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Year end Thoughts About Strategy in the Pharmaceutical CDMO industry

The end of the year is the time to put your thoughts together, look back at what happened over the last 12 months and make plans for the ones that will follow.

So, I was thinking of the discussions we had with our partners all these previous months, their worries, their plans, and the challenges they faced in the pharma CDMO industry. Some of them were simple, some of them more complicated but all of them generated interesting discussions.

There were questions about the industry such as what will be the needs of pharma companies in the near future, who are really our competitors, what are other CDMOs doing better than us, is our level of cost within the market range? And then there were questions about internal challenges certain people at the top management faced, like what is the right profitability measurement that we need to use in order to capture more efficiently the impact of new business and discontinuations. Or discussions about the strategy to be followed and how realistic the targets are when it comes to business plan expectations, both in terms of timelines but also of figures.

Finally, there are those discussions we had with pharma companies, that face problems with their current CDMO, they want to understand if what they pay to CDMOs is fair or they have other concerns like for example wanting to add in their pipeline a new product and they can’t decide if they have to develop it from scratch or to in-licence it.

Playing all these discussions in my head, different thoughts come to my mind. I think for example how difficult is to convince internally that from now on, on top of gross profit we need to start also looking at contribution margin for new quotations and this is because our manufacturing site is not underutilised any more and fixed costs are already covered by existing products. So, we don’t need to cover every time all our fixed costs and add on top a margin, especially when the customer is not ready to pay this amount. It might sound easy, but I dare you to try make this discussion with the CFO of a CDMO, who has set the profitability target for new business at 30% and overall EBITDA level of 15%.

Similarly, presenting to the board the impact of discontinuation of a loss making product, it is much trickier than it sounds. If the product is discontinued, but the direct labour cost related to it remains, what is really the impact? And if fixed costs of the site do not go down, what will happen to the profitability of other products that will remain in site? Will they have to absorb more fixed cost from now on? And then what will be the impact on their profitability? To me these are very interesting discussions but rarely people have the time to dive deep into the figures and make this analysis. Let alone that starting such a discussion may trigger other discussions about cost cutting. And nobody wants to start talking about this. So, unfortunately the convenient way of approaching the matter is to continue doing things the way they used to be done up until now.

Another difficult subject is to convince a board which intends to sell the company in the next years, that the 5 years business plan that is about to be created cannot be super challenging and unrealistic. Although it is nice to show to potential investors that in 5 years time, a CDMO can double its EBITDA, it is something that not all CDMOs can succeed in. Especially if the pipeline of new business is poor and new business will come from quotations that will be submitted in the future. But then, which Commercial Director or even which CEO will argue with the board that what you ask is unrealistic? The reply will be, if you believe that you cannot do it, we will hire someone who can. And so, second thoughts come to people’s minds and they avoid opening this subject.

Then, discussions about what price to give for new quotations and the strategy behind the pricing policy are the ones that intrigue me the most. Because there will always be this person with influence somewhere in the organisation who wants to standardize things. So, when the target for new quotations is for example set at 100 and profitability at 30, who will convince him that for the specific product that is about to be quoted with very high material cost, profitability cannot be 30 but it might be 15? Because if we stick to 30 it will be like adding 30% mark up on materials and this is something that is not acceptable by the market? So, is it better for the site which asks for new business to lose this opportunity and wait for the next, or is it better to provide a price with 15% margin and maybe win the business? And who will be responsible for this decision? Will it be the Site Head, the Business Development Director or the CFO? All of them have different priorities. Site head wants to add new business in the site as long as it is profitable, the Business Development Director wants to bring the customer in so to open the door for other new business also maybe for other manufacturing sites of the CDMO, and the CFO wants at least 30% profitability. If there is no common understanding and dialogue between them, then the one which is impacted negatively it’s the CDMO itself.

On top of all these, discussions about the growth strategy of a CDMO are also always interesting. How can we attract more new business, should we invest in Contract Manufacturing activity or into our own business (for integrated CMOs), in which technology should we invest. What the competitive environment that we operate looks like, what we can do better than our competitors, which are our direct competitors? I remember that when Fuliginous Management Consulting created the European CDMO Mapping including companies offering CDMO services, the number of companies in this database impressed me a lot. More than 330 companies offer CMO services for finished dosage forms of small molecules in Europe. Not, 100, not 200 but more than 330. This means that CDMOs that want to outperform should start adding more value to their customers in order to have some luck to increase their pipeline. And then discussions with our partners on what we can do better, where we should invest, what are the needs of the pharma industry start to take place. One way is to invest in new technologies that other CDMOs do not offer. Another way is to start offering services that we currently do not offer, like strong development capabilities. Because many CMOs have a “D” in their name, making them a CDMO, but how many of them can really develop a product from scratch? The truth is that not so many can do so efficiently.

But apart from the discussions we had with CDMOs over the last year, we also had discussions with pharma companies cooperating with CDMOs. Their main concern was to understand if what they pay for their existing products to different CDMOs is fair or if they can find synergies by negotiating prices or moving products to other CDMOs. Moreover, there are many pharma companies which suspect that the number of CMOs that they cooperate with, is big for the number of products they have in their portfolio. What is really the market average of the number of products vs the number of suppliers that a pharma company cooperates with? In a study that Fuliginous Management Consulting performed, the ratio of products / manufacturer has an average of almost 2.5. This means that a company with 100 products in its portfolio, cooperates on average with 40 suppliers. This was also a figure that impressed me, when I first found out.

And then we had of course discussions with several pharma companies, that wanted to outsource their production and they were puzzled to find the appropriate CDMO able to deal with the peculiarities of the specific product and having a good strategic match with them. The most interesting case last year, was a discussion we had with someone of the top management of a big VET pharma company who had asked more than 50 CDMOs if they can produce its VET, high potent, lyophilized product to be marketed in USA and all he got was negative replies. It was rewarding (also mentally) for us to find a solution for him, from a CMO that he had never heard before based in USA.

Approaching the year end, looking back but also looking forward, all these thoughts make me feel lucky that I have the opportunity to take part in such interesting discussions and being part of the solution. Politics inside organizations will never stop to exist, there will be different departments with different agendas and priorities, there will second thoughts in certain people’s minds but at the end of the day, all of those people work for the benefit of the organization. So, discussions around topics like the above should be made and progress will come only if people get out of their comfort zones. Strategic decisions should be based on information and having the knowledge of what the market is doing is something that always helps.