Outsourcing Outlook: Outsourcing Is Front Page News in 2003

Outsourcing has become a political hot potato in the United States this year, and it is getting a lot of coverage in the general press, not just in the financial pages. A major focus of the debate is the flow of outsourced work to countries with lower labor costs, especially India. Domestic job growth has lagged significantly behind the overall economic recovery in the United States, and offshore outsourcing, as the practice is often called, is getting a lot of the blame.

This debate has particular relevance for the pharmaceutical industry because offshore outsourcing, especially to India, is likely to figure more heavily in industry outsourcing efforts in coming years. Like other industries, the pharmaceutical industry is attracted by substantially lower labor costs in India (50 to 90% lower, depending on the position) and the number of highly educated technical and professional people in the country. The pharmaceutical industry has the additional incentive of accessing India’s huge population for clinical trial subjects.

Among U.S.-based contract research organizations (CROs), Quintiles Transactional is one of the first to set up operations in India, where it has a major data management facility. Covance recently announced an alliance with Indian CRO Siro. A number of Indian pharmaceutical companies have set up CRO units in recent months, and the Indian chemical industry is pursuing contracts for the production of pharmaceutical intermediates and actives.

The other arm of the political debate on outsourcing has been sparked by the Bush Administration's competitive sourcing initiative. The Administration says it would like to open 450,000 federal jobs — about 25% of civilian federal positions — to competition from private contractors and has tasked the heads of federal agencies with identifying which jobs within their respective agencies might be eligible to be contracted out. Labor unions and members of congress with many federal employees in their districts have actively opposed these efforts, including adding amendments to appropriations bills to block outsourcing.

The pharmaceutical industry has a major interest in the outcome of the competitive sourcing initiative, because both NIH and FDA are major targets. At NIH, as many as 9,000 positions have been identified as potentially eligible for outsourcing — nearly 50% of the agency's total staff. Initially, grants administration and property management positions are the most likely to be targeted, but there has been increased discussion of technical and scientific positions being included as well. Indeed, NIH has historically contracted out a number of important functions, such as long-running relationships with Charles River Laboratories International for management of laboratory animals and with SAIC for manufacture of biologics for clinical trials.

When they combine these outsourcing initiatives with government programs in bioterrorism defense, some CROs see a major boost coming from federal government contracting activity. Stock analysts now regularly question CRO executives about government contracting opportunities in quarterly earnings calls. As I reported last month, Chris Kuebler, chief executive officer of Covance, noted that the government’s efforts to outsource to CROs are at unprecedented levels.

Heads Up

Pharmaceutical companies using CROs will want to keep a close watch on project schedules and deliverables in the closing months of 2003. Most CROs reported an upsurge in request for proposal (RFP) volumes and contract signings in the second quarter and as a result are expecting a busy second half of 2003 after a somewhat sluggish first half. Pharmaceutical companies need to be concerned that a flood of new projects could strain contractors’ ability to meet year-end targets.

It is a normal tendency in the pharmaceutical industry to load up on study starts in the second half in order to show progress in achieving annual goals, but this practice could cause some special problems this year for two reasons: Pharmaceutical companies seemed to be especially slow at making decisions at the beginning of this year and may have pushed more work than normal into the second half. Additionally, CROs have engaged in some "right-sizing" — capacity reductions or delays in increasing capacity — over the last year in response to the weaker business environment in 2002 and the first half of 2003. They may be hard-pressed to handle the flow of new projects pushed into the second half.

We haven't heard of serious problems yet, but pharmaceutical companies will be well advised to keep close watch on project progress in order to prevent any nasty surprises at the end of the year. BPI