Big Pharma Moving More Work Offshore

It wasn't long ago that Merck (MRK Quote - Cramer on MRK - Stock Picks), Pfizer(PFE Quote - Cramer on PFE - Stock Picks) and other drug giants made it clear that they preferred developing drugs in their own labs, in their own plants and in their own backyards.

"This was an extremely profitable sector and a classically vertically integrated business," says David Finegold, dean of the School of Management and Labor Relations at Rutgers. "The model was working very well."

However, the old model doesn't work as well now due to pressures from generics, the rising costs of creating new drugs and difficulty in producing drugs with tremendous revenue, Finegold adds.

As a result, as drugmakers try to cut expenses and get a bigger bang for their R&D dollars, they're farming out more responsibility to independent companies and seeking to do more business overseas.

Although it is doubtful Big Pharma will match the scope of outsourcing seen in the shoe or apparel industries, it's clear they can reduce the costs of capital and labor by hiring others to do an increasing share of the manufacturing.

"Other than pilot plants, I don't see them [the drugmakers] doing any building of new plants," Finegold says.

In early December, Bristol-Myers Squibb(BMY Quote - Cramer on BMY - Stock Picks) said it will consider outsourcing as part of a cost-cutting plan that includes firing 10% of its workforce and closing or selling perhaps half of its 27 manufacturing plants.

Just weeks before, Pfizer executives told analysts at a meeting in Hong Kong that the company expects to double the outsourcing of its manufacturing -- to 30% from 15% -- but it didn't offer a timetable. Pfizer had 93 plants at the end of 2003, and it expects to have 48 by the end of this year.

Also late last year, GlaxoSmithKline(GSK Quote - Cramer on GSK - Stock Picks) said it expects to increase outsourcing while continuing to reduce the number of plants. It had 108 in 2000 and 80 in 2006. Glaxo also wants more manufacturing of active pharmaceutical ingredients done by other companies, a percentage that grew to 41% last year from 9% in 2001.

Cutting costs via outsourcing and "offshoring" -- moving operations outside the U.S. but still keeping them under Big Pharmas' auspices -- isn't a new strategy, but it is an increasingly popular one, Finegold says. The push started in the mid-1990s as companies tried to reduce R&D expenses ranging from preclinical testing to human clinical trials.

The Tufts University Center for Drug Development predicted in 2006 that as much as 65% of clinical trials regulated by the Food and Drug Administration "for top pharmaceutical companies will be conducted abroad" within a few years.

A poll early last year by the publication Contract Pharma found that 31% of big drugmakers had planned to raise outsourcing spending by 10% from 2006. Another 39% expected to raise such spending by less than 10%.

And a recent report by Wachovia Capital Markets says "approximately 25%" of drug development is now outsourced by big and small drugmakers. "This figure could increase to 35% to 40% over the next three to five years."

Wachovia analyst Chad Fugere notes that during a fourth-quarter 2006 conference call with analysts, Merck executives said 30% of drug development would be outsourced. A few months later, Novartis(NVS Quote - Cramer on NVS - Stock Picks) said outsourcing played a role in cutting $700 million between 2006 and 2007.

Fugere also cited Glaxo remarks indicating that it was outsourcing "up to 40% of its clinical trial work," saving "roughly 80%" on each test.

All of these comments "suggest a higher degree of outsourcing in the future [for companies] that have historically done much of their own development work," Fugere says in a November report to clients.

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