Pharmaceutical fine chemicals can be broadly defined as the set of products—intermediates and finished API, or active pharmaceutical ingredients—as well as related services like process development and optimization associated with the access by pharmaceutical companies to the drug substance (API) throughout the product life cycle excluding pre-clinical development.

This definition covers products and services either in- or outsourced by pharmaceutical companies; the entire pharmaceutical product life cycle excluding discovery and pre-clinical steps; intermediates, also often referred to as building blocks having to undergo further chemical processing steps as well as finished API ready to be formulated; and both small and large molecule based products, the latter often referred to as bio-pharmaceutical.

Size of the Demand
The size of the pharmaceutical fine chemical demand is a highly controversial topic. Wide-ranging estimates reflect a combination of factors including: ill defined boundaries and scope as some definitions cover just products; and absence of reliable statistics; controversy on the impact of drug substance supply chain related costs associated with the access to the drug substance; and extreme fragmentation of the customer as well as the supply structure.

Based on a combined bottom and top down approach, the total pharmaceutical demand can be tentatively estimated in the order of $80 billion, roughly corresponding to 8-9% of total pharmaceutical sales as reported at the manufacturer level.

Obviously the impact of pharmaceutical fine chemical costs as a percentage of formulated drugs sales differs depending on the segment considered. This ranges from an estimated 3% for OTC (over-the-counter) formulation to 25% for generics sold in emerging markets, reflecting widely different cost structures, the drug substance accounting for an estimated percentage of manufacturer prices: 10% for generics sold in Western markets; 5% for Rx (prescription) pharmaceuticals still under patent protection.

Out of this $80 billion pharmaceutical fine chemical demand is about 10% for large molecules—also referred to as biopharmaceuticals—with the remaining 90% being associated with small molecules obtained through organic synthesis, extraction or microbial fermentation.

Services associated with process development can be estimated to a value of about $5 billion—the remaining $75 billion being for full scale supply related activities.

An estimated 50% of this $80 billion total pharmaceutical fine chemical demand is believed to be outsourced by pharmaceutical companies to third party vendors corresponding to a merchant market of $40 billion.

This merchant market is expected to grow in real terms at around 5% per annum and well above projected GDP growth driven by a combination of factors. These include:

• Steady growth of pharmaceutical demand contributing for 4% per annum volume growth reflecting in the West graying of the population with as a corollary increasing pro-capita pharmaceutical consumption. While in Africa, Asia and Latin America, also referred to as emerging markets, tail wind favoring demand growth will include advances in health care standards and purchasing power.
• Steadily increasing share of pharmaceutical fine chemical outsourcing contributing for 2-3% per annum reflecting a trend amongst pharmaceutical companies to farm-out to specialized third party vendors parts if not their entire pharmaceutical fine chemical requirements. This trend is fueled by different drivers including the increasing share of NME (new molecular entities) developed by emerging pharmaceutical companies applying virtual supply chain models as having little if any own pharmaceutical fine chemical related capabilities.

Also, the reduced emphasis of established pharmaceutical companies on backward integration in the full scale production of their drug substance requirements, an activity increasingly viewed to contribute little to competitive edge while highly capital intensive.
Part of this growth will be offset by continuing unit price erosion reflecting both leverage applied by customers on their suppliers as well as move towards the maturity/ageing phase in their life cycle of products.

Competitive Dynamics
A salient characteristic of the pharmaceutical fine chemical industry is represented by its extreme fragmentation in terms of its slate of offerings covered. This includes both products and services, intermediates as well as finished API, custom made and catalogue products, not to mention items at different stages of their life cycle spanning from early clinical development, commercial launch, maturity and eventually sun-set, the total number of products being well in excess of ten thousand.

The customer base is also fragmented. Covering pharmaceutical majors like Pfizer or GSK farming out part of their pharmaceutical requirements as well as emerging pharmaceutical companies having none of their own pharmaceutical fine chemical related assets, generic pharmaceutical companies also being an important customer group.

In terms of supply structure, the number of vendors offering pharmaceutical fine chemicals stands well in excess of five hundred and comprises industry majors like Lonza with sales north of $1 billion to smaller players such as Helsinn Advanced Synthesis. The high degree of fragmentation of the pharmaceutical fine chemicals supply structure can be illustrated by a combined market share for the top largest vendors not exceeding 15 to 20%.

This extreme diversity makes generalizations of the pharmaceutical fine chemicals scene difficult if not even pointless as each product/service often corresponds to a distinct situation characterized by its own dynamics.

From a high level strategic perspective three product centric segments can be identified in the pharmaceutical fine chemical space.
“Ever green” large volume API such as acetylsalicylic acid, ibuprofen, paracetamol or 5-aminosalicylic acid produced at the thousand of ton scale are characterized by very long life cycles while commanding prices rarely exceeding $20-25 Kg and most often produced in dedicated highly automated units.

Niche types of API involving in their production of some special type of capabilities in terms of hardware. See the example of highly potent substances whose handling requires high containment facilities, know-how in some distinctive synthesis technologies such as biopharmaceuticals, peptides or steroids, licensing permits as it is the case of controlled substances. Volume and price ranges for niche type API can vary widely spanning from gr/kg for most prostaglandins to tens if not hundred of tons in the case of some steroids.

In-between API covering by default all other products, these share as their main characteristic to be accessible through the use of multipurpose equipment and to involve generalist synthesis skills.

In terms of the supplier slate there are five main models of vendors having different approaches to the market.

Technology/niche specialists whose value proposition revolves around distinctive focus is on selected chemistries and/or types of products involving special technologies such as tide (peptide and oligonucleotide) synthesis or high potency substances like cytotoxics. Most often they are extensively backward integrated performing in-house all synthesis steps starting from base intermediates. Archetypes of such model of players include Bachem in peptides or Umicore in platinum based anticancers.

Relationship managers, whose business model is to position themselves as the fine chemical supply arm of pharmaceutical companies eager to outsource part if not their entire drug substance requirements. Most often relationship managers offer supply services covering the entire product life cycle spanning from early phase to full scale supply provided on a custom, one-to-one basis. Most often they do not have a particular emphasis on any chemistry, rather positioning themselves a generalist molecule builders. Examples of such type of vendors include CML, FIS, Hovione and Lonza.

Opportunist-street smart vendors focus is mainly on off-patent API falling in the in-between category. Their business model revolves around ability to seize emerging opportunities as an example taking advantage of patent expiries and being amongst the first on the market, a key skill being to continuously rejuvenate their product portfolio. To achieve this they operate multipurpose synthesis capacity able to handle most chemistries and they excell in swiftly developing synthesis processes that while adroitly circumventing patents can be implemented in standard hardware and start from readily available advanced intermediates, performing in-house only the last couple of synthesis steps—a key to maintain the required high levels of flexibility. Examples of such model of player include Sifavitor—part of the Infa Group—or Chemo.

Asian players, mostly located in China and India, whose value proposition is largely revolving around their reported lower cost position. The focus of this set of vendors is mainly on off-patent API for the generic market. Contrary to earlier predictions, their involvement in custom made products remains modest if not even marginal, reflecting both a rapidly escalating cost structure often making savings achievable through these sources rather questionable as well as supply reliability concerns also fueled by the high profile regulatory set backs suffered by some players.

Industry Drivers
While the growth outlook remains promising for pharmaceutical fine chemical demand, players active in this field continue to face a number of challenges.

One is an escalating cost base associated with elements such as ever increasing compliance requirements as well as tighter operating hurdles. While justifiable from a societal perspective as contributing to environmental and consumer protection, these development swell non-production related costs and also lead to inflating the investment base.

Leverage applied by customers is another issue as pharmaceutical companies invariably try to extract pricing concessions while continuing to ask more from their vendors. The tactics applied include systematically putting various vendors in competition for every piece of business as well as simply exerting buying power. The customer vendor balance of power in pharmaceutical fine chemicals leans most often overwhelmingly in the disadvantage of the latter.

Demand patterns for the offerings provided are becoming increasingly difficult to predict in terms of elements such as ramp-up time and/or volumes at steady state reflecting the growing volatility and uncertainty facing the life cycle of pharmaceutical products. Witness late development failures, delays in registration, smaller than expected market or shorter IP protection periods. This obviously has detrimental implications on the vendors ability to plan with any degree of accuracy future cash flows. This is not an insignificant issue in a capital intensive industry like pharmaceutical fine chemicals, also characterized by long lead times.
These challenges are by no mean insignificant as they are threatening the future viability of several vendors.

In fact it may be argued that a shake out of the pharmaceutical fine chemical supply structure is long overdue. A factor having delayed this being represented by the combination of questionable scope for economies of scale and the ownership of a large number players by patient capital including family shareholders.

However the law of gravity can be expected to take its toll on both these two factors as an escalating fixed cost base provides for an increasing need for scale and size in order to ensure adequate coverage. The growing revenue unpredictability combined with a consolidating customer base also pushing in such a direction as allowing to reduce dependency issues on a main product and/or customer.

At the same time owners become more rationale in allocating their funds and demand from their investments returns commensurate with the risks incurred and in line with those achieved in other sectors.

Does this mean that the pharmaceutical fine chemicals industry is heading towards a massive consolidation?

Probably not as the competitive advantage provided by scale and size per se is and is most likely to continue to remain limited and counterbalanced by the need to maintain high levels of flexibility and customer centric approaches to the market easier achieved by smaller players having nimbler and flatter organizations than by industry giants.

However at the same time successful players will need also to show several traits including discipline in their investments decisions. Ensuring that the free cash flows generated by the business reach levels corresponding to acceptable risk adjusted returns on capital investments.

Also important is the ability to assemble a balanced customer and product portfolio preventing any over-dependency issue, a key from a risk management perspective.

Acumen in formulating crisp value propositions providing a sustainable differentiation compared to the other vendors is another highly valued trait.

Lastly, there needs to be a commitment to relentless operational excellence and continuously improving performance, with gilt situations being the exception more than the rule in pharmaceutical fine chemicals. 

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Dr. Enrico T. Polastro is a vice president and senior industry specialist of the Global Pharmaceutical and Fine Chemicals practice of Arthur D. Little. He can be reached at polastro.enrico@adlittle.com.