Focusing on the keys to success for contract drug manufacturers, Arnaud Sergent, Serge Hovsepian (partners), Nohmie Ben Rekassa (principal) and Ben Faircloth (partner) from L.E.K. Consulting detail the differentiation strategies that have proven themselves in the marketplace and provide a roadmap for investors.
Winning formula
Pharmaceutical companies are increasingly outsourcing ‘non-core’ activities to cut costs and focus their energy, capital and management on sales, research and marketing, the two activities considered key for their value chain. The volume of worldwide outsourcing has almost doubled since 2006, bringing significant growth opportunities for contract manufacturing organizations (CMOs) and attracting substantial investment.
Contract manufacturing is a complex market, with companies exposed to a range of unpredictable factors, including changing government reimbursement policies or outright drug bans, such as the one that affected the analgesic dextropropoxyphene in 2010. Positions can also be affected by more predictable factors, such as branded drugs becoming generics and new product launches. Companies that succeed find ways to differentiate and protect their business by positioning themselves in sectors where underlying drivers are attractive and barriers to entry are high.
Opportunities and risks in the outsourced manufacturing market
Contract drug manufacturing is growing fast, driven by the expansion of the overall drug market and the outsourcing trend among pharmaceutical companies. The development of generic drugs has particularly benefited this market, as manufacturers outsource as much as 80% of their production to CMOs. Branded pharmaceutical companies are also increasingly outsourcing their more mature molecules, although they typically continue to manufacture their newly launched drugs themselves for strategic reasons.
Although the overall outsourcing market is growing, CMOs are not all growing at the same rate. The contract drug market is highly segmented with each category having different growth characteristics; as a consequence, each segment has to be analysed separately. A segment is characterised by the typical size of the production run, the nature of the active pharmaceutical ingredients (APIs), the galenic form and the step of the product lifecycle to which it relates.
CMOs can also be impacted by developments in a specific therapeutic area; they can be vulnerable to changes in the regulatory environment specific to a class or a product, or the launch of a new competitive product. One example of the potentially unpredictable nature of the market is in France. Here, the state health insurance system, under pressure to shrink its deficit, decided in April 2010 to reduce reimbursements to consumers of dry cough syrup from 35% to 15% of the retail price, and to end reimbursement for children below two years old. The drop in demand caused by this decision affected makers of all syrups, generated overcapacity in production lines and negatively impacted the syrup contract manufacturing market as a whole.
Strategies for a hyper-segmented market
To help mitigate the impact of such risks, CMOs need to identify and position themselves in segments where growth prospects are strong and where they have, or can build, a differentiated position. They can do this in four different ways: in terms of scale, optimising their manufacturing capability to support either very large or very small production runs; in terms of product segment, having the capability to manufacture products with complex or hard to handle APIs; in terms of galenic form, offering a galenic form in which the market lacks capacity or capability; or finally by developing life-cycle management support competencies, which they can offer to pharmaceutical companies directly, alongside manufacturing (see figure 1).
L.E.K. Figure 1
Scale: Size is a significant differentiating factor, as the biggest players achieve considerable economies of scale. However, small can also be beautiful: the ability to deliver very short production runs is a differentiating factor, as it requires considerable manufacturing flexibility. Building a global organization able to deliver large-scale contracts requires substantial financing and commitment, while being able to cater profitably for short runs also requires highly flexible, small scale industrial capability. Those providers positioned solely to support mid-sized production runs face the biggest challenges.
Product segment: CMOs can focus on drugs with high underlying growth and whose API is complex to source or handle. Examples include high potency drugs such as cytotoxic medicines used in chemotherapy and controlled substances such as opioids that are used to control and alleviate chronic pain. The APIs used in these drugs often have specific licensing, authorisation requirements and environmental or safety needs while having to be manufactured in a ‘cleanroom’ setting. Sourcing can also be complex. For example, in France, morphine has to be sourced through Francopia, a subsidiary of Sanofi, which has a licence from the French government to be the country’s exclusive supplier. The requirement to establish a close relationship with Francopia is thus an additional barrier to entry for CMOs who want to manufacture opioids. In contrast, companies focusing on lower potency drugs are exposed to more competition and possible over-capacity in some galenic forms.
Galenic form: Demand is rising for sophisticated, specific galenic forms such as liquid stick packs, blow fill seal, multidose preservative-free drops, pre-filled syringes, aerosols and other forms combining the drug with the delivery system, because they provide a range of benefits, including optimal drug efficiency, improved adherence by patients, safer use and limited side effects. These advanced forms are difficult to manufacture and not every CMO is able to produce them profitably. One example is preservative-free eye drops, which are seeing increased growth because they are safer for the cornea than multidose droppers containing preservatives and are cheaper than unidose packages. However, they require an expensive, highly customised production line that acts as a barrier to entry for many CMOs and keeps demand ahead of supply. Companies focusing on the most common, traditional galenic forms, such as tablets, have to deal with overcapacity in the market, especially if they don’t have a robust product segment strategy.
Product life-cycle support: Some CMOs have built in-house development capacities which have allowed them to partner with generic drug companies in the development of generic formulations or with branded drug makers in the development of life-cycle management programmes for existing drugs. These essentially translate into new formulations and/or galenic forms of existing products that have additional customer benefits, such as faster delivery or taste masking. Part of the development process includes ‘scaling-up’ from making prototypes to full industrial production. A CMO which has helped on the ‘scale-up’ has an advantage when it comes to capturing the associated manufacturing contract, which will typically run for several years, thereby cementing the business relationship with the pharmaceutical sponsor. CMOs seeking to pursue this route have two options: they can either position themselves at the tail end of sponsors’ portfolios, specialising in reformulations of generics, or they can support branded drug launches, which often require investment in bespoke plant or material to support innovative manufacturing techniques and/or production scale-up (see figure 2).
L.E.K. Figure 2
Multiple specialisations as the path to success
Specialising in a single segment can mitigate the risks, but cannot eliminate them altogether, so successful CMOs often have multiple specialisations to insulate them against individual market risks.
Having only a limited share of sales dependent on the product ‘at risk’ gives the CMO enough time to find other ways to fill its production lines, but developing multiple areas of specialisation is no simple task. To successfully diversify risk, areas of specialty have to be uncorrelated, which implies limited synergies, increased investment and the identification of appropriate commercial opportunities.
The growth of the outsourced manufacturing market shows no sign of slowing and the underlying drivers — a buoyant drug market, increased activity from generic players and more outsourcing — are all positive. Navigating this market, however, is complex and market players will need to become more specialised and even multi-specialised in the years to come. For investors, the market growth offers attractive returns, provided there is a clear understanding of where a CMO’s competitive advantage lies. Where expertise is developed based on a careful read of the market, the rewards can be substantial.