Could cheap CRO rates threaten to destabilise biotech?

Back in the early 1990s, the arrival of high throughput synthesis and screening raised several questions in drug development organisations. How big will the increasing demand be? And how variable would it be? The answer to managing these uncertainties was to create a flexible, external supply chain. At around the same time, a sector of small biotech companies began to emerge, which began to supply drug candidates to fill big pharma pipelines. While it’s interesting to think about what came first, it’s now evolved into a mutually dependant ecosystem. But how robust is this ecosystem?

Today, partly due to the growth of contract research organisations (CROs), a significant proportion of big pharma pipelines derive from small biotech companies – an estimated two-thirds of all new drugs produced in 2022, according to a report by the CRO IQVIA Most of these charge for their drug discovery work using full time equivalent (FTE) rates – the charge for one person working 100% on a project for a year, pro-rated for the actual time used. This type of costing model means that the CRO will get paid irrespective of whether it ultimately succeeds.

And yet full-time equivalent (FTE) rates in many CROs today are similar to those of the early 1990s. This represents a decline of over 60% in real terms. Some FTE rates were as high as $300,000 (£235,000) in 1990, which would be equivalent to over $800,000 today. The actual highest charge I’ve heard of is around $350,000 per FTE.

Therefore, over time, much of the western chemistry manufacturing and controls CRO sector has moved from a high-risk, high reward enterprise to a high-risk, low reward one. Asian competition has played a major role in this reduction, but even some Asian CROs are beginning to feel the pinch. One can see the tell-tale signs of this margin reduction. Occupancy figures (the proportion of a CRO’s staff working on an active project), already high, will have to increase, higher capital expenditure will be more difficult. The recent high level of inflation has been difficult to absorb, especially the increases to energy costs. The net result will be a loss of overall CRO capability.

I’m writing about CROs working on active pharmaceutical ingredients (APIs), but this will also be an issue for other parts of the CRO sector. All the biotech sectors – including medicinal chemistry, formulation and toxicology – will be affected by this.

The emergence of small biotech companies has allowed the industry to run far more projects than we would be able to in just big pharma and with a more diverse range of targets. But the overall scientific challenges that need to be overcome during drug development and discovery are certainly not decreasing in significance.

Those of us who experienced the early to mid-1990s witnessed the disruption caused in the western contract manufacturing organisation (CMO) sector, where many western companies closed. Many of these closures were caused by projects being cancelled or new drug applications being delayed. Lower margins caused these companies to be less financially resilient. Today, we are constantly scouring the globe looking for secure, quality CMOs. A similar situation has been emerging in the CRO sector.

Now some will say that this is simply part of the cut-and-thrust of business – companies fail all the time. However, the level of margin reduction makes these organisations more fragile. Historically, some industries have been able to innovate their way out of these pressures, but finding the required capital expenditure and being given the required time to innovate are very difficult but with margins under such pressure. Some companies have been looking at risk sharing. This might be appropriate for very large CROs but the risks need to be proportionate to the balance sheets of the respective organisations, otherwise they destabilise financial health even more.

Trying to grow a company from scratch today is extremely difficult. Many of the best CROs and biotech companies are those that have grown out of larger companies that had already established the required research capability. These companies have deep expertise and so are not quickly replaced anyway, but with lower margins it will be harder to raise money to restart the enterprise, especially with interest rates rising.

Customers are going to have to have a more pragmatic attitude to prices if we want to sustain the CRO sector. Once one realises that FTE rates haven’t significantly increased in 30 years then one has to conclude that things are historically cheap, probably too cheap. The ecosystem is under stress and for the sake of new, innovative medicines, it needs to change.

When selecting a CRO, one has to match the scientific challenges of the project with the scientific capabilities of the CRO. To do anything else will set you up for failure. Maintaining capability while margins are being reduced isn’t sustainable, let alone enhancing that capability.