New Start - Major changes are impacting the pharmaceutical industry: the financial crisis, hard hitting government finances and health care budgets throughout the world, as well as patent cliff effects exacerbated by inadequate R&D productivity levels. Traditional business models applied by the pharmaceutical industry are being undermined, forcing change within the sector that also could spell out sweeping implications from the pharma CMO sector.

To respond to these challenges, pharmaceutical companies are increasingly confronted with the imperative for maintaining revenues to increase while also increasing access and affordability. Within this frame, some industry observers are predicting a further downgrading of the pharmaceutical industry to a simple AA (affordability and access) as opposed to its rapidly fading AAA (guaranteed returns and steady growth) status. If this holds true, the industry would evolve at an accelerated pace towards a model characterized by:

• Massive consolidation of the supply structure;
• Downscaling of R&D activities as the emphasis shifts from new chemical entity (NCE) development to reformulation and product life extension;
• Massive surge in the share of generics; and
• Pruned product lines - eventually only a couple of APIs in each therapeutic category being maintained.

Evolution, Not Revolution

We are likely to witness is - rather than a revolution - a gradual evolution scenario for the pharmaceutical industry. These developments are mainly a continuation of a process that began in the late 1990s. The recent economic crisis acted more as a revelator than a trigger for these developments:

• The focus within consolidation and mergers amongst companies has shifted from securing access to complementary resources to cost synergies as a tactic to protect the bottom line.
• R&D programs are redirected and reassessed, with the focus moving away from the quest for blockbuster products to specialist products. Companies are also being more selective in their development decisions, rationalizing their pipelines while placing increasing emphasis on lifecycle management. 
• New organization models being explored to find a more appropriate balance between growing size and the imperative to maintain entrepreneurial behavior. 
• More attention is devoted to costs, which leads to the downsizing of own M&S as well as industrial operations.
• Business development efforts are being redirected towards emerging demand areas and assembling full- product lines to meet the requirements of the therapeutic areas targeted - a move dictated by the need to offer a complete range of solutions to the patient as opposed to single molecules.

What Does It Mean for CMOs?

The implications of these developments on the pharmaceutical CMO sector are substantial, resulting in increasing business volatility patterns.
In particular CMOs are confronted with:

• Smaller average project size and tighter budgets, combined with unpredictable timelines;
• High staff turnover within the customer organization - jeopardizing thereby value of personal relations, making the creation of goodwill between the vendor and the customer organization an elusive concept;
• Increase leverage application from customers as they try to pass the burden down value chain; 
• As the flows of new projects dries up, new sets of players are entering what was traditionally Western CMO territory - a development actively encouraged by several customers;
• Evolving customer requirements -as an example in molecule building: the demand for organic synthesis is stagnating while biomanufacturing is still growing; also, product tonnages tend to decrease, mirroring the smaller markets targeted by the NCEs being developed; and
• Low delivered prices and values are absolute musts.

These developments are hard the CMO sector hard, and several players are reported to be struggling. The situation for CMOs focusing on dosage form manufacturing is not much better - CROs focusing on earlier stages of the pharmaceutical product creation process also struggling. Problems that have arisen include project cancellations, postponements and price-volume reductions, all of which lead investors to reassess the prospects of the business.

The Future of Western CMOs?

It is important to note that the aggressive behavior of pharmaceutical companies with their CMO or CROs vendors is nothing particularly new. The sole real novel factor in the current situation is the volatility patterns. In fact, the situation CMOs are facing today represents an intensification and acceleration of trends that have been observed over the last decade or two. Factors behind this include globalization, cuts in healthcare budgets and financial turmoil.
Also, the situation of flux that several CMOs/CROs are facing is now is not very different from what was seen 10 years ago with the advent of the CMO bubble.
At that time, a rush of new entrants scrambled to take a position in the pharmaceutical CMO /CRO space, which was viewed by some as a harbinger of prosperity and continuing growth.

These prospects lured many new entrants, who often acquired CMO/CRO activities to set up a base in the field - AlliedSignal, Honeywell, Clariant, PPG, Rhodia are just a few. However, many of these players (who were all invariably jockeying to reach a $500 million + size) have been forced to exit the scene after suffering major losses. These setbacks have been largely self-inflicted: Many of these new entrants failed to properly understand the dynamics of the industry; its intrinsic lumpiness; the continuing quest for value characterizing pharmaceutical companies who are not eager to share their comfortable high margins with their vendors.

Old Recipes For New Success?

CMOs are taking an active part in the industry consolidation, a larger size often being associated with increasing resilience, as well as enhanced bargaining power in regard to ever-larger pharmaceutical giants - the benefits of such a move being all but clear, as size tends to go in parallel with:

• The loss of efficiency and of responsiveness - one of the pitfalls often encountered by mega pharmaceutical groups resulting from mergers amongst pairs; and
• The failure to diversify risks, rather creating increasing dependence on key products and customers.

CMOs can also broaden the range of services offered to the pharmaceutical industry, for example combining capabilities in molecule building with formulation or developing full service research and development platforms. However, the viability and need for this have yet to be tested. This is a major issue being represented by the breadth and diversity of skills having to be mastered under a same roof.

In the quest from new traction, some players are considering moving outside of their home turf - for example, API producers moving into dosage-form generics or setting up an Asian base. The benefits here will depend on the company's ability to leverage synergies in order to avoiding moving in untested waters - a fail-safe recipe for disaster

The Right Track

The key for success can be found by gaining insights in what it will take for vendors to be successful in the evolving environment. It is important to keep in mind that the pharmaceutical industry will continue to evolve with:

• Continuing volume, but not necessarily value growth;
• Growing convergence between innovators and generic marketers as the boundaries between the two become more diffuse; and
• Pharmaceutical companies continuing to insist on maintaining a firm control as overall project managers and supply chain orchestrators.

This will imply for vendors:

• Fewer but more sophisticated and more complex to serve customers ; few will be willing to move to a virtual mode of operations for R&D or supply chain - all, however, will continue to have multiple sourcing requirements;
• Continuing unpredictable product life cycles; and
• Diminishing turnover and volumes associated with any given contract.

In the end, success for vendors will hinge on:

• Reaching a certain size - differing depending on the segment of activity considered - large enough to reach critical mass - whilst small enough to operate efficiently
• Develop a balanced - yet coherent business portfolio avoiding critical customer or product dependencies 
• Being able to conduct business in all parts of the world being comfortable dealing with different cultures
• Continue to focus and excess on internal operations whilst striving to exceed customer expectations avoiding moving in unrelated areas