• Reduction in the time spent in development;
• Improvement in the number of hits coming out of screening;
• Increase the conversion rate of hits to leads;
• Expansion of the number of high quality compounds; and
• Earlier elimination of compounds that will eventually fail.

Achieving any one of these objectives would mean millions of dollars in cost savings and additional revenues for the pharmaceutical company involved. The question remains: how can this be accomplished?

The Outsourcing Answer
The development and testing phases of the drug pipeline are no stranger to outsourcing solutions. Contract research is a maturing industry sector, and there are more than 1,000 CROs in the U.S. and Europe. The top 10 account for approximately 40% of industry sales. However, CROs have been focused on drug development and clinical trials support, where they can effectively speed drugs to market. Earlier stages of the pipeline—drug discovery and various preclinical development tasks—have not traditionally been outsourced. This is changing.

Changing Attitudes at Big Pharma
Since the 1990s, pharmaceutical companies have fallen into the “bigger is better” trap. If a compound library of 500,000 is good, a library of 5,000,000 must be better! If screening 1,000 compounds per day is good, screening 100,000 must be better! If spending $200 million on discovery doesn’t do the job, let’s spend $500 million! The net result has been a sharp increase in the money spent and data generated, but without much improvement in results.

During the past few years, the mantra has changed to, “Quality counts; work smarter, not harder.” More emphasis is being placed on high content screening, not just high throughput screening. Now companies are interested in building focused libraries, not just expanding the size of their existing libraries. There is also an increased willingness to hedge bets. There is no one “super solution” for drug discovery, so it makes sense to explore as many possibilities as are feasible.

The other major change in attitude is Big Pharma’s willingness to use outside suppliers earlier in the discovery process. As noted, pharmaceutical companies have been using outsourcing services in development and manufacturing for years, but they’ve kept their early stage drug discovery programs in house. There are many reasons for this. Two major factors have been proprietary turf issues for in-house R&D personnel and concerns about secrecy and confidentiality. These attitudes can no longer be justified. There is now widespread understanding that outsourcing in drug discovery is not just an option, but a necessity.

There are five major reasons for this shift in attitude:

• Most drugs marketed today were not discovered in house;
• The impact of genomics and proteomics has increased the numbers of targets;
• New discovery techniques are breaking too fast to master them all;
• It can be faster and cheaper to do discovery work outside; and
• Building outsourcing into an R&D plan pays off in major dividends.

The question in outsourcing for drug discovery is no longer: “Yes or no?” It has become: “How much and with whom?” Most major pharmaceutical companies now recognize that outsourcing is a crucial part of their business; they can no longer afford to do it all themselves. There are several immediate benefits a drug company can reap from outsourcing in these early stages:

• Divert time-consuming tasks; let scientists focus on higher priority activities;
• Provide an external buffer to handle an increased number of new programs;
• Defer internal increases in headcount and expenses;
• Provide access to a larger and more diverse set of skills; and
• Incorporate technologies not available at company site.

If executed properly, outsourced services can become an integral part of the company’s R&D operations. They’re just as crucial to future success as internal projects are.

Dawning Realities at Biotech Companies
While these things were changing at Big Pharma, there were also major changes taking place on the biotech landscape. After the boomlet of 2000, there was a crash in the biotech markets. The number of IPOs fell from 40 in 2000 to just three in 2002. Biotechs were getting hammered on Wall Street, as great expectations were replaced by slow developments. Biotechs needed new funds to stay alive. This is why many are actively promoting the sale of their services. We estimate that 90% of biotech revenues come from outsourcing, alliances and partnerships.

A biotech start-up with a hot new technology could create a lot of interest among Pharma customers by offering new compounds, faster screening, better protein characterization, or a range of things that were not previously available. The client could buy in for a modest price, check out the goods, and make additional investments if the biotech delivered as promised.

From the standpoint of the biotech supplier, outsourcing contracts are just as vital. First and foremost, they provide immediate revenue to pay for current operations. Just as important is the credibility that an alliance provides. The fact that a major pharma has invested in its technology adds status to the biotech supplier. This increases the value of the biotech stock if it has already gone public, or its ability to attract venture investors if it has not.

If structured properly, the biotech can expand its technology expertise and management skills as a result of cooperation with the client. Down the road, these relationships could lead to milestone payments and royalties, or even to acquisition of the biotech by its corporate partner.

A Growing Market
The breadth of product and service offerings in this emerging market make definitions difficult, but in a market study conducted in the first half of 2003 and published under the title Outsourcing in Drug Discovery, Kalorama Information developed a scheme for understanding the areas of competition within drug discovery before the drug development phase occurs. As pictured in Figure 1, drug discovery in the Kalorama study is defined as the steps from determining a target to lead optimization and ADME/Toxicology, but before the preclinical in vivo testing that has traditionally been the province of the larger contract research organizations.

Within the discovery area, we further subdivided the market into four areas of technical expertise (see Figure 2): biology, chemistry, screening and lead optimization. Some competitors such as Millennium or Icos compete in all of these areas, offering so-called end-to-end discovery solutions, while others focus on one specific task, such as deCode in genomics and early target identification. Currently, the fastest growing area of discovery outsourcing is biology, according to our findings, but changes in the state of play are about the only thing that is constant in this emerging market. Rapid growth in the biology sector reflects the current hunger for drug pipeline. The other later areas of research—chemistry, assay development, ADME/T—will, in the coming years, also see strong growth as companies need more and more capacity to accommodate the boom in targets.

We estimate that the market for outsourcing in drug discovery as a whole stands at approximately $3.2 billion. According to our forecasts, the market will move forward at a 15% to 20% growth rate to almost $6.0 billion by 2007. The top 10 competitors in the space currently account for approximately 30% of the market, or an estimated $837 million (see Figure 3).

Complexity and Competition In the Years Ahead
“Outsourcing,” as readers of this publication know, is a very generic term that describes a wide range of relationships between a client/customer and a service provider. From simplest to most complex, these include:

• Product Purchase;
• Service Contracts;
• R&D Partnerships;
• Collaborative Agreements;
• Milestones & Royalties;
• Equity Participation; and
• Company Acquisition.

As you move up the scale, the complexity of the deal and the amount of interaction between client and provider increase. In some Big Pharma companies, all these relationships are managed by a centralized staff or department. In other companies, different organizational groups are involved with different aspects of relationships. Regardless of how these responsibilities are divided, it is important that the company have a coherent strategy for the management of services provided by outside vendors.

Traditionally, most outsourcing alliances have been done at later stages of drug development. In 2000, it was estimated that 67% of these alliances were for work in Phase I, II, or III, and only 33% in preclinical. To optimize drug development, more early stage deals need to be done. According to the consulting group McKinsey & Co., 85% of the alliances should be done in preclinical areas. This is another positive indicator for future growth in drug discovery outsourcing.

The number of deals being done has grown dramatically during the past decade. In 1991, there were only three deals done that were valued at more than $20 million.

In 1997, this number had grown to 45. The number of Big Pharma companies competing to do a given deal has also increased from an average of two companies per deal in 1995 to more than six companies in 2000. Biotechs with highly valued services to provide are taking advantage of this competition by doing more non-exclusive deals. Pharmas need to take into account how best to leverage these deals when their rivals are also involved in the action.

This has created a new dynamic in drug discovery alliances—one that may be unfamiliar to many of the old hands in the industry. In the past, it was one pharma and its biotech partners vs. another pharma and its biotechs. Now the more likely scenario is one group of companies vs. another group. Alliances are no longer like monogamous marriages; it’s now OK to “play around.” Group dynamics need to be carefully considered, and it is vitally important for suppliers to select the right position within the group so that the structure and design of the group dynamics work in their favor.

Other concerns that make this new complex partnering environment so tricky are matters of corporate culture and style. Big Pharma companies have found an excellent match in some of the major CROs, but when it comes to partnering with young, innovative, entrepreneurial technology suppliers, there can be conflict. It is important to consider the management style of your prospective partner now more than ever. A company with a formal, centralized style of operations is not a good match for one that is casual and decentralized in its approach.

It’s also important to understand the underlying business policy of your company, regarding partnering. Some experts argue for a “top-down” approach to outsourcing strategy. They believe that top-level commitment is required to make alliances succeed. Upper management is the only place where all lines of responsibility converge. After strategies are defined and technology needs identified, partners are selected. The next step is effective alliance management. Some Big Pharmas are very good at this, while others have had problems.

A common mistake is not allocating enough resources to the alliance management function, both in terms of money and people. It makes sense that, if 40% of the growth of your organization comes from the alliances you develop, you should commit 40% of your resources to achieve success. Good alliances are built over time and depend on effective communications and interpersonal relationships. As outsourcing continues to grow in importance, expect companies to increase their capabilities in alliance management.

So, the stage is set for an active market: eager sellers, motivated buyers, and a wide range of products to choose from. The environment could not be more conducive to robust alliance formation, but the pitfalls of mismanagement and inadequate strategic positioning will definitely separate the winners from the losers in this emerging area of pharmaceutical contract work.