API Sourcing: Supplier’s View
Sourcing to relieve external pressures
Apicore
Sourcing of APIs or intermediates has been a subject of interest in the pharmaceutical industry for decades now. This is a look at the subject from the perspective of an API supplier.
The importance of sourcing ebbs and flows over time depending on pressures from the business and political environments. Currently, the most important of those pressures are:
1.The looming “patent cliff” and resulting loss in revenue for branded pharmaceutical businesses.
2.Lower than peak flow of new drugs to offset revenue lost due to patent expirations.
3.Increasing complexity of the molecules that are coming though the pipeline.
4.Exploding government obligations to fund healthcare costs and active efforts to control them.
API sourcing is being used in several ways to relieve these pressures. The core competencies of pharma companies are generally considered to be (a) drug discovery & development and (b) sales & marketing. This creates an interesting dichotomy where manufacturing isn’t considered critically important but supply is a critical success factor. API sourcing is used to solve the supply problem and frees companies to invest capital in drug discovery, development and marketing.
The three most important decision-making criteria for API sourcing are typically:
1.Quality
2.Security of Supply
3.Cost
The first two factors are frequently taken as a given, and cost is the focus for decision-making — until one of the first two goes wrong! At present the API supply market is experiencing an excess of capacity relative to demand. The intense competition to fill available capacity results in deals being struck that are, in the long-term, economically questionable for the API supplier. The productive result of this pressure on margins is that API companies are forced into a relentless quest for manufacturing cost improvements. The less productive outcome for some API companies and their customers is that the quest for cost improvements creeps into activities that compromise quality and security of supply.
Every pharma company has a duty to return a profit to its shareholders. Every dollar or euro saved in sourcing costs is transferred to the bottom line. Driving down the cost of sourced APIs is a responsibility. There comes a point in the cost reduction curve where incremental cost saving must be balanced with the profit margin generated by the product manufactured using the sourced APIs. Particularly for branded pharmaceutical companies, the cost saving can be dwarfed by the margins on lost sales if the security of API supply or quality is compromised. Generic pharma companies have the most delicate balancing act to manage between minimizing cost and protecting profits by virtue of their slim profit margins.
API Sourcing and API suppliers can make other contributions in addition to cost containment. Particularly important is the potential of API sourcing to improve speed to market. In the early days of the outsourcing trend, the decision of what to outsource was based on what in-house manufacturing could not or did not want to make. Now the decision is often based on what in-house manufacturing cannot make fast enough or what investment in manufacturing capability doesn’t add incremental value to the pharma firm. API supply is frequently on the critical path of the drug development schedule. The capability may exist in-house but it might be faster to outsource manufacturing. The capital may exist to fund the creation of manufacturing capability, but the pharma firm is increasingly likely to decide that capital is better deployed in discovery and development of new drugs or the acquisition of new drug development projects. The increasing complexity of synthetic molecules being developed as new drugs increases the range of chemical technologies required to manufacture the product. It’s not viable for one company to build in-house capabilities for the full range of technologies that might be required to make the next new drugs to emerge from its pipeline.
The flow of new drugs from the pipeline is not consistent from year to year. That’s the nature of R&D. It’s a wasteful use of capital to invest in the capacity and capabilities to accommodate the peaks in demand from the pipeline while leaving it to lie idle during the less productive periods in R&D. Outsourcing the peaks frees up capital for more productive uses. It can also reduce cost, because API companies are better able to come close to level loading their capacity and minimizing overheads per unit.
I should note that there’s an important contrast between API outsourcing and Clinical outsourcing. API sourcing is important before NDA approval and afterwards. Both API outsourcing and Clinical outsourcing may be necessary in order to meet aggressive schedules for NDA flings. The API Sourcing decisions made early in the development of the drug have long-term implications after the launch. The pharma developer is somewhat locked into the suppliers used in the NDA preparation phase. It’s a time-consuming process to qualify a new supplier and obtain approval for a supplemental filing requesting FDA approval to use the new supplier.
An important strategic sourcing decision is how many suppliers to qualify for a particular material. Qualifying larger numbers of suppliers increases leverage in price negotiations and in theory maximizes security of supply. Having multiple sources approved and buying small amounts from each (or none from some) can lend an opportunistic element to the relationships, which can lead to unpleasant surprises for either the pharma or API company. Different pharma companies adopt different approaches that fall somewhere on the philosophical continuum of getting married and building a harem. “Marriage” is somewhat out of fashion nowadays. However, it is generally accepted to be a firmer platform for a healthy relationship than the other extreme. In any case, “divorce” is legal and culturally accepted in most jurisdictions.
One trend where marriage is becoming more popular between pharma companies and API suppliers is the sale of underutilized pharma facilities to API companies. These transactions are typically accompanied by a supply contract for one or more materials that the pharma company still needs from the plant but not in sufficient volumes to operate it efficiently. The attraction for the API company acquiring the plant is generally the access to capacity or new production capability at a lower cost than building it from scratch. These deals can be a match made in heaven if the API company has pipeline products with launches pending and a need for incremental capacity to manufacture them.
Sometimes these deals seem to be motivated by a belief that the idle capacity can quickly be filled by new business that wasn’t on the API company’s books before the deal. Deals founded on that value proposition are probably headed for divorce. Nobody wins if the API company cannot rapidly increase the plant utilization after taking it off the pharma company’s hands. The API company is drained of funds feeding an underperforming asset and the pharma company risks losing supply of the products that were part of the supply agreement. This may be what happened to the Merck/Cherokee deal. In 2008 Merck sold its plant in Riverside, PA to Cherokee, but by September 2010 announced that it would re-acquire the facility. Pfizer and Hovione struck a deal also in 2008 to transfer a plant in Cork, Ireland. That plant is still owned and operated by Hovione and hopefully for them they have a pipeline of pending launches to increase and maintain capacity utilization sufficiently high enough to generate operating profits.
The question of how much capacity utilization is optimal is a very important one. It’s also a very difficult one to answer with specific percentages. A very rough estimate is that when utilization exceeds 75% flexibility starts to suffer and when utilization falls below 60% it becomes a challenge to make an operating profit. These percentages are dependent upon a large number of variables, including the number of products manufactured, complexity of the manufacturing processes and predictability of demand. What seems certain however is that the range between choking a plant and losing money is a tight one.
It’s a very challenging business and political environment for the pharmaceutical and API industries today. Those pharma companies with the strongest relationships with their suppliers and those API companies with the strongest relationships with their customers are the companies most likely to survive and thrive.
Ambrose Stafford is vice president, Sales & Marketing at Apicore LLC, a NJ-based Indian-American API developer and manufacturer. He can be reached at ambrose@apicore.com.
