Pricing in the Pharmaceutical CDMO environment

Outsourcing the manufacturing of a product comes at a price. Sometimes metaphorically but always literally. What is the right price to pay to outsource your product? Who decides the price? Is it the CDMO who sells or the pharma company who buys? At the end of the day which factors affect pricing in the pharmaceutical CDMO environment?First things first. Price is different than cost and although sometimes they are related, it happens very often that they are not. This article tries to explain why this may happen and give some food for thought for different parameters affecting the price that a CDMO charges (or the pharma company pays to outsource the product).There are two perspectives of this topic. First is the angle of the CDMO and then there is this of the pharma company who outsources. Let’s start with the first one. When a CDMO offers a price for a product, probably the first parameter that considers is its cost. What is the cost of materials, the direct cost, the fixed cost etc. It is not uncommon that this is the only parameter that CDMOs take into consideration and this is what I call Cost Plus pricing strategy, where a cost is calculated and then a specific margin is put on top in order to calculate what price to offer. This is the easy but at the same time more simplistic approach, which sometimes leaves some money (value) on the table or in other cases may lead to rejection of the offer due to uncompetitive price. This is because the Cost Plus pricing strategy does not take into account market related factors.

Market related factors include what competition offers for the same product but also what the customer (the pharmaceutical company which outsources) is willing to pay for the specific product. It is the combination of three elements that should, in my opinion, be considered when a CDMO offers a price. CDMO’s internal parameters, Competition and Customer’s willingness to pay.

CDMO’s internal parameters should not include only cost related factors. There is so much more than the cost that should be considered. It was some years ago when I was about to propose a price to a customer which asked for a price without API. It was a low annual volume product (couple of batches per year), difficult to produce and API would be provided by the customer free of charge. During a meeting where we would discuss what price to offer, the CCO asked the question. What is the Value of the API? Since the API price would be provided free of charge, nobody had bothered to evaluate what was its cost. But it turned out to be that this was a crucial point because the API value finally was double than the value of the remaining batch cost. What would happen if a batch failed due to CDMO’s fault? It was calculated that if the CDMO had to pay for the value of one rejected batch, this would mean that not only the profit of one year would be evaporated but also CDMO would run at a loss. It doesn’t matter what finally was decided in the specific example. It feels to me that this is a nice example explaining that cost should not be the only parameter that should be considered when a price is about to be offered to the customer.

But of course, there are more. Free available capacity, difficulty of manufacturing the product, complexity, expectations of more business from the specific customer are some of the internal parameters that should be considered. It maybe the case that the CDMO charges a premium for a product that is difficult to manufacture, especially if competitors cannot cope with it. Similarly, if free capacity is limited, maybe it makes sense to charge a premium for giving away this limited free capacity. On the contrary, if the specific project is a door opener for a new promising customer, then it might be wise to consider sacrificing part of the margin, in order to bring the customer in. This of course is related to the strategy of each CDMO. Some have a growth strategy, for some others next year’s EBITDA is more important.

It is not the scope of this article to go into details. It is to give some food for thought and therefore further elaboration of internal CDMO’s parameters will be avoided. And this gets us to Market related factors.

Since what price competition is offering for similar products is difficult to know, unless maybe you ask for external advice, lets jump to what the customer is willing to pay for the specific product. CDMOs should, in my opinion, put themselves in the shoes of their customers for a while.

Is the customer willing to pay more because the CDMO has limited free capacity? Does the customer care if the CDMO has a growth or an EBITDA related strategy? Probably not, but maybe a difficult manufacturing process plays a role in the price that pharmaceutical companies are willing to pay. Of course there are more important parameters that the latter consider when deciding on what is a fair price to pay. The most important of which is what margin this price (which is a cost for the customer) leaves them on the table. And this is where it starts to get difficult for the CDMO. Defining what is the margin of the customer, letting alone what margin is enough for their customers might be seen as a long shot. Nevertheless, there are some ways to approach it. And the closer they get, the better the chances are for defining the right price for the product.

Is it the same if a product is a commodity like generic paracetamol tablets as if the product is an innovative lyophilized vial, patent protected? Manufacturing technology, therapeutic area, competition in the market of the pharma company (how many other pharma companies market this product) and country of sale are some of the parameters that affect what is the willingness to pay.

A good approach for the CDMO to define the margin that its price will leave to its customer, is to see what is the price of the specific product in the pharmacies in different markets, remove taxes, pharmacy margins and distributor margins and get a flavor of the margin that its customer will have. Of course this is not enough. Different pharmaceutical companies have different expectations on their margins but in general there are specific patterns. For a commodity like a generic paracetamol tablet probably something around 60% is fair enough. On the other hand, for an innovative lyophilized patented vial, they would expect something around 90%. These figures exclude rebates and marketing costs that pharma companies need to pay. If the CDMO does not consider factors like this, providing a price only based on internal parameters significantly reduces the chances to provide the appropriate price. Although it is difficult for many CDMOs to run this exercise, it probably worth the time and the effort.

Yet, margin is not the only factor affecting what is the willingness of a pharma company to pay. Culture, location, quality, cooperation, responsiveness and flexibility of the CDMO also affect customers’ willingness to pay. If the pharmaceutical company is satisfied with the service level they get from a CDMO, if they feel that they are important and their supply is secured, they are probably ready to sacrifice part of their margin as opposed choosing a CDMO with a lower price but also a lower service level and higher supply risk.

And of course, the better the pharmaceutical companies outsourcing their products are informed about what is the average price in the CDMO market for the specific product, the more ready they are to answer what is the fair price to pay.

Most pharma companies know that persisting in receiving a very low price from a European CDMO only because they want to keep their margins at a certain level, will not work in the long run. If the average conversion price in the European CDMO market is 2 cents for a simple tablet, asking to receive it at 0.5 only because they want to keep their margin above 60%, is not realistic.

Even if there is a CDMO that will accept to provide such price, in the long run this cannot be viable. His costs will continue increasing year after year and one day he will ask to change the price to a level which will be closer to the market average. Or, worse, he will inform the pharma company that he cannot afford continue producing it anymore.

So, answering the question what is the right price to pay (or to charge) it needs market knowledge. Knowledge of the CDMO market but also knowledge of the pharmaceutical market. CDMOs should put themselves in their customers shoes but the opposite is also true in order to have a healthy long-standing cooperation.

Knowledge of the market is important. Get to know your market but also get to know your customer’s market. Combining both will make you better prepared to answer the question of what is the right price in the CDMO environment.

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