The Evolution of Contract Research Organizations

by Jeffrey Stafford

The Drug Development Process: What Do CROs Do?

Drug development, the task pharmaceutical companies most often outsource to CROs, is divided into two phases: preclinical and clinical. During preclinical development, new compounds are analyzed in test tubes and in laboratory animals for safety and efficacy. After the preclinical phase is complete (generally one to three years), testing moves into human subjects, also known as the clinical development stage. In the United States, the bulk of in-human clinical work is divided into three phases. Phase I involves testing for safety in approximately 20 to 100 healthy volunteers. In Phase II, a pool of 100 to 500 volunteers suffering from the specific disease target is tested over a period of a year or longer. During Phase III, several thousand people are tested to verify efficacy and long-term safety on a larger scale. Most CROs specialize in either early-stage (preclinical and Phase I trails) or late-stage development (Phase II-III trials). Drugmakers spend billions of dollars per year attempting to discover the next blockbuster drugs, with the vast majority of potential compounds failing to reach the consumer. In fact, the Pharmaceutical Research and Manufacturers of America estimates that a pool of 10,000 potential compounds produces only one FDA approved drug on average. Furthermore, the process is very time consuming with an average development period of about 15 years. As we will explain in more depth, drug companies outsource development work for a variety of reasons, such as temporary or permanent lack of capacity or infrastructure and to focus on core competencies.
Early History of Contract Research

For decades, biopharmaceutical companies have enlisted outside parties to assist in the drug development process. Prior to the contract research organization boom, academic institutions and independent laboratories handled the bulk of outsourced drug development work. In 1962, regulatory scrutiny on the development process increased when Congress passed the Kefauver-Harris amendments, requiring drug manufacturers to prove efficacy before marketing a new product. The new law also took steps to ensure greater safety. Burdened by a greater workload, drug companies began to outsource additional studies that couldnt be handled internally. Private firms sprouted up to help pharmaceutical companies manage these new challenges, which included more complex clinical trial work to gather data for submission to the Food and Drug Administration. During this period, drug companies only let clinical development pass outside their own walls when internal capacity was temporarily constrained. Large firms operated with a vertically integrated model that kept nearly every step of the process in-house. Development outsourcing in this mold continued through the 1980s, with several of todays major players in outsourced clinical trial management starting operations, including Parexel International PRXL (FV: $21) in 1983 and Pharmaceutical Product Development PPDI (FV: $42) in 1985.
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Research & Development Productivity

40 32 24 16 8 0

40($Bil) 32 24 16 8 0 93 94 95 96 97 98 99 00 01 02 03 04

200 160 120 80 40 0

R&D Expenditures

Total NDA Submissions

NDA for NME Submissions

12 10

Source: Study by the United States Government Accountability Office: New Drug Development, November 2006.

Beginning in the 1990s, the dynamics between the CRO and pharmaceutical industries began to change. 8 Pressured by declining research and development productivity and the looming loss of patent exclusivity 6 for a number of blockbuster drugs, big pharma was faced with higher future expenses to replace its 4 current revenue stream. Although the total dollars spent on research and development by drug companies 2 continued to climb, the number of new drugs submitted for approval by the FDA was not keeping pace. 0 According to a report by the United States Government Accountability Office, annual inflation-adjusted R&D expenses increased from nearly $16 billion to nearly $40 billion from 1993 to 2004, an increase of 147%. However, the number of new drug applications for new molecular entities increased only 7% over the same time period. The CRO industry offered a compelling solution for big pharma. By giving a larger portion of their noncritical studies to CROs, pharmaceutical firms were able to lower their development costs, as CROs paid lower salaries than in-house pharma departments. CROs also gave pharma companies the opportunity to turn a portion of fixed development costs into variable costs by shifting studies offsite. With heightened demand from drug companies, CRO industry revenues began to take off. Global industry revenue increased to $7.7 billion in 2001 from $1.6 billion in 1993, a compounded annual growth rate of nearly 22% over the period. To accommodate growing demand, CROs added infrastructure, personnel, and service capabilities. For example, employee headcount at Covance CVD (FV: $74) ballooned to 7,900 by the end of 2000 from 5,400 at the end of 1996. Significant industry consolidation also occurred, as CROs armed with strong valuations and newfound cash needed to expand rapidly to meet demand. Large CROs expanded into nontraditional areas, such as post-approval services, and used acquisitions to fill therapeutic and functional holes. In 1998 and 1999 alone, CROs acquired 39 smaller competitors in total (CenterWatch). To the chagrin of drugmakers, rapid CRO growth and the integration of newly acquired companies led to quality issues, straining the industrys already delicate relationship with large pharmaceutical firms. During the consolidation period, a Covance insider compared integrating newly acquired companies to changing tires at 80 miles per hour (Bridging the Gap, Lamb). Failed trials and the mishandling of some projects made pharmaceutical firms weary of handing over important projects to CROs. In one of the more notable cases of quality deficiency, Bloomberg News exposed SFBC International, now
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part of PharmaNet PDGI, for its lack of patient safety in a 2005 article. Bloomberg outlined numerous inadequate quality controls at SFBC and questioned the strength of regulatory bodies paid to monitor trials. Stories like this are a prime example of the reasons many CROs still lacked the trust of big pharma.
Biotech Surge & Relationship Building

Despite heightened interest, big pharma was still not ready to fully jump into bed with CROs. Intellectual property, quality, and productivity concerns all remained at the turn of the century. Two trends helped drive the gradual acceptance of the major CROs: the surge of the biotechnology industry and preferred provider lists. Fueled by a bolus of scientific breakthroughs, a rash of venture capital funding, and the maturing of the industry, biotechnology firms began to take off in the late 1990s. Mapping of the human genome gave biotech firms a blueprint to create new and exciting treatments. Moreover, newly introduced biologics, such Genentechs DNA (FV: $91) Herceptin, were gaining steam in the market. While large companies like Genentech and Amgen AMGN (FV: $71) had been successful for some time, many smaller biotech firms were just beginning to turn a profit developing new drugs (CNNMoney). This wave of drug development meant the prospect of more preclinical and clinical studies. However, these newly successful companies often lacked the internal resources, personnel, and expertise necessary to conduct clinical trials. Without the required infrastructure, biotech firms relied on CROs to conduct much of the preclinical and clinical development work related to new candidates. As CROs conducted more and more work for biotech firms, solid relationships developed between each industry. During this period, CROs proved capable of handling important drug studies. Also, biotech customers diversified the revenue base of CROs, decreasing the impact of cancellations from big pharma clients. For example, PPDs composition of revenue changed from 72% pharma and 19% biotech in 2002 to 56% pharma and 31% biotech in the third quarter of 2008. In addition to building relationships with biotech companies, CROs were also slowly gaining the trust of large pharmaceutical companies through the use of preferred provider lists. Big pharma realized that using a large number of CROs was inefficient and didnt allow for strong relationships to form between sponsor and CRO. As a result, pharmaceutical firms began whittling down the number of CROs used for outsourcing until the companies were left with a handful of preferred providers. Only the most reputable and capable CROs made these lists, driving even more business to the top echelon of the industry, and separating the Covances and PPDs of the world from their smaller competitors. As drug company sponsors and CROs worked more closely together on more projects, a level of trust was fostered. Moreover, making a preferred list gave big CRO players more confidence to increase capacity and invest in additional infrastructure. K
This article originally appeared in Morningstar HealthcareObserver (January 2009). To learn more, visit http://healthcare.morningstar.com

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