. Their management team seemingly understands that harmonization and operational optimization is an ongoing process. Covance scientists could be challenged to balance additional harmonization efforts while maintaining an appropriate focus on ongoing client studies. Covance seems to have an appropriate management structure to direct a growing preclinical operation. Still, especially after the explosive growth in industry capacity in 2007 and 2008, some CROs have been challenged to maintain quality and acceptable service. Maintaining quality and customer service is a challenge that all CROs face on a daily basis. It is worth considering then whether this daily challenge becomes greater as a management team is tasked with additional operational and strategic responsibilities. Established work processes may not be as effective as the size of a preclinical operation expands. The problem is that a CRO may not realize that a work process is no longer effective until quality issues arise. Some clients shy away from large CROs because they are concerned that they won't receive the attention and level of customer service that they expect from an outsourcing partner. Covance will have to continue to manage this perception and proactively manage its preclinical operations.
What Does the Deal Mean for thePreclinical Outsourcing Industry?
If the Sanofi sites in France and the UK have preclinical capabilities, this would add capacity to a preclinical outsourcing industry that already has significant unused capacity due to low customer demand. The good news for the industry is that this would equate to lower capacity in the client community, but it appears that Covance would be the primary beneficiary of this reduction. The degree of exclusivity of the Covance-Sanofi deal will determine how much, if any, preclinical business is lost by Covance's competitors. On the other hand, the aforementioned client concerns that Covance has become too large could drive new business to small or mid-sized CROs. You can bet that Covance's competitors will jump at any opportunity to woo Covance clients, especially if any quality issues arise in the immediate future.
Beyond the Covance-Sanofi deal, other changes in the preclinical outsourcing industry could impact the competitive landscape. It has been reported that LAB Research was recently put up for sale. Businesses are bought and sold all of the time, but such news can create uncertainty in the internal operations of a CRO and in the client community. Clients should make sure their due diligence is current and should maintain ongoing monitoring activities. Any detriment in the business of existing CROs will only benefit the competition. Along those lines, all CROs are potentially subject to operational changes due to the aforementioned stance by the FDA on contributor reports.
The Covance-Sanofi partnership has obvious benefits for both parties. Covance will face operational challenges, just as it did with the Lilly deal, and although the preclinical outsourcing industry has experienced a long decrease in customer demand, Sanofi is a recent example of another pharmaceutical company that is diminishing its internal drug development capabilities. This trend is likely to continue as the pharmaceutical industry faces patent expirations on key drugs.
In the end, the real significance of the Covance-Sanofi partnership may be the affirmation of a brighter future for the preclinical outsourcing industry.
Steve Snyder is a consultant with more than 25 years of experience in preclinical toxicology as an outsourcing customer and provider. He can be contacted at info@outsource-support.com.
