Pharma's Prescription: Offshore R&D

 In the last decade, while the top-line growth of big pharmaceutical companies has declined, Research and Development (R&D) costs have shot up by 55%, according to a study by Tufts University. R&D spending in this space recently hit $39 bn, up from $2 bn in 1980, says Pharmaceutical Research and Manufacturers of America (PhRMA), an association representing major drug manufacturers in the US.

Even more revealing, however, is aggregated R&D cost as a percentage of sales. At 19.2%, drug R&D soars higher than any other global industry. The high cost is not just salaries-it also includes the costs of 'failed' pursuits, which in the drug industry could run as high as 95%. What is more, each drug can take anywhere between 8-12 years to develop. The long gestation period adds significant cost and risk.

This has made major pharma companies focus on fewer projects instead of trying out more new products, thus shifting the cost from 'research' to 'development.' While this may sometimes effectively take care of the quarterly pressures from the investors, innovation tends to suffer-leading to fewer new products.

There's no fast solution in sight. Only 58 new drugs in 2002–04 received marketing approval from the US Food and Drug Administration (FDA), a 47% drop from the peak of 110 new drugs in 1996-98, according to the Tufts Center for the Study of Drug Development (CSDD). In fact, the last real blockbuster molecule was Pfizer's Atorvastatin, marketed as Lipitor, which was introduced almost a decade back in 1997.

Critical Mass

The challenges facing the major drug industry are threefold: To reduce the actual cost of research; to compress the period of drug development; and to try out more research work, as opposed to focusing on a few projects.

Outsourcing provides opportunities to meet all the three challenges. And large pharma companies are already aggressively exploiting these opportunities.

The global pharma industry spent about $1.25 bn on R&D for each New Molecular Entity (NME) application approved by the US FDA in 2004. Offshoring could bring that cost down by 40%–65%. Today, for example, the cost of hiring a medicinal chemist in the US is approximately $250,000–$300,000 per year. In India, chemistry service providers such as Jubilant Chemsys, GVK Biosciences and Chembiotek charge on an average of $60,000 per chemist-that is a straight reduction of 80%. The reason is they can hire a chemist at a pay package of $20,000 per year.

Employing Contract Research Organizations (CRO) is a good strategy for speeding up the drug-development project, especially during the clinical-trial phases. According to a January 2006 study by Tufts CSDD, drug sponsors (pharma companies) that are more extensive users of CROs tend to complete projects faster. According to the same study, CROs managed nearly 23,000 Phase I–IV studies at 152,000 clinical sites worldwide. CROs accounted for 15% of the total drug-development spending. India and China have emerged as the favorite destinations of global CROs.

The area of outsourcing that is still nascent, but emerging rapidly, is research in the preclinical-development phase. Companies such as AMRI, Charles Rivers, Nektar, Evolva, and India-based companies such as Jubilant Biosys, Syngene, and GVK Biosciences are players in this area. Outsourcing vendors here provide two advantages to major drug companies. First, they provide a reduction in cost because of offshoring (no wonder most of the major global companies such as AMRI, Nektar, and Evolva have opened India-research labs) and second, they often work on a risk and reward sharing mode. This enables the pharma companies to take up more projects than they would have otherwise taken, thereby widening the base of new drug-development projects. This is a fairly new model, and there is no major tangible data available. But industry sources say that some of these co-development projects-as they are known in industry parlance-are progressing quite satisfactorily.

It is no surprise that pharma companies have embraced outsourcing with open arms. Outsourcing drug-discovery services such as chemistry, biology, screening and lead-opt, is expected to touch nearly $7.2 bn by 2009, according to a new study by Kalorama Information, a division of MarketResearch.com.

Kalorama's study, Outsourcing in Drug Discovery, predicts that the swiftly growing market for outsourcing services, fueled in part by impressive advances in the Asian market, will increase at a rate of 15% from the 2005 figure of $4.1 bn. In fact, upon discovering the benefits of outsourcing to Asia, many of the top pharma and US-based CROs have opened their own operations in the continent, it says.

Pharma is Different!

This is one industry where basic research is still used to build competitive advantage. Notwithstanding the fact that pharma majors do not lag in business and IT-services outsourcing (with landmark deals such as the Pfizer-IBM IT deal and GlaxoSmithKline-Genpact F&A contract), much of their time and energy is invested in drug-discovery outsourcing, as the development of a new product offers a more strategic competitive advantage for them than making the regular processes more efficient-barring procurement and distribution. It is no surprise that most of the drug-discovery contracts are more focused on the intellectual capability of the service provider than the promised process efficiency, which is a major difference when compared with traditional outsourcing industries such as financial services, logistics, retail, and telecom.

The second important differentiator in terms of challenges for the companies wanting to outsource, as well as for the service providers eyeing those contracts is the regulation that governs this industry. “The pharma industry is probably the most regulated industry after aviation,” says Dr Surinder Kher, CEO, Jubilant Clinsys, a CRO based in Noida, near New Delhi, India. The regulation makes it difficult to outsource quickly. For example, in clinical trials where FDA has strict guidelines, in terms of processes, infrastructure and ethics, all these guidelines have to be adhered to by all the sites (usually clinics/hospitals) participating in the trials. Preparing a site for trial takes up considerable amount of time.

Pharma Offshoring, Not so Different

Just as the big Business-process Outsourcing (BPO) wave was kick-started by a few committed global corporations such as American Express, British Airways, and GE that sold the India concept to the global business community, the first companies to start clinical trials in India were two of the biggest names in the global pharma industry-Eli Lilly and Pfizer. Eli Lilly expanded globally in 1995, and faced all the initial hurdles that the pioneers do. “The concept of clinical trials was completely new to India. One had to virtually train people on the ethics standards and set up ethics committees as people did not understand what they were,” says Dr Vinod Mattoo, Medical Director, Eli Lilly.

Eli Lilly and Pfizer can be credited for starting the wave in India at a time when India had just promised that it would implement its drug-patent regime. A few Indian companies emerged as providers such as Daksh, Spectramind, Exl, and vCustomer. They were soon followed by Siro Clinpharm and DiagnoSearch. These pure-play CROs were joined by separate divisions or companies created by Indian contract manufacturers and generics companies like Ranbaxy, Nicholas Piramal, Biocon and Dr Reddy's Lab. US and Europe based CROs like Kendle, Pharm-Olam, PPD, Chiltern and Icon were the last to join. Only one major US CRO came in as early as 1997 and has been looking at India quite strategically. American CRO Quintiles, has the same position in drug discovery-offshoring as Convergys in traditional BPO. Today, the clinical-research industry in India is dotted with more than 100 entities - captive centers of Eli Lilly, Pfizer, AstraZeneca, Novartis, GlaxoSmithKline and the like, numerous Indian CROs as well as the who's who of global CROs.

Like the traditional offshore business services, this industry has started seeing a captive versus outsourced debate, though it is nowhere as intense. “There are myriad financial benefits to outsourcing research (from direct-cost savings to capital-expenditure savings) that are incurred even if the contractor is next door in New Jersey. I would argue that the movement offshore is only an add-on in savings, but that initial move out of the house is where the major benefits are realized-where the contractor is only a matter of degree,” says StevenHeffner, Kalorama Information, the author of a report on the drug-discovery outsourcing opportunity, adding that offshoring is still very small.

The growth has been made possible by a supply of top managers from the ranks of early movers, as well as the global Indians in the US and other developed countries, returning to India. “Reverse brain drain has also fueled this industry growth, as it has in the IT industry,” says Dr Kher, though he belongs to the other dominant category of homegrown managers coming from early movers, having worked in Eli Lilly and then subsequently DiagnoSearch.

The evolution and maturity of the pharma value chain has followed patterns familiar to other forms of BPO. Starting with the comparatively high volume, low value work of clinical research, the offshore drug-discovery industry has moved across the value chain to provide services in the preclinical phase, especially in the area of chemistry services, for which talent is available in plenty in India, thanks to the large number of generics companies based there. A few players are also beginning to provide services in the area of molecular biology and bioinformatics.

"The pharma industry is probably the most regulated industry after aviation"

-Dr Surinder Kher, CEO, Jubilant Clinsys

“India has proved its expertise in systems, quality and cost,” says Dr Kher. “Now, it is moving to more knowledge-intensive work,” he adds.

Meanwhile, the IT-services companies are making their 'entry' into this space and at the moment it is gaining steam. TCS, Infosys, HCL, Cognizant, and Infosys are making serious moves to enter the drug-discovery domain. “Many of the processes are systems driven, where IT companies excel,” says Dr Mattoo of Eli Lilly.

While almost all major IT players agree that life sciences presents one of the best growth opportunities before them, there is still no consensus on where they will fit themselves. Infosys and HCL have so far largely restricted themselves to building solutions and algorithms for the drug-discovery industry, and are flirting with clinical-data management. TCS has announced its foray into areas such as bioinformatics aggressively. Accenture and Cognizant have actually bagged large deals for managing clinical data from Wyeth and Pfizer respectively. Accenture's Bangalore center is executing the project. But the IT-services company that is clearly ahead of the pack in taking a complete plunge into drug discovery is iGate. The US-based offshoring company has acquired Mumbai-based DiagnoSearch to form iGate Clinical Research, which makes it a player in the whole value chain of clinical research, including clinical trials.

HCL understands the potential of the opportunity, but is following a partnership approach. “We realized early on in our life-sciences foray that, to offer our customers and prospects a full basket of services covering the breadth of drug and device value chain, we will need to acquire or develop a lot of life-sciences specific competencies like understanding of clinical trials etc.,” says Pradeep Nair, VP, Life Sciences Practice, HCL. “The organic route takes a lot of time and investment, while win-win partnerships with best-in-class players allow you to offer niche services to your customers right away.” HCL has a strategic tie-up with Synchron, an Indian CRO, where both the companies have a joint GTM (go-to-market) initiative. Clinical-data management and bioinformatics are the areas where IT companies are likely to make their major mark, initially.

Signs of Maturity

Thanks to the slow development cycle, the size of the industry is still small, pegged at around $100 mn in 2004–05 (April–March, of the Indian financial year), according to BioSpectrum, an India-based publication. Yet, the industry has started showing signs of maturity, represented by the early trends. Some of these trends include:

Major offshore contracts: A few major contracts have come calling to offshore service providers. Wyeth's contract with Accenture that the IT-services company is delivering out of Bangalore drew attention, but equally significant are the two contracts awarded by Pfizer to Siro Clinpharm and Cognizant for clinical-data management. Both the contracts are in the area of clinical-data management. GVK also won a major deal from Wyeth to establish an FTE-based R&D center for the pharma major, whereas Jubilant won a major deal from Eli Lilly to perform a lead-optimization program deploying 100 scientists.

Companies building end-to-end capabilities: Companies such as Biocon, TCG Group and Jubilant Group are some of the Indian players building end-to-end capabilities to compete with companies such as Quintiles. Biocon has Syngene (R&D) and Clingene (clinical research); TCG Group has ChemBiotek (R&D) and ClinInvent (clinical research); whereas Jubilant has Jubliant Clinsys (clinical research), Jubliant Biosys (biology services) and Jubliant Chemsys (chemistry services), not to speak of Jubilant Organosys, the promoter company focused on contract manufacturing.

Emerging hub: While the offshore IT industry has its hub in Bangalore, its neighboring Hyderabad has emerged as a clear favorite for most of the R&D companies in drug discovery, but only in the preclinical development area. Like BPO, the clinical-research industry is spread across all major cities, starting at Ahmedabad, thanks to the presence of a lot of pharma companies in the city.

Mergers, acquisitions, and partnerships: When growth and opportunity are there, can Mergers and Acquisitions (M&A) be far behind? The industry has had its share. Some of the significant M&As are iGATE's acquisition of DiagnoSearch; European generics company, Actavis' acquisition of Indian CRO, Lotus Labs; Jubilant's acquisition of U.S-based CRO Target; and the merger of Phase I Clinical Trials Unit of U.K. with Indian CRO ClinSearch to form Vedda Clinical Research. Major partnerships include U.S.-based CRO Covance's partnership with Siro Clinpharm; a tripartite partnership between Indian CRO, Suven Life Sciences and chemistry and manufacturing service providers, Innovasynth and Shashun; and HCL's partnership with Indian CRO, Synchron.

Rise in knowledge-based preclinical development: Many global R&D companies have started their R&D activities in India. While some pharma majors such as Sandoz, AstraZeneca, and Altana have set up their captive R&D facilities in India, global R&D companies such as US-based AMRI and Nektar; Switzerland-based Evolva; and Germany-based Taros have opened their research facilities. Hosts of Indian companies such as GVK BioSciences, Syngene and Sai Life Sciences have also joined the fray.

Beyond India: Both China and Russia are emerging as major offshore destinations in addition to India. Not only are companies like Quintiles, PPD and Covance working in these countries, homegrown companies such as WuXi in China and ChemBridge in Russia are making their mark.

So Far, So Good

The nascent pharma R&D industry is doing well. But it still needs a few catalysts that the IT industry has developed in India. Private equity is on the sidelines watching to see what happens. Serious private-equity investment could change the story drastically.

“Cost pressure will come. You cannot live in a fool's paradise that costs do not matter in this industry,” says an industry executive. With more competition and better standards and quality, services like clinical trials will tend to come under cost pressures.

If we may add, do not forget the manpower issues that the IT and BPO industry is going through-attrition, sharp rise in wages.... All that will have to be tackled, when pharma goes mainstream.