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Pricing high value API products in the pharma CDMO industry. Trickier than it sounds

What is the right price to quote in order to win the business but at the same time secure profitability and avoid future surprises for our CDMO business? This is a question that probably everyone that has to provide a price for a new RFQ (Request for Quotation) has to answer.

This is not an easy question to be answered and this is because there are many ways to approach the matter, as well as different considerations that need to be thought of. But when it comes to high value API products (or expensive materials in general) pricing decision becomes more and more tricky.

According to Fuliginous Management Consulting there are 3 elements to consider before you decide what is the right price for a specific product. To increase the probability of getting the business with the highest possible profitability, all three elements should be combined.

  • Cost Plus (where a profit % is added to the cost)
  • Market Minus (what is the customer willing to pay for the specific product)
  • Competition (what other CDMOs offer for the same product or type of products)

The first one is the easiest to apply because the only thing that someone has to do is to add on the total cost of the product a predefined by the top management profit %. If for example the guidelines are to have profit of 30% for every new product, the pricing for the new product will be based on this.

But if the other two parameters are neglected then we might leave value on the table or our price might be too high and thus the probability of success will be low. So, define what the customer is willing to pay should somehow be estimated and there are different ways to do so. One way is to find the price of the product in the market of interest and calculate a profit for your customer which you think it will be satisfactory for them. Another way is to see what prices you have quoted in the past for similar products (API, technology, customer type etc) and have made it to production.

Coming to what competition is offering for similar products is very difficult to know and this is because you never know what strategy each CDMO applies. Consider that there are 2 CDMOs that compete for the same product in an RFQ process from a customer that is very promising and asks for a full cost price. The product is a 50 mg tablet and has a high API cost (lets assume 5000 euros per kg). This means that the cost of the API per tablet is 0.25 (250 per 1000’s tabs), while the remaining cost of the product is an average one (lets consider 20 euros per 1000’s tabs), similar to both CDMOs. Lets also consider that both CDMOs want to have 30% profit, but the difference between the two is that first CDMO applies a profit % on the total cost, while the second CDMO does not ask for profit from the API (he just adds some working capital cost and some production losses assumed combined at 10% of the API cost) and adds 30% profit on the remaining of the costs.

It is clear that the prices of the two CDMOs will be totally different. The price of the first CDMO will be 386 euros per 1000’s tabs while the price of the second CDMO will be around 306 per 1000’s tabs. If we assume that the annual volume is 10 million tablets the annual difference in the spend is 800K euros. If the annual volume is bigger, then the annual difference between the two CDMOs will be even greater.

Of course profitability of each CDMO will be very different. In the first case will be 30% (1.1 million euros per year for the 10 million tabs) and in the second case 12% (360K euros for the same annual volume).

If everything else is the same between the two CDMOs, the customer will most probably select the second one, since  the price of the first CDMO is 26% more expensive. The customer might also form the impression that the first CDMO is an expensive one in general, and this impression could lead in excluding this CDMO from future quotations.

But now consider the following situation. Two years later, when the transfer is completed and the product is into production in the second CDMO, something goes wrong, and a batch fails and needs to be destroyed or recalled due to fault of the CDMO. I wouldn’t want to be in the shoes of the CFO asking for the impact on profitability. Assuming 4 batches per year to produce the full volume, the annual revenue of the CDMO will be around 3 million euros and annual profitability as seen above 360K euros. The cost of the API per year is 2.5 million euros and since 1 of the 4 annual batches needs to be destroyed, the CDMO will have to pay from its pocket 625K euros. (annual cost of the API dived by 4). This is the profitability of almost 2 years, meaning that the CDMO will have to produce the next two years with zero profit in order to pay for the damage.

If the same happened in the first CDMO, with annual profit from this business of 1.1 million euros, the damage would be of course smaller. (Profitability would be decreased of course but the product would still be profitable in annual terms).

This brings to the table a dilemma. Which is the best pricing decision to make when quoting for high value API products? The one of the first or the second CDMO? Of course, there will be those arguing that adding 30% profit to the total business makes sense but on the other hand if there is competition who does not apply profit on materials, probably, business like this will never be won in the first place.

Is there a magic solution? Can someone guarantee that a batch will never fail? Mitigating such risk is necessary and certain actions can be taken, like increasing the quality level, strictly monitoring of processes, insurance for the API, etc, but if you were on the shoes of these two CDMOs, what would you do? Aiming for the new business from the promising customer or aiming for the peace of mind but decreasing the probability of getting the business?

It might depend on how much each CDMO wants to win the business and tolerance towards risk each CDMO has. It might also depend on the confidence each CDMO has in itself or even the financial security of each CDMO. And it definitely depends on the CDMO’s strategy for growth going forward. Furthermore, if a CDMO is already familiar with the product and its difficulty to produce, this might also help them taking the right decision. Finally, of course, it is also a matter of profitability measurement. On one hand there are CDMOs who set targets on profitability for new business considering their full cost including API and on the other hand there are CDMOs that measure their profitability as contribution on conversion (meaning profit expressed as part of the direct labour cost, where materials don’t affect profitability) and there are others in the between that add profit on materials but not as much as they do on their conversion cost.

But there are CDMOs which might not even think of such dilemma when quoting. These might be the ones with products with low-cost materials in their existing portfolio which may have not encountered such dilemmas in the past. There are also pharma companies cooperating with CDMOs that might not understand why offers received from two CDMOs for the same product can be so different.

This article hopes to give some food for thought to different stakeholders. Operating in the CDMO industry is not always easy and if pharma companies cooperating with CDMOs put themselves in the shoes of the first, cooperation will be easier. The same is true the other way around, putting yourself in the shoes of pharma companies builds stronger partnerships.

Being transparent also helps. If I was in the position of the first CDMO in the above example, I wouldn’t just provide a high price letting the customer make its own assumptions behind the reason. I would explain the rationale behind the decision, and although this might not be enough to win the business, it might not close the door to the customer for future RFQs. Likewise, if I was the customer in the above example, I would provide feedback to the first CDMO for its price (by the way this in not always done by pharma companies towards CDMOs) opening the discussion, and this might change the impression about the general competitiveness of the specific CDMO.

One thing is certain. Quoting for a new RFQ with high API value in the CDMO industry is trickier than it sounds.