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The changes in biologics manufacturing regulations contained in the 1997 FDA Modernization Act significantly bolstered the growth of CMOs.
Biologics manufacturing is a technologically complex, highly regulated process. In comparison to small-molecule manufacturing, biologics manufacturing requires far more planning, investment, and skilled personnel and, therefore, can be much riskier. For biotech companies requiring such manufacturing capabilities and experience, partnering with a biologics-focused contract manufacturing organization (CMO) can be a good solution.
Today, however, the CMO landscape for biologics is relatively undeveloped. We believe that the biotech industry is well positioned to benefit from companies pursuing a strategy to build a sizable biologics CMO and that there is significant opportunity for such companies to generate substantial returns if they have the necessary capital, a long-term view, and a tolerance for risk.
To support this hypothesis, we will address these key questions:
In the biotech industry's early years, very little contract manufacturing existed for biologics products. This resulted from a combination of regulatory constraints and the immaturity of biologics manufacturing technology.
In those early years, the philosophy that "process defines product" governed regulatory actions.1 Because biologics manufacturing is so complex, the US Food and Drug Administration (FDA) believed it was insufficient to define the product by just its molecular composition. Instead, a product was also defined by the process with which it was made.
As a result, early manufacturers were required to perform pivotal Phase 3 trials in the same facility used for final commercial production. This required companies to invest in full-scale plants before entering Phase 3. Further, companies were required to file two license applications for a biologics product, a Product License Application (PLA) and an Establishment License Application (ELA). The PLA and the ELA had to be held by the same company. The company also had to perform a significant portion of the manufacturing itself to hold the ELA. This regulatory environment made it impossible for contract manufacturers to exist.
The high risk to which biotech companies were subjected as a result of these regulations led to several high-profile failures. One was Synergen. The company was unable to demonstrate the efficacy of Antril in its Phase 3 trials conducted in 1994. Unfortunately, this occurred after the company had already invested in a costly manufacturing facility. The wasted expense of the plant significantly contributed to Synergen's financial distress. Synergen was eventually acquired by Amgen.
Evidently, experiences such as Synergen's forced the FDA to rethink its policies. The FDA Modernization Act (FDAMA) of 1997 changed manufacturing regulations and significantly bolstered the growth of CMOs.
Among the most important changes in FDAMA was the replacement of the PLA and the ELA with a single Biologics License Application (BLA). This change allowed companies with well-characterized products to alter manufacturing as long as product comparability was established. Thus, it allowed a company to enhance its manufacturing process or change its facilities without having to conduct additional clinical trials. Manufacturing could finally be outsourced without the drug company losing control of its product.
Since the late 1990s, the use of CMOs has steadily increased. Our research indicates that complications remain, however, as companies with relatively sophisticated manufacturing capabilities still encounter issues in replicating a facility. Consequently, biologics manufacturing companies should carefully weigh the risks associated with contract manufacturing against the potential benefits before making an outsourcing decision. Our research also indicated, however, that an increased level of knowledge, experience, and skills among contract manufacturers and their deeper understanding of biologics manufacturing are helping to reduce these risks, thereby keeping the outsourcing of manufacturing as a viable option.
Since recombinant insulin was first developed and commercialized in the early 1980s, biotechnology-derived therapeutic products have grown in both number and revenues generated. The growth has accelerated in recent years and is expected to continue in the near future. The worldwide market for biotech drugs in 2010 is estimated to be nearly $70 billion, with an estimated compound annual growth rate of around 10% from 2005 to 2010 (Figure 1).
Figure 1. Estimated number of biotech drugs in the market and their revenues (adapted from reference 2).
As shown in Figure 1, the number of biotech drugs is expected to grow from 100 in 2005 to about 150 in 2010. A closer look at the current research and development (R&D) pipeline shows more than 500 protein and 150 peptide drugs in various stages of development, suggesting that this growth will continue (Figure 2). This increasing demand for biotech products will likely require greater manufacturing capacity.
Figure 2. Number of biotech drugs, including peptides and proteins, in the pipeline (adapted from reference 3).
Spare capacity based on planned capacity projections is decreasing from around 57% to 25% for monoclonal antibodies (Figure 3). While it may appear that no additional capacity is required, we believe this is not the case, for two reasons.
Figure 3. Implied demand for manufacturing capacity for monoclonal antibodies (MAbs). (Adapted from reference 4).
First, all capacity is not the same. While certain types of manufacturing capacity, such as those used for fill-and-finish operations, are abundant, industry professionals have indicated that other types of capacity for upstream processes like fermentation and purification are scarce.
Second, both supply and demand in biotech operations can be highly uncertain. Even though biologics manufacturing is more advanced now than before, it is still relatively immature and may lead to significant supply uncertainties. On the demand side, drug development and commercialization risks can lead to large de-mand variations. These uncertainties require a substantial buffer in manufacturing capacity.
We believe these reasons, combined with the significant reduction in spare capacity we expect to see in the near future, indicate that the need to develop more manufacturing capacity is high. However, additional capacity is needed more in some areas than others, as we will discuss below.
There are significant differences in the outsourcing market for the two main types of biotech drug manufacturing, microbial manufacturing and mammalian cell manufacturing.
As a first-generation technology, microbial manufacturing is typically less complex than mammalian cell culture, but has limitations. As a result of less frequent use in new products and the commoditization of technologies, the majority of microbial manufacturing capacity already resides in CMOs (Figure 4). Thus, the growth potential for microbial manufacturing appears to be limited (Figure 5). These observations suggest that microbial manufacturing is maturing and there may not be a substantial need for additional capacity in the future.
Figure 4. Distribution of biotech drug manufacturing capacities (adapted from reference 4).
On the other hand, mammalian cell culture technologies are still less developed, and most technologies and processes involved are proprietary. A large portion of manufacturing is still controlled by the product companies (Figure 4). At the same time, significant expected growth (Figure 5) suggests that opportunities for process improvements are abundant and additional capacity may be needed. This additional capacity could be built internally or outsourced to a CMO. The following sections discuss how both alternatives can be pursued.
Since the late 1990s, the overall CMO market has grown significantly, to around $2 billion. CMOs now represent 66% of total microbial manufacturing capacity and 25% of overall mammalian cell culture capacity.4 As shown in Figure 4, CMOs play a dominant role in microbial manufacturing, with the three largest CMOs—Sandoz, Akzo, and Avecia—representing 40% of the market. On the other hand, mammalian cell culture manufacturing is still largely dominated by in-house capabilities.
Figure 5. Estimated size of the CMO markets for biotech drug manufacturing technologies (adapted from reference 4).
As the biologics manufacturing market matures, we believe that CMOs will continue to grow and provide compelling value propositions to biotech companies, both small and large, for the following reasons:
1. CMOs can provide access to capacity with lower investments. For small-to-medium-sized biotech companies, or large biologics companies that prefer to focus on drug development rather than manufacturing, CMOs can provide access to capacity without having to invest in a plant. Significant investment is usually still required for upfront fees, contract management, and technology transfer, but these expenses generally amount to about $40 million—considerably less than the cost of setting up a plant, which is typically about $400 million (Figure 6). Contracting with a CMO can help a biotech company share the risks of building manufacturing capabilities for an unproven product. If the product does not pass Phase 3 clinical trials, the company has lost only its initial investment with the CMO, not an investment in an entire manufacturing plant.
Figure 6. Cash reserves of biotech companies. Of a sample portfolio of 41 companies, only eight have cash reserves above the $400 million required to build a plant (adapted from reference 5).
We believe that outsourcing to a CMO can be particularly attractive for small biotech companies that don't have the capital or access to capital required to make the investments required to build a plant. Currently, there are more than 650 biopharmaceuticals in development, with two-thirds coming from small companies that have revenues below $1 billion. The large majority of these companies are unlikely to have the cash reserves required to build a manufacturing plant. To illustrate this point, out of 41 companies in a representative biotech company portfolio assembled by CIBC, a North American financial institution, only eight have cash reserves of greater than $400 million, the estimated cost of building a manufacturing plant (Figure 6).5 And more than 50% have cash reserves of less than $100 million. Further, debt and equity financing often are not viable for these companies. Based on our experience and observations, the public markets view inexperienced biologics companies that lack sufficient manufacturing experience as too risky for such financing.
Without the option to partner with a CMO, many of these small companies will likely be forced to form alliances or become acquired by large biopharmaceutical interests to realize product commercialization. We believe that partnering with a CMO can provide an option that could help biologics companies retain greater control of their products. By maintaining their autonomy, companies would have more control over their future as well, whether they mature into a fully integrated biotech company, better position themselves for later acquisition, or pursue other options.
2. CMOs can help reduce overall operational risk and time to market. The process of setting up and running a plant is complex and specialized. Slight delays can lead to high opportunity costs in the form of lost sales. Common causes for delays include setbacks in a drug's Phase 3 trials (such as with Synergen's Antril), poor capacity planning, a lack of effective manufacturing experience (as in the case of Immunex's Enbrel), and regulatory issues.
For biologics companies without effective manufacturing experience, contracting with an established CMO can reduce these operational risks and accelerate the time to production. This can be accomplished by leveraging the CMO's experience and skills in setting up plants and navigating through the regulatory system. This also could translate into significant revenue enhancement, by reducing time to market and the risk of not meeting market demand.
3. CMOs can help biologics companies focus on the higher value parts of the value chain. For large biotech companies, which already have sophisticated manufacturing and regulatory capabilities, a CMO can provide a different value proposition compared with that offered to a small biotech. The large companies may have little reason to devote resources to manufacturing processes that are likely to become commoditized and may not represent a differentiating capability. Partnering with a CMO can provide these companies with the flexibility to focus their internal efforts and investment on the pieces of the biotech value chain with the potential to generate greater value.
We believe that although biopharmaceutical companies have led advancements in biologics manufacturing to date, CMOs are well positioned to help solve many of today's difficult production problems.
First, CMOs are likely to increase the rate of manufacturing innovation. Unlike traditional biotech companies, CMOs have many resources dedicated to analyzing manufacturing issues and identifying improvement opportunities. In traditional R&D-focused biotech companies, discovery and development efforts typically overshadow manufacturing improvement initiatives. However, with a CMO, the focus is entirely on manufacturing. With significant incentive to maintain or improve their margins, CMOs continually seek ways to improve setup times, lower costs, and improve yields. Lonza estimates that technology improvements in the next decade will substantially improve yields from 1–2 to 5–10 g/L.4
Second, as discussed in more detail later, contract manufacturers do not have the same margin requirements as biopharma companies. R&D-focused biotech companies typically have operated in an environment of high R&D investment, followed by high-margin commercialization activities. Manufacturing biologics on a contract basis generally does not yield the same type of returns, making it difficult for biopharma companies to justify engaging in contract manufacturing. However, a CMO can operate with such margin expectations and be economically viable. The financial model discussed in the next section of this paper helps to further demonstrate this perspective.
Third, we believe that CMOs can provide an attractive alternative to the difficult capital investment problem biotech companies typically face when they need to build manufacturing capabilities for products nearing commercialization. The significant costs required to build a plant, coupled with uncertainty about the product's effectiveness and lack of manufacturing skills and experience, can make the decision to invest in a plant less attractive.
A biopharmaceutical company's use of a CMO can be compared with leasing versus building office space. For example, if XYZ, Inc. wanted to expand its offices, it would look to lease office space rather than build its own building. Leasing would be the logical choice because building office buildings is not XYZ's core competency and does not provide it with a competitive edge. Furthermore, leasing would provide additional flexibility as market environments change.
Finally, CMOs can help mid-size R&D companies gain value before they are purchased. When their products reach Phase 2 and Phase 3 trials, mid-size R&D companies often partner with or are acquired by other companies. This typically happens because these companies don't have the capital or resources to support commercialization. By engaging the services of a CMO, these companies may have the opportunity to mature further and potentially become fully integrated companies themselves.
Having explored the industry role of CMOs, the next step is to determine if a CMO can add value to the biotech industry as a whole. Under what conditions does it make sense for a biotech company to self-manufacture, and when is it more effective to outsource?
For this research, we created a valuation model to determine cash flows and the net present value in two scenarios:
Assumptions made in the model for a sample biologics manufacturing plant are laid out in Table 1. The calculations shown use illustrative numbers and are meant for comparison purposes only.
Table 1. Assumptions made in the economic modela
For the first scenario, the net present value (NPV) was calculated for the investment made by the biotech company in setting up a biologics manufacturing plant. For the second scenario, the NPVs for both the biotech company and the CMO were calculated. A conservative approach was taken, and it was assumed that the plant used by the CMO is a single-product facility. If multiple products were produced in the same plant, costs per product would decline.
Figure 7. Net present value for a biotech company self-manufacturing its drug
The NPV was calculated at four different expected peak revenue levels for both scenarios: $1.5 billion, $1 billion, $500 million, and $200 million. The expected peak revenue levels incorporate the revenue risks involved with the drug. The risks could include product development, manufacturing, and commercialization risks. Figures 7 and 8 summarize the results of the analyses of both scenarios.
Figure 8. Net present values for a biotech company outsourcing its manufacturing to a CMO
The calculations provide several key findings from a biologics company perspective.
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:
We believe the analysis above helps establish that the following factors are critical for a CMO to achieve its desired results:
As this analysis shows, contract manufacturing organizations (CMOs) can play an important role in the biotech industry and can help create a potentially valuable investment. Based on our research, the CMO market is relatively undeveloped, especially in mammalian cell technologies, and represents a significant opportunity. However, sizable capital requirements and long set-up times for a manufacturing plant to begin operations often create barriers to entering this market.
However, we believe that a company with significant financial clout, an appetite and ability to take on risk, and the reputation and ability to recruit top talent, can be well positioned to lead the biologics CMO market. With adequate scale and superior operations, such a company could very well dominate the CMO market and potentially realize high economic returns.
Jayant Lakshmikanthan is a senior consultant at Deloitte Consulting LLP, 415.783.5288, firstname.lastname@example.org
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