Contract manufacturing

Analyse three reasons contributing to growth in the value of contract manufacturing (outsourcing) in the pharmaceutical industry since 2005. Assess the potential business benefits and pitfalls to a pharmaceutical firm involved in this business practice.

Introduction:

Contract manufacturing (outsourcing) is contractual arrangements by a company with foreign organizations to perform services and tasks on his behalf. Such arrangements are based on long-term relationship between the partner firms with an objective of transfer of knowledge and skills between such firms in different countries.

Due to cost pressure, strict regulatory formalities, patent expiries and highly competitive and tough business environment, pharmaceutical companies are increasingly outsourcing to the new rising markets i.e. India and China, to reduce costs.[1]

Furthermore Contract manufacturing might be crucial in order to overcome the trade barriers and some time it is the option available to gain entry to a foreign market where the Government attempts to secure local employment by insisting upon local production. If political instability makes foreign investment risky, this may be the best way of achieving market presence without having the risk of a large investment in manufacturing. The disadvantages of contract manufacturing as an entry method to a foreign market does not allow the buyer control over the manufacturer's activities.[2]

This assignment is mainly focused on pharmaceutical contract manufacturing (outsourcing), it discusses in detail the rational behind contract manufacturing, main drivers of increase in pharmaceutical manufacturing outsourcing and the advantages and disadvantages of contract manufacturing (outsourcing) with reference to a case study of an Indian firm Ranbaxy.

Contract Manufacturing; an overview:

Contract manufacturing is one of the intermediate entry modes to a foreign market where a domestic firm gets entry into an overseas market. Contract manufacturing is very advantageous in situation where firm possess competitive advantage but is unable to exploit it at home country.

When a firm is marketing and selling products in international markets through its own subsidiary might arrange for a local manufacturer to manufacture the product for them under contract. In such situation the advantage of contract manufacturing is that it allows the firm to concentrate upon its core activities i.e. sales and marketing and because investment is kept to a minimum, and makes withdrawal quite easy and less costly if the product proves to be unsuccessful.[3]

Contract manufacturing (outsourcing) with reference to pharmaceutical industry:

Over a period of time because of speedy growth in pharmaceutical industry outsourcing has become an important strategy for pharmaceutical firms. Increasing pressure to reduce cost and time to market has led to outsourcing not only in non-core functions but also in other areas such as drug discovery and Research and Development (R&D).[4]

Biopharmaceutical contract manufacturing is the fastest growing sector of outsourcing and CMOs are increasing their competence to fulfil the increasing demand.[5]The trend of contract manufacturing is expanding with enormous speed "the industry is forecast to show strong growth, with total revenue rising by 13% per annum, on average. In 2005, the market value was $ 31.5bn but by 2010 will account for just under $ 50bn".[6]

Rational behind pharmaceutical contract manufacturing:

The rational behind contract manufacturing (outsourcing) is that it allows pharmaceutical companies to access needed technologies at reduced costs and improve flexibility.[7]

A pharmaceutical company may wish to enter into a global market, to take such a responsible step the firm will look at different aspects, such as to analyse the advantages and disadvantages of different methods available to such firm. For instance the firm may do not want to adopt direct investment as a method of entry into foreign market, because FDI requires huge investment in foreign market. The firm will also face a number of risks such as country risks, political risks, foreign exchange risk and commercial risks. The firm may also do not want to adopt joint venture as a foreign market entry mode because this method of entry is also having a number of pitfalls, for example in joint venture the foundation of relationship between the parties is based on close partnership, common understanding and commitments which is very complex to achieve and takes time and need efforts to build up such kind of relationship. To avoid such problems the firm will prefer to adopt a hassle free business practice overseas which can manufacture and distribute its products in overseas market by way of contract manufacturing.

According to a survey conducted by Contract Pharma in 2006, the main factors for outsourcing decision among pharmaceutical firms are quality, timeliness, confidentiality, good manufacturing practice capability, and relationship. [8]

Similarly contract manufacturing enables the firm to have foreign sourcing (production) without making any final commitment. The firm may lack resources or may be unwilling to invest equity to establish and complete manufacturing and selling operations. Yet contract manufacturing keeps the way open for implementing a long term foreign development policy when the time is right. These considerations are perhaps more important to the company with limited resources. Contract manufacturing enables the firm to develop and control Research and Development (R&D), marketing, distribution, sales and servicing of its products in international markets, while handing over responsibility of production to an external organization.[9]

Furthermore biopharmaceutical product developers are reinforcing their internal focus on research and development, discovery, and marketing, while strategically outsourcing certain manufacturing activities to overseas companies. This will continue to feed the growing demand for CMOs' manufacturing capacity. Drug manufacturer will consider contract manufacturing more as an asset to drive strategic manufacturing decision than as simple capacity alternative.

Reasons of growth in pharmaceutical contract manufacturing (outsourcing):

The following are the key drivers of growth in outsourced manufacturing in pharmaceutical industry;

Cost savings:

CMO service globalization offers significant cost advantages. Regions such as India and china are becoming popular locations for pharmaceutical outsourcing, offering capable services at a lower cost. Through outsourcing, companies also avoid or postponed significant capital investments, thus reducing drug development costs.[10]

To develop a particular drug needs huge financial investment and a thorough research. For instance a pharmaceutical firm intend to develop a drug will need to make huge investment on research and development and will need further investment to establish the infrastructure to facilitate manufacturing. It would be rational for such firm to sign a sub-contract with an organization in a foreign country where the manufacturing cost is low in order to reduce the cost of manufacturing.

According to a statement made by the Voice President of AstraZeneca, the estimated cost of bringing new drug to the market is over $897m, and takes about 12 years to develop a new medicine, but 80 percent of drugs do not show positive return on investment, leaving only 20% to fund the R&D engine.[11]

Therefore cost is a key criterion which outsourcers factor into decision on which contract organization to use. As evident from contract pharma's survey in 2005 that 79.4% of outsourcing executives said that cost was either important or very important to them. Only relationships with outsourcing companies were more important, with 82.4% of respondents citing such associations as being important or very important.[12]

Government regulations and patent expiry:

The growth of pharmaceutical contract manufacturing is also driven by strict regulatory requirements and patent expiry. "Major driver of growth in contract manufacturing organization is in bio-similar, with many high selling biologic drugs reaching patent expiry in the next few years. With the upcoming regulations for bio-similar drug approval in the EU and US, the industry needs more proficient methods for manufacturing, which is also contributing in pouring investment in contract manufacturing organizations".[13]

According to Global Opportunities Special report over the next few years the pharmaceutical industry faces an almost unprecedented severe bout of patent expiry. Drugs that contributed some 17% to world pharmaceutical sales in 2008 lose patent protection between now and 2012. These include seven out of the fifteen top-selling drugs. Most of the leading companies are affected to some extent.[14]

Moreover since obtaining approval for a new drug through the clinical phase is both expensive and highly uncertain the construction of manufacturing facility based on the anticipated marketing approval of a new drug is a hazardous and potentially very expensive business. In addition it is extremely difficult to accurately predict manufacturing capacity requirements.[15]

Advance technology and skills (access to outside expertise):

The rapid expansion of pharmaceutical industry technology became more challenging, and makes manufacturing more complex and requires high skills and advance technology. In newly emerging pharmaceutical products the challenge is to make viable commercial production possible in a reasonable time period, for which the company needs to make huge investment in order to provide advance technology and skills.

When a firm is unable to develop skills and utilise its services in their home country and which can not be acquired through other means than contract manufacturing gives an opportunity to such firm to access skills and acquire services of foreign firms and organisations.[16]

Furthermore because of the broad range of skills required to bring a novel compound to market, drug developers have always relied upon external organizations, since even the largest, most financially stable pharmaceutical companies often do not have sufficient resources to process these skills in-house. This is particularly true since ongoing cost pressure on the industry have led to cost containment initiatives and downsizing at many companies. According to a survey conducted by contract pharma in 2005 these financial pressures have led to a rising use of outsourcing. The survey found that 43% of the 200 pharma/biopharma outsourcers participating in the study had increased their use by approximately 10% over as compare to 2004.[17]

Increasing demand and growing supply to the market:

"The growth of biologics is another significant driver of CMO growth"[18]the increasing demand and growing supply of biologics has made huge contribution in outsourced manufacturing.[19]

Big pharmaceutical companies like GlaxoSmithKline and Pfizer are streamlining manufacturing and increasing investment in biologics production. These efforts will provide an opportunity for CMOs, as there is a considerable overcapacity in the marketplace which will drive substantial strength over the next few years.[20]

A few Asian pharmaceutical companies have made their name in manufacturing biological products by taking advantage of the low cost manufacturing capacity. For instance Autek Bio, Wison in China, Ranbaxy, Biocon, Intas, Kemwell, and Reliance Life Sciences in India, Celltrion, Korea Biotechnology Commercialization Centre in Korea, A-Bio, Lonza in Singapore and Development Centre for Biotechnology are big companies providing contract manufacturing services in biologics on competitive price.[21]

Pharmaceutical Company involved in international contract manufacturing; a case study of an Indian company Ranbaxy:

Indian pharmaceutical market is expanding with high speed. The market was assessed at $7,743m in 2008 which increased about 4% compare to 2007. It is predicted by business observers that the Indian Pharmaceutical market will escalate at an increasing mode as compared to the global pharmaceutical market, at a CAGR of 13.2% during the fiscal years 2009-2014 to reach an overall worth of $15,490m in 2014.[22]

Ranbaxy Laboratories Limited is an international pharmaceutical company based in India, manufacturing an extensive choice of quality, cost efficient products. The company has its business operations in 23 countries worldwide[23]and has its global footprint in 49 countries.[24]Ranbaxy provide world-class manufacturing facilities in 10 countries in coordination with its subsidiaries and other companies based in these countries Namely Brazil, China, Ireland, India, Japan, Malaysia, Nigeria, Romania, South Africa and USA. Its overseas manufacturing facilities fulfil the requirements of International Regulatory Agencies.[25]

Advantages of contract manufacturing (outsourcing):

The following are main advantages of contract manufacturing outsourcing to both, pharmaceutical companies and CMOs.

No local investment:

Ranbaxy is operating its business activities worldwide by manufacturing pharmaceutical products for its clients through contractual arrangements. Ranbaxy clients do not need to make any local investment in terms of cash, time and executive talent required for manufacturing. All they need is to enter into an agreement of manufacturing. In some cases the Ranbaxy also agree to take the responsibility of shipping, marketing and sales either in the country of manufacturing, the country of his client or in a third country.

Access to foreign resources:

Pharmaceutical companies need vast resource for producing a particular drug. When such resources are unavailable in home country than such companies will opt to go for contract manufacturing with foreign organizations overseas, where such resources are available easily and with a reasonable cost. For instance Ranbaxy provide manufacturing services to its clients worldwide, if the resources required for manufacturing a particular drug are unavailable or available at high cost than in such case these companies outsource their manufacturing services to Ranbaxy either in India or to its other subsidiaries based in other parts of the world.

Global presence:

Contract manufacturing (outsourcing) provides an opportunity for pharmaceutical companies to operate their business activities in overseas markets at a reasonable cost with minimum risk. For instance for U.S. pharmaceutical companies it is very hard and expensive to manufacture their products in their home country at a high cost of labour, technology and skill and export it to Indian market at high transportation cost, therefore these companies outsource their manufacturing process to Ranbaxy or any other CMO in India and than distribute it in Indian market through a host distributor.

On the other hand contract manufacturing also provides an opportunity for CMOs to extend their operation globally, such as Ranbaxy is enhancing its reach leveraging its competitive advantages to become a top global player.[26]The key advantage of Ranbaxy Laboratories Ltd is its global presence. The company is operating in 23 major pharmaceutical markets worldwide and serves its customers in 125 countries by providing quality pharmaceutical products. "The company aims to achieve significant business in proprietary prescription products by 2012 with a strong presence in developed markets".[27]

Cost efficiency:

Ranbaxy is manufacturing high quality pharmaceutical products for its clients on competitive price which has increased its sales in international market. For instance, "in 2008 the company's global sale was US$ 1,682, including sales of US$ 449 from North America, US$ 330 from Europe and US$ 330 from Asian market".[28]

The company has established its manufacturing facilities in many countries because the cost of supply to these countries is very high therefore it is advantageous for both Ranbaxy and its clients to have the manufacturing facilities near to its clients overseas, to avoid the excessive cost of supply in order to maintain its competitive and cost advantage in international market and provide cost efficient products to its clients.

Minimal country and political risks:

Joint Venture, Foreign Direct Investment and Licensing etc are highly exposed to country and political risk when operating their business activities in international market. In order to avoid these risks contract manufacturing (outsourcing) is the most appropriate mode of entering into an overseas market. In case if any threat arises out of country and political risk it will only affect the manufacturer, but to certain extent it may also affect the company that outsource manufacturing, which is explained in pitfalls of contract manufacturing.

Pitfalls of contract manufacturing (outsourcing):

The following are the main pitfalls associated with the contract manufacturing (outsourcing).

Potential quality issues:

It is very hard for Pharmaceutical companies to maintain control over the manufacturing quality when outsource their manufacturing facilities to a CMO that does not have sufficient expertise, this will affect the production quality and in return will damage the reputation of such CMOs in the markets where they distribute their products.[29]

On the other hand because of poor manufacturing quality CMO can suffer loss and will extremely damage its reputation in the market and may result in regulatory intervention,[30]for instance in September 2008 because of defective quality the U.S. Food and Drug Administration (FDA) banned imports of more than 30 generic drugs made by India's Ranbaxy Laboratories Ltd.[31]

Indirect impacts of country and political risks:

As mentioned earlier that Ranbaxy is operating its manufacturing facilities in different countries therefore the company would not be able to avoid any kind of risks arising out of political instability, government's policies and any force majeure acts in these countries. Such political and country risks will indirectly affect Ranbaxy clients, for instance if Ranbaxy is unable to manufacture a particular product in specified period of time because of above mentioned risks than its clients would not be able to distribute their products in the market within a required time frame and will loose its potential customers and will suffer major financial loss and may also face legal consequences.

Partner's reliability:

Contract manufacturing is based on close and reliable partnership between the pharmaceutical company that outsource its manufacturing process and CMO. In contract manufacturing it is very hard to find a reliable partner, for instance a pharmaceutical company in the U.S. outsource its products manufacturing to an Indian company Ranbaxy in such case it is very hard to trust the reliability between partners because both are from different countries subject to different rules and regulations with different cultures.

Extensive technical training:

Furthermore when a company outsource products manufacturing to CMO such company also provide an extensive technical training to the local staff of CMO to familiarise them with in-depth knowledge regarding the manufacturing of a particular drug in order to maintain the quality and other requirement of the products, such training could be very expensive, for instance a pharmaceutical company in U.S. providing training to local staff of Ranbaxy in India could be very expensive.

Nurturing future competitors:

Similarly by giving extensive technical training to local staff, contract manufacturing is directly nourishing potential competitors in future as subcontractors tend to become formidable competitors at a future date, for instance a U.S. company providing extensive technical training to Ranbaxy's staff, Ranbaxy may subsequently decide to make production for himself and distribute and sell it the local market and make more profit instead of manufacturing for an overseas company and making low profit.

Breaching confidentiality:

When a pharmaceutical firm outsource manufacturing processes to an external contractor there is a reasonable apprehension of breaching confidentiality and could pass on important confidential information to the existing rivals in the market and can give an opportunity to such rivals to enhance their production strength and gain information about the production strategy of pharmaceutical firms.[32]

Conclusion:

Contract manufacturing industry is growing with high speed. "The industry has predicted to show strong growth in its revenue, rising by an average of 13.0% per year. In 2005, the market was worth $ 31.5bn but by 2010 will account for just under $50bn".[33]

Because of speedy expansion in pharmaceutical industry contract manufacturing (outsourcing) has become an important strategy for pharmaceutical firms which allows companies to concentrate upon its core activities i.e. sales and marketing and outsource its non-core activities such as manufacturing at reduced cost.

Major drivers of growth in pharmaceutical contract manufacturing are, cost advantage, increased demand of biological production, government regulations and patent expiry and advance technology and skills etc

Finally, contract manufacturing is best option to avoid uncertainty and pitfalls associated with the pharmaceutical products manufacturing. it enables rapid product transfer, higher rate of technology changes, better investment return on continuous product and process improvement, and a systematic supply with variable demand and reduced risk of non-compliance. On the other hand it also have a number of drawbacks such as Potential quality issue, exposure to country and political risks, partner's reliability, expensive technical training and fostering future competitor.

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