Outsourcing Outlook

Riding the Wave

Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, info@pharmsource.com, www.pharmsource.com

The pharmaceutical outsourcing industry is well into its second year of very strong growth, and indications appear that it will enjoy a healthy third year as well. Most publicly traded CROs and CMOs enjoyed revenue growth exceeding 10% in the first half of the year and announced even greater profit increases. Among contractors that participated in the 2005 PharmSource–Pharmaceutical Technology1 outsourcing survey—including a large portion of private companies that don't report publicly—more than 60% said their revenues will increase 10% or more in 2005. More than a quarter of the companies surveyed expect their revenues will increase more than 20%. Half of pharmaceutical company respondents said their contract services spending will grow 10% or more this year. The prospects for 2006 look positive as well. Pharmaceutical company respondents to the PharmSource–Pharmaceutical Technology outsourcing survey expect that contract services spending will grow in 2006 at the same rate as 2005. In the meantime, major CROs are building record backlogs of future studies to be conducted over the next 2–3 years. In the midst of this good fortune, CRO and CMO executives must ask themselves: Are we enjoying a periodic upswing in the business cycle, or are we benefiting from a fundamental and long-term shift in how pharmaceutical companies do business? The answer will have a big effect on how they run their operations and the kind of investments they make in coming months. Determining whether we are at a high point in a business cycle is a tough call because the pharmaceutical contract services industry is too young to track its business cycles. Certainly, the last 10 years have had some cyclical characteristics including a relative strength in the second half of the 1990s, a slowdown during the 2000–2003 period, and an upswing over the past two years. This contract services cycle has been closely correlated with two other industry developments that also tend to be cyclical: the strength of the new product pipeline and the availability of funding for early-stage companies. These cycles turned up in 2003, and the contract services industry improved in lockstep. But now, the cycles are giving mixed messages. After a strong run in 2003–2004, funding for early-stage companies has dropped in 2005. According to statistics compiled by Dow Jones VentureOne, the first quarter of 2005 saw the second lowest volume of venture capital flowing into biopharmaceutical companies in nearly five years. In addition, the window of opportunity for initial public offerings closed in the first quarter after having been open from late 2003 through 2004. The soft financing environment comes at a critical time. Venture-backed companies must raise new money every 18–24 months, so companies that raised money in 2003 and 2004 must now replenish those funds. Early-stage companies spend what they raise quickly and outsource a high percentage of what they spend, so their funding problems could hurt the CRO and CMO industry in coming months. The news is much better regarding the new product pipeline. The flow of new candidates appears to be very healthy, judging by the number of candidates reported in various pipeline databases and the pronouncements of pharmaceutical executives about the improving yields of their research and development programs. Further evidence that the demand is strong include the lengthening lead times for booking preclinical and Phase I research capacity at CROs, and the mounting backlogs for Phase II/III studies. The robust pipeline is a function of maturing science and re-engineered organizational processes. These  structural improvements should have long-term positive implications for contract services, because they can provide a steady flow of new candidates for years to come. A financing shortage could hurt the flow of candidates coming from small companies, however. (continued)