Outsourcing Insights: Booming Biopharma Pipeline Straining CRO Capacity

While the largest pharmaceutical companies account for the bulk of research and development spending and contract research revenues, expenditures by early-stage biopharmaceutical companies are vital to the health and viability of the contract research organization (CRO) industry. The comparative health of early-stage companies has lifted the entire CRO industry—including small and mid-size CROs—to a new level of robust activity and profitability.

Jim Miller

Early-stage biopharmaceutical companies have become especially important to the small- and mid-size CROs as the major pharmaceutical companies consolidate their supply base and limit their sourcing to a few preferred providers. Most small CROs don't qualify as preferred providers because their capabilities, especially their limited service networks and narrow therapeutic experience, are not broad enough to serve the multidisciplinary and large-scale needs of the major pharmaceutical companies. However, the capabilities of the smaller CROs are adequate for early-stage biopharmaceutical companies, which generally run smaller studies spread across fewer sites in fewer countries. More importantly, perhaps, the smaller CROs are willing to provide the hand-holding and close support that the less-experienced smaller companies need to get through the development process.

This doesn't imply that large CROs ignore early-stage biopharmaceutical companies. Smaller companies account for 25–30% of the volume at most big CROs, and are valued because they offer better margins than big pharma projects while diversifying the client base. However, the major pharma companies are where the big money and largest pipelines are, and they are the principal targets of the largest CROs.

VENTURE CAPITAL IS FLOWING

CROs are benefiting from the big jump in new drug candidates driven by early-stage biopharmaceutical companies. Over the last five years, the number of Phase 1 drug development candidates has grown nearly 50%, and the number of Phase 2 candidates has jumped 25%. The great enabler of this flow of candidates from early-stage pharma has been venture capital (VC).

The flow of venture capital has risen markedly in the past five years. Burrill and Company, the investment bank that specializes in the biotechnology industry, reports that VC investing in the biopharmaceutical industry reached $4.2 billion in 2006, up 50% from what it was in 2002. According to Ernst and Young, the biopharmaceutical industry now accounts for 18% of all VC investing, a level that has remained steady for the past three years.

Venture capital insiders say that the flow of funds into biopharma is likely to continue. To a large degree, this is driven by the large amount of money available for investment. According to Dow Jones Venture Capital, US venture capital firms raised $24.3 billion in new funds in 2006, just below the $24.9 billion they raised in 2005. These amounts are well below the record sums raised at the peak of the dot-com boom, but are still large by historical standards.

The mix of companies that get funded continues to evolve. In the late 1990s, venture capitalists favored companies offering genomic technologies and other discovery tools. In recent years, the trend has been toward companies with products in late development, including Phase 1 and 3. Those companies are attractive because they offer the most immediate promise of success, and because they can absorb larger amounts of capital.

According to Nick Galakatos, managing director at Clarus Ventures, the pendulum is now swinging toward companies with early development candidates. This reflects the increased willingness of major pharmaceutical companies to enhance their development pipelines by buying early-stage companies or in-licensing their candidates. According to Galakatos, competition among major pharmaceutical companies for early development candidates has raised valuations to very attractive levels, and offers a viable alternative exit strategy to the initial public offering.

CRO CAPACITY A PROBLEM

The strong support for early stage companies has been a boon for CROs; in fact, it's almost too much of a good thing. The growth in the pipeline is resulting in severe capacity shortages in early development services, especially preclinical toxicology testing and clinical pharmacology (Phase 1). The shortages are increasing drug development costs and delaying development timelines.

Reports from the annual meeting of the Society for Toxicology (SOT), held in March, indicate the problem. Analysts covering the meeting estimate that the preclinical services market is growing at the rate of 15 –20% per year, the fastest of any contract services sector. The growth is driven by the many candidates in early development and the increased willingness of major pharmaceutical companies to outsource their toxicology testing. Analyst reports note that increased demand from several major pharmaceutical companies (including Pfizer, which is closing several sites where preclinical testing is conducted) could overwhelm the market this year.

Preclinical CROs are adding capacity, but this may not be fast enough to absorb growing demand. One analyst estimates that announced new facilities and expansion plans will increase capacity by 15–20%, but it will take another two to four years for that capacity to come on stream. Biopharmaceutical companies are investigating new sources of supply in Asia, but are finding that compliance with good laboratory practices (GLPs) and animal welfare practices are still not up to Western requirements.

The capacity shortages are taking a toll on biopharmaceutical development efforts. Companies are being forced to reserve toxicology testing slots up to six months in advance, a long lead time for acute toxicology testing. Development budgets are being impacted by price increases of up to 5% annually.

CROs are using the supply and demand imbalance as leverage in negotiating long-term dedicated capacity deals with the major pharmaceutical companies. These deals are seldom good for the client, as they usually result in their paying for capacity they aren't using, but many companies are anxious to avoid the risk of not having access to preclinical capacity.

Clinical research service providers are also enjoying strong demand for their services. Exhibitors at April's "Partnerships with CROs" conference expressed considerable satisfaction with the current state of their market. While the large, publicly-traded CROs are reporting record backlogs (expected future revenues based on signed contracts), the smaller CROs are reporting strong growth thanks to the early-stage companies and overflow from the large CROs. One indicator of the good times for the smaller CROs is the intense interest in the sector being shown by private equity investors, who are actively looking for acquisitions in the industry.

For biopharmaceutical companies, however, the strong clinical CRO business has its costs. While there is no indication of an upward spiral in prices as yet, competition for key staff like site monitors is intense and costly. Further, patient recruitment has become very difficult, such that prolonged efforts to enroll patients are delaying the completion of trials. Another problem to watch out for: rapid growth at smaller CROs may outstrip their project management capabilities and the executive talents of their founders.

The bottom line: good times for biopharma are translating into good times for the CRO industry. But if there is such a thing as "too much of a good thing," the CRO industry may soon experience it.

Jim Miller is president of PharmSource Information Services, Springfield, VA, 703.383.4903, Jim.Miller@pharmsource.com