Patent cliff, the rise of "pharmerging" markets: These are just a few of the challenges the global pharmaceutical industry is facing. In order to ward off billions of dollars in losses, pharma companies will have to redesign their supply chains and become less squeamish about outsourcing more and more elements of their businesses.

These issues were highlighted in the recent study "Drug Supply 2.0" conducted by the ESB Business School and Camelot Management Consultants. Brandi Schuster spoke with Camelot's pharma experts Ulrich Korneck and Michael Jarosch about the results of the study.

CHEManager Europe: The study shows that Western pharma companies have to cooperate with contract manufacturers and/or R&D providers in order to compete with pharmerging markets. Although all signs have been pointing to this kind of shift in the market, Big Pharma has been very slow to outsource. Why?

Ulrich Korneck: In the past, the main business model in the pharma industry was about blockbusters. With such high-value products - more than $1 billion in sales per product - pharma companies were very adamant about protecting their intellectual property, keeping most of their knowledge and processes in house. But now there is pressure to reduce costs and blockbusters are going off patent, practically invalidating the blockbuster business model.
Did the industry just not see the signs or did they choose to ignore them and trudge on with the blockbuster business model?

Michael Jarosch: Yes, they did see the signs, but they also have an existing asset footprint that needs to be leveraged. It takes time to sell assets to contract manufacturing organizations (CMOs). On the other side, the pharma industry has also been working intensively on lean programs to make their manufacturing more efficient and to reduce costs. It's clear that the industry hasn't been completely sedentary on this, but they are late moving down the path that other industries have already taken 10-15 years ago, such as automotive, consumer products and electronics.

Many large pharma companies see moving into the rapidly growing emerging markets as something that can offset losses incurred due to the patent cliff. How realistic is this?

Ulrich Korneck: A lot of companies are striving to get into these rapidly growing markets. I believe there is up to $180 billion in pharmerging country markets. As to whether or not it's realistic: These are areas with huge populations, which means a huge patient base. The caveat is that people in these countries have much less money to spend on protecting and improving their health than their counterparts in the western world. The price for entering these markets is selling at a lower price and maintaining margins to serve at a lower cost. To put it into perspective: In the traditional markets - Japan, U.S., EU - more than $4000 spent per capita per year. In these new markets, there's a per capita spending of anywhere between $40-400.

Michael Jarosch: There is really a race going on to secure large volumes in those markets; companies can only offset those lower prices with economies of scale.

So what we are really talking about here is the sheer quantity of the patient base in these economies that is hoped to offset the losses that will come from these blockbusters going off patent?

Michael Jarosch: Absolutely. The growth rates in the BRIC regions are very high. In China we're looking at 23-26%; in Russia 12-15%; and in India, 11-14%.

The study recommends that established companies should by-pass their traditional business models and opt for new ones for the emerging markets. How are these new markets different from the traditional ones other than spending per capita?

Michael Jarosch: Other than the lower amount spent, there is also a different infrastructure in those emerging markets with respect to logistics and sales capabilities and capacities. The population might be spread very differently either in population centers or very rural populations. While there are many differences in these markets, the key element is the lower spending per patient. This, of course, requires companies to also move their production to these lower-wage countries.

Many companies consider building greenfield projects in these pharmerging countries to be too risky and prefer to opt for partnerships instead. What do companies need to take into consideration when they are looking for a CRO or a CMO in these areas?

Ulrich Korneck: Our study has shown that there are certain prerequisites. For example, quality really is a basic criterion that needs to be provided by the CRO or CMO. Delivery reliability is very important, as is then financial capability and stability, and flexibility.

Michael Jarosch: Yes. Another important aspect is that CMOs are expected to have experience in cooperative sourcing. But there are also threats or risks that need to be managed at the pharma company: the transfer of know-how; the increasing administration and coordination costs; a risk of high staff turnover during the changes and change process; and establishing and monitoring quality standards at the CMO.

If we would look at all the Western-based CMOs and CROs, what does this growth in the emerging markets mean for them?

Michael Jarosch: It means two things: In entails risks, but also new opportunities for them. As far as risk is concerned, Western CMOs are currently rather specialized, and they might get trapped in this niche. There is also strong pressure coming from originators on prices and costs - this could threaten the Western CMOs' business models.

On the other side, there are also new opportunities, too. CMOs could orchestrate the activities for the originators in emerging markets based on their experience as a CMO, and kind of work as an agent who takes part of the risk for the pharma company, but also receives then a price premium for this service. This would really transform the Western CMOs to more full-service providers. What this means is that the CMOs would need to follow the originators into these emerging markets with their Western know-how. An example for that is Lonza, who has taken that step and already built-up capacity in China, but still is a Western partner for the pharma companies.

This brings us back to the reluctance of most companies to put concrete in the ground in these pharmerging markets. Is this just a phenomenon for pharma companies, not for CMOs such as Lonza?

Michael Jarosch: This is very strongly dependent on the experience of the respective pharma company. It also depends on the country's initiatives for encouraging investment. In Russia, the recently announced government support has made it an attractive region for pharma companies to invest directly. For example, AstraZeneca is currently investing over $150 million in the construction of a manufacturing plant there. In other countries the political risks might be very different, but Russia took that risk out. India, for example, is very stable, but also rather protectionist, because they have such a strong domestic pharma footprint.

What kind of a role will private equity companies play in the future of full-service providers?

Ulrich Korneck: Private equity is usually very thin-lipped about their investment plans, and so the picture is not as clear as it is in other branches. However, we do see there a lot of small loose players all over the world, especially in Central and Eastern Europe. These small players are very specialized with big pharma companies who require full service as customers. There seems to be a textbook baseline for a buy-and-build strategy that some private equity companies pursue. When I look at the current landscape - at the Cardinal Health investment of Blackstone, for example -there is currently a buy-and-build strategy within the portfolio of some private equity companies.

Michael Jarosch: We see an opportunity for private equity to consolidate the CMO markets, and create those full-service providers with big enough scale. Internally, the CMO market is quite fragmented, and the size and scale of the CMOs is limited. And there is certainly a trend in the pharma companies to reduce the number of their suppliers, because the complexity is growing so strongly. There is a real opportunity for consolidation here.

What risks are involved in outsourcing multiple facets of a business? Are there any parts that should definitely be kept internally?

Ulrich Korneck: According to the study, there is no technology or no step of the value chain that should remain untouched. In the future, outsourcing along the value chain will focus on formulation and packaging. Also, solid forms - hard-capsule tablets, for example - are most suitable to outsourcing, but also 80% of those surveyed said that also liquid and all other pharmaceutical technologies could be outsourced. The one exception is injections; only 50% of participants said it was appropriate for outsourcing. In my opinion, the pharmaceutical industry is working on breaking some long-standing taboos in order to catch up with other industries. Designing new supply networks has the potential to break taboos from the top downwards.

What will the big pharma company of the future look like?

Ulrich Korneck: If we look at the evolution of other industries that have gone through this process, it shouldn't be any different for pharma. Looking at food and consumer goods, the local supply for local demand strategy has been very successful. As for companies who don't own a strong pipeline and need to "harvest" products from the current portfolio, this local-to-local strategy could be a very good one for several reasons. For example, there is the advantage of taxation and overcoming local protectionism, but also being able to hedge currency and political risks by producing local with local costs and local sales.

Companies with strong pipelines are more interested in protecting their IP and keeping relevant processes in-house. For them, it would be more interesting to serve globally from one side and to finish locally.

If we look at the idea of a virtual supply chain - meaning outsourcing big portions of manufacturing and R&D - it should be noted that pharmaceutical companies that are pursuing this business model for the last years are entering the global pharmaceutical top 50 by sales. These companies ‘ core competence is managing the brands and supply chains very differently than we see in traditional pharma comps. These companies are more flexible to act on the currently fast changing landscape.

Traditional pharma recognized this as well. One thing all of our survey participants unanimously agreed on was that the current supply chain is completely different to the supply chain we'll see within the next five years.

Read a condensed version of the study here.