The Macro View

The global economy and financial system are not in great shape. The European debt crisis rolls on and on, driving European economies into recession. China's growth has slowed to "only" 7%, but that slowdown is enough to reduce growth prospects of countries that export to China. India's economy is feeling the effects of institutional problems, such as corruption and poor infrastructure. The US economy is growing, but at a rate too slow to bring down unemployment.

Jim Miller

The apparent incompetence of political leaders has not improved the mood. The inability of the US Congress to address the nation's debt and economic issues and the uncertainty surrounding the upcoming national elections have created great uncertainty and caused business executives to scale back investment and employment plans. The failure of European political leaders to resolve their problems has undermined investor confidence and created volatility in financial markets. Even in China, where the Communist party maintains a strong grip, the impending change in leadership has added an element of uncertainty.

In the not-so-distant past, such macroeconomic developments would have had little impact on the bio/pharmaceutical industry. Global bio/pharmaceutical companies were generating large profits from patented blockbuster medications and pouring them back into expansive R&D programs and investments in new laboratory and manufacturing facilities. People had to take their medicine and the effectiveness of drugs, such as Lipitor and Plavix, ensured that governments and private insurers would continue to pay for them regardless of price. Attracted by the returns on successful new pipeline candidates and flush with cash, investors poured record amounts of capital into early- and mid-stage companies.

FULLY EXPOSED

Today, having fallen over the patent cliff, the bio/pharmaceutical industry finds itself fully exposed to the vagaries of the macro-economy at a very inopportune time. Not only have companies lost the big profits from blockbuster drugs, but they also face increased pressure from governments and private payers who are desperate to reduce healthcare expenditures. Drug prices are being forced down, generic substitution is accelerating, and it is increasingly difficult to get coverage for expensive new drugs.

Smaller companies are being buffeted by the uncertainty in financial markets. Venture-capital funds have less money to invest as their traditional investors have become more risk-averse, and venture capitalists themselves have focused on less-risky investments with faster payoffs, such as social-media companies. In instances where they are still investing in bio/pharmaceutical start-ups, they are favoring companies with later-phase candidates with strong near-term prospects for outlicensing. Funding by way of initial public offerings is scarce. The number of bio/pharmaceutical initial public offerings is way down, and most have lost value since they were launched.

These pressures could not come at a worse time for an industry desperately trying to maintain profitability in order to fund new product development. Pipelines at many bio/pharmaceutical companies are sparse, and R&D operations have been notably unproductive despite significant cost-cutting. High profile drugs continue to fail at Phase III despite the "kill-it-early" philosophy that guides decision-making at most bio/pharmaceutical companies.

So, instead of a stable macroenvironment in which to transition to the next generation of products, bio/pharmaceutical companies must fight fierce headwinds to make progress. They have been forced to remake their business models not just to address the new scientific and clinical realities but also to reflect their closer connection to a world that cannot afford to maintain the rapid growth in healthcare expenditures.

The business model changes thus far have been dramatic. Global bio/pharmaceutical companies now pursue growth opportunities in niche products, generic drugs, and emerging markets instead of traditional blockbusters. They are downsizing their remote R&D campuses while building their presence in urban centers of medical research where their researchers can be continuously exposed to new ideas and technologies (a model that other knowledge-based industries have long subscribed to). They are rebuilding R&D processes to more thoroughly assess new candidates before graduating them to expensive clinical development stages. They are re-engineering supply chains to reduce costs and increase security. Although still dependent on physicians to prescribe their medications, they are looking for ways to interact more directly with patients.

LINKED FORTUNES

If the fortunes of bio/pharmaceutical companies are now closely tied to the macro-environment, then too are the fortunes of CROs and CMOs. CMO revenues and margins are directly impacted by the declining unit volumes and growing customer demands in that they help absorb the lower prices being paid by governments and insurers. Providers of preclinical toxicology and API process-development services have seen their revenues stagnate as more rigorous graduation criteria and decreasing venture-capital support have reduced the level of early-development activity. In these changing times, CROs and CMOs have two choices: they can continue their traditional strategies of passively bobbing up and down on the rising and ebbing tides of the industry or they can seize the opportunity to help bio/pharmaceutical companies deal with their increased exposure to the macro-environment.

Clinical CROs have shown the way on how service providers can help bio/pharmaceutical companies adapt to their new realities. Although originally just a source of supplemental labor, they have come to set the standards for quality and innovation in the running of clinical trials. In particular, they have led the way in the use of information technology to revolutionize the way in which clinical data are collected and analyzed. CRO-driven technology innovation has enabled faster review and analysis of clinical data, flexible trials designs, and patient-reported data using mobile devices.

Similarly, clinical packagers have been in the forefront of adopting sophisticated packaging and printing and logistics technologies and practices to reduce the costs of clinical-trial materials while ensuring supplies get to patients in a timely manner. All of this has enabled clinical research to be conducted faster and more cost-effectively.

CMOs have lagged behind other service segments in identifying technologies and practices that can help bio/pharmaceutical companies respond to the changing macro environment. In particular, they need to find more flexible and lower cost manufacturing solutions to address a medical marketplace that is more focused than ever before on managing total expenditures.

The ability and willingness of CROs and CMOs to contribute to the remaking of the bio/pharmaceutical business model, and especially to the ability of bio/pharmaceutical companies to respond to the macro-environment, is likely to determine their long-term success.

Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, Twitter@JimPharmSource, info@pharmsource.com, www.pharmsource.com.