First, based on our calculations, the initial investment required to self-manufacture is high: about $400 million. A biologics
company will likely be unable to explore this option if it does not have the ability to raise such capital.
Second, the decision to outsource manufacturing or self-manufacture is dependent on the expected revenues for the drug. At
high expected peak revenues, it makes sense to self-manufacture (Figure 7). This is to be expected, as there is a high likelihood
of achieving the desired results, and the biologics company does not have to pay a premium to the CMO to share the risk. On
the other hand, below the $200 million revenue level, the investment in a manufacturing plant would result in a net loss.
Finally, outsourcing can help reduce the variation in NPV across revenue levels. Even though the average NPV in the self-manufacturing
case is higher than with outsourcing—$570 million versus $348 million—the variation in NPV also is much higher. The standard
deviation for self-manufacturing is $626 million, in contrast to $272 million for the outsourcing scenario. This is primarily
because of the lower upfront investment required for outsourcing.
From a CMO perspective, there appears to be a high sensitivity to expected peak revenues. During initial negotiations, it
is essential that the CMO understand the revenue risks to which it will be exposed and negotiate compensation accordingly.
The model assumes that an existing plant is being remodeled for the new drug, thus lowering initial investments. If the CMO
builds a brand-new plant for the product, the plant NPV will go down significantly. This suggests that the CMO must be able
to absorb initial losses with a plant to get long-term returns.
Figure 9. To outsource or not to outsource?
In summary, we believe CMOs can add value for both the biologics company and its investors (Figure 9) when:
- The company does not have access to the capital required to build a plant.
- There is moderate-to-high risk of loss of revenue.
- The company would prefer to focus on other aspects of the value chain, such as drug development and commercialization.
- The drug is not a blockbuster but can still produce acceptable results (for example, if it targets a small patient population).
CHARACTERISTICS OF AN EFFECTIVE CMO
We believe the analysis above helps establish that the following factors are critical for a CMO to achieve its desired results:
- An effective CMO should have access to significant amounts of capital—on the same order as the large biopharmaceutical companies.
- An effective CMO should build a reputation to help attract top talent in all aspects of biologics manufacturing.
- Biologics manufacturing technology is expected to change rapidly. Therefore, a CMO should have access to top research, with
a goal of being at the cutting edge in its field.
- The first few products for each plant will probably produce financial losses. A CMO must be able to absorb these initial shocks.
For the conservative model we used (calculated using an average of the four revenue scenarios), a CMO will have to produce
at least four products in a plant before it becomes an overall positive NPV investment.
- To help a CMO manage its operational risk, it should effectively collaborate with drug development companies. This relationship
should facilitate process development and the effective transfer of the drug from clinical development to large-scale production.
- Finally, a CMO should be well-versed and experienced in advanced risk management techniques. The risks inherent in biotech
products require tight risk management through contracts and appropriate selection of customers and products.