The Preclinical Year in Review

As I write this article on a Saturday morning, the price of a barrel of oil that was at $150 just a few months ago is now less than $80 because of declining demand. In the U.S., we are in the midst of a presidential campaign where both candidates are promising changes to the status quo. The New York Stock Exchange just concluded its worst weekly performance in history and financial markets throughout the world are a mess. We are told that we are experiencing a crisis of confidence. Demand. Change. Confidence. These are the same themes that we will address as we look back at preclinical outsourcing in 2008.

Demand

One of the challenges in writing an end of the year review article in October is that we don’t know what will happen in November and December yet. That caveat aside, there are some interesting year-to-date observations about the sponsor demand for preclinical outsourcing services. Through much of 2008, preclinical CROs were enjoying a robust business. Many CROs have built or are expanding capacity. Scientists that were laid off by large Pharma companies were hired by CROs. Everywhere you turned, it seemed like clients had to wait for months to get a study started. Although no one on the CRO side of the business likes this terminology, it now appears that this demand has “softened” here in the fourth quarter of 2008. CROs are now reporting open capacity. Some Pharma companies have curtailed travel budgets. Several of my clients have experienced delays in test article availability, which has resulted in subsequent delays in starting studies.

The last time the preclinical outsourcing market really went “soft” was in 2003 but a fundamental change in the business since then would suggest that this current experience is just a transitory occurrence. During economic challenges in the past, sponsor companies would control spending by reducing their external outsourcing activities and conducting this work internally. Since 2003, many large Pharma companies have reduced their internal capacity to conduct toxicology studies, which now limits their ability to curtail their outsourcing activities. Furthermore, many companies have increased the number of compounds in development to increase the likelihood of success in getting a new drug to the market. Even if companies have internal preclinical capabilities, it is unlikely that they have the capacity to maintain this throughput. For companies like Lilly and Pfizer that are faced with key patent expirations in a few years, it would not make sense to cut back on preclinical development activities. However, if there was an appreciable decline in the funding for Biopharma companies, we could see more than a temporary decline in demand, although my Biopharma clients have not reported that this is happening.

CROs that opened new capacity may be experiencing a lag before this new space is utilized. It has been reported by some in the industry that preclinical CROs are being very competitive on pricing to fill vacant capacity in the fourth quarter. In my opinion, the economy is bad everywhere so if there is a softening trend in preclinical outsourcing, it is more likely due to sponsors “hunkering down” for the fourth quarter until they get into a new budget year in 2009.

Change

Perhaps the biggest news of 2008 was Covance’s purchase of Eli Lilly’s research facilities in Greenfield, IN. I think it is fair to say that this deal represents a new way of doing business in the preclinical outsourcing marketplace. It was a brilliant move for both Covance and Lilly. Now that the transaction has been completed, let’s examine the details of the agreement:

Benefits for Covance

• Guarantee of approximately $100 million in Lilly business per year for 10 years.
• Approximately one square mile of land in Greenfield, with various research buildings, including a large toxicology facility and associated laboratories.
• Open space for future facility expansion.
• An additional toxicology facility in a Midwest setting with less severe winters than Covance’s Madison facility. Ease of travel to a CRO is a significant issue for existing and potential clients.
• A highly experienced workforce. This was really the only risky part of the deal when it was announced. Would the Lilly employees accept jobs with Covance? It has since been said that 98% of the former Lilly staff accepted positions with Covance. At a time in the industry where rapidly growing capacity results in CROs hiring lesser trained employees, the acquisition of the Lilly workforce by Covance may be the real hidden gem in this deal.
• The additional capacity allows Covance to continue to pursue additional reserved space agreements with other clients.

Benefits to Lilly

• Covance paid Lilly $50 million in this transaction.
• Lilly reduces its operating overhead by a reduction in headcount and facilities.
• Because Lilly and Covance have worked together so long, their corporate cultures are similar and solid working relationships have been developed. Remember, this is a relationship-based business.
• The close proximity of the Greenfield site to Lilly’s Indianapolis headquarters will allow Lilly scientists to monitor work conducted by Covance.

If the number of calls I received is any indication, this deal sent shockwaves through the CRO industry.

So the preclinical CRO “capacity wars” continue. Covance upped the ante on the CRO industry with the Lilly acquisition. Charles River continues to add capacity at several of its sites. MPI Research continues to grow and grow. In the past, I indicated that these CROs would be challenged to bring this new capacity into production mode due to the challenge to hire new staff. While that remains a significant issue, new concerns are emerging for these expanding CROs. Who’s managing this growth at a high level in these companies? Is there the “people infrastructure” in place to operate this new capacity? Are the existing work and communication processes sufficient to support the new capacity? Will study quality be compromised by expanding capacity? It will be interesting to watch these areas as we move into 2009.

Confidence

When we look at the preclinical outsourcing marketplace, what causes sponsors to have confidence in CRO providers? Successful outsourcing experiences? Good business relationships? Trust? The answer is “all of the above” and more. As 2008 draws to a close, it continues to amaze me how some CRO management teams still fail to understand the preclinical customer base. The drug development client community is small and bad news travels fast. Sponsors can be fickle in their decision-making. One thing that some providers fail to understand is that a problem with one sponsor can impact their business with other sponsors. A sponsor may take its business elsewhere solely because they fear that they may encounter the same problem that another sponsor experienced. Many CROs don’t seem to appreciate the sponsor’s “fear of failure” and their need to trust their CRO provider. What erodes a sponsor’s trust? The reasons can range from the failure to return telephone calls or emails to significant operational events to the misrepresentation of or failure to disclose information about a CRO’s operations. Yes, sponsors have taken their business elsewhere simply because a CRO did not return phone calls or emails.

The Achilles heel of many CRO management teams is that they either think that they can “wow” clients with the “bells and whistles” of new capabilities or, even worse, think they know all there is to know about the sponsor community. We call this latter point, “arrogance.” It is alive and well among some preclinical CROs. And yes, I know sponsors who have taken their work elsewhere solely because of a CRO’s perceived arrogance. I really wonder sometimes if some of these management teams believe what they are saying. This work would be much easier if CROs would embrace courtesy, believability, and customer service. Some CROs have, but some still have not.

In 2008, we learned of operational accidents at two CROs that resulted in the deaths of non-human primates. Anyone who has ever managed a preclinical research operation will tell you that accidents can happen. While this may be a fact, it should never, ever be considered as an acceptable excuse. It appears that the root cause of both of these accidents seems to be a training issue, although one wonders if more effective employee training would have eliminated that negligence. One CRO immediately went public with the news of its accident; the other CRO did not. Apparently, at least one CRO hasn’t embraced the principle that it is best to share bad news with your clients quickly so that you don’t otherwise invite unwanted speculation about your decision-making. The sponsor community was shaken by the news of both accidents. I know sponsors that will not do business with either of these facilities for fear of being associated with these tragic events. At the same time, sponsors need to get drugs to market. Other sponsors are and will continue to work with these CROs. No one at these CROs wanted these accidents to happen and I don’t doubt that they were devastated by this news. I mentioned these events because they were noteworthy in 2008 and they did impact business decisions. I hope they are not leading indicators of quality issues in a CRO industry that some fear is growing too fast.

With the exception of what seems to be a short-term slowdown in the demand in the fourth quarter of 2008, all indications are that preclinical outsourcing will continue to grow in the coming years. Even with all of the capacity that is coming online, it has been said that demand will continue to outpace available capacity. Sponsors will seek to work with CROs that reward their trust through quality, on-time delivery and customer service. Poor CRO performance will make them inclined to take their work elsewhere. These same sponsors will have limited alternatives if capacity at their preferred CROs is not available. If you look back over the years, the preclinical CRO industry was slow to grow because sponsors did not believe that they could find the quality of work that was equal to or better than their own internal research operations. Several CROs in the industry now enjoy the reputation for quality that is at least equal to that in the pharmaceutical industry. Having met this standard, the demand for preclinical outsourcing has grown as has the preclinical CRO capacity. We are in the midst of a fundamental shift in the preclinical drug development business from Pharma companies to CROs. More and more work is being outsourced. With Pharma companies shutting down or now selling off their preclinical research operations, CROs may feel that they have a captive client base.

Therein lies the problem. Can these CROs maintain quality while they continue to grow? Will CROs put quality ahead of revenue growth? Are customer satisfaction and quality inversely proportional to increasing CRO capacity? Demand. Change. Confidence. We have seen the bottom fall out of the financial markets after a rapid growth phase due to a credit crisis. The preclinical CRO market is in an exceptional growth phase. We are headed for uncharted territory. Let’s hope we don’t see a catastrophic failure due to a quality crisis.

Steve Snyder is a consultant with more than 25 years of experience in preclinical toxicology as an outsourcing customer and provider.