The Balancing Act of Small to Medium Sized Custom Manufacturers

14 April 2003 00:00  [Source: ICB Americas]

Custom manufacturers, regardless of size, find themselves struggling for survival amid difficult economic conditions and decreasing demand for their services from the pharmaceutical industry. While smaller custom suppliers have some disadvantages in dealing with increasing price pressures, they do offer some advantages over their larger competitors that help them to maintain a competitive position in the marketplace.

Competitive Pressures

Smaller custom manufacturers in both the US and Europe point to seven key trends and issues that are impacting their performance. First, the slower economy in general has affected the availability of projects for custom manufacturers. "The economic shakedown after September 11, 2001, and other corporate governance events resulted in a very nervous industry in 2002 with many large custom manufacturing plants lying idle," says Gareth Jenkins, business development manager with Peakdale Molecular Ltd.

"Because of operating leverage, a relatively small reduction in order flow has a magnified negative impact on the bottom line," says Roberto Fernandez, vice president, sales and marketing with Texas Molecular/Sea Lion Technology. "When customers are nervous about the economic climate, there is a tendency to look after their own, preserving cash for internal use rather than spend it with an external supplier or collaborator."

Second, reduced productivity in the pharmaceutical industry, traditionally the largest and most profitable market for custom manufacturing, has resulted in fewer outsourcing opportunities. Third, emerging biotech and virtual pharma companies that outsource their manufacturing are suffering from the volatility of available venture capital and have reduced their use of custom suppliers. "The fallout of virtual pharmaceutical companies decreases or slows the projects available for custom manufacturers," notes Michael Czarny, vice president of business development with Tetrionics.

"The investment market is depressed at the moment and investors are more knowledgeable about biotechnology than in previous years," adds Peakdale's Mr. Jenkins. "As a result, there is a preference to only invest in companies that have a product in the pipeline that will offer a good return in the medium term."

Fourth, competition from foreign manufacturers continues to increase, resulting in downward pricing pressure on domestic producers. Chinese and Indian suppliers will gain the ability to compete for projects based on more advanced intermediates as they become compliant with regulatory and environmental requirements.

Fifth, environmental and regulatory compliance costs continue to rise. "Smaller custom manufacturers are held to the same standards as larger environmentally compliant companies who can spread the cost out over larger revenue bases," says Mr. Fernandez. "The result for the small company too often is a higher percent of cost of goods sold for environmental compliance. This cost disadvantage is particularly acute when competing with foreign suppliers who are not held to the same environmental standards." Within the UK, says Peakdale's Mr. Jenkins, smaller players are facing the burden of additional regulation, such as Integrated Pollution Prevention and Control (IPPC), which creates additional costs and bureaucracy.

Sixth, rising cost burdens, including health care, general liability insurance, property taxes and natural gas and other petrochemicals, make it difficult for smaller custom manufacturers to remain competitive. Small companies do not have the buying leverage of larger companies, Mr. Fernandez notes. "For example, the high cost of general liability insurance resulting from the September 11th tragedy and increasing premiums by insurance companies to compensate for negative investment income in their portfolios have a direct impact on the bottom line of smaller companies," he explains.

Lastly, margins are being squeezed as larger chemical customers expect almost automatic annual price decreases, even though smaller companies may be operating at a minimum cost level already and do not have the leverage to demand equivalent decreases from their own suppliers. Large customers are also expecting more services without paying any additional fees.

Some Positive Factors

On the positive side, Mr. Fernandez sees larger companies tightening their focus on core competencies and on product lines that make a reasonable financial impact on their bottom lines. "This situation creates opportunities for smaller companies to acquire product lines or become the outsourcing manufacturing partner," he notes. "In addition, custom manufacturers are adding value to what they do by assisting customers in process and product innovation."

Other companies have turned to markets that they were not previously interested in to fill excess reactor capacity, says Tetrionics' Mr. Czarny. Alfred Schulte, CEO of Dynamic Synthesis, says that the fine chemicals industry will continue to respond with further consolidation and that this trend will allow those companies that are able to expand their capabilities through acquisitions.

With so many challenges facing those in the custom manufacturing sector, it is increasingly important for companies to differentiate themselves from competitors to remain successful. Smaller custom manufacturers do have some advantages over larger service suppliers that will provide opportunities for these companies to attract and retain customers.

Roger Laforce, director of sales and marketing with Helsinn, notes that smaller custom manufacturers can help their customers to control the costs and timelines of their projects. "We try to use a modular project design that provides our customers with enough decision points within their projects." He adds that smaller companies are very responsive and have flexibility that larger organizations typically cannot offer.

"We are much more responsive than the larger players, both technically and commercially," says Peter Murin, chief operating officer with Halocarbon Products Corp.

"The speed of decision-making is a real benefit that allows the customer to proceed with projects more quickly-thus being faster than others in the marketing of new drugs," Dynamic Synthesis' Mr. Schulte adds. "This is real time-to-market, compensating waiting times caused by regulatory sides."

Tetrionics' Mr. Czarny believes that smaller companies can be quick and nimble while maintaining a strong customer focus. "In most cases, they do not have layers upon layers of personnel and procedures that hinder decision-making activities. Projects can be well defined up front with the appropriate professionals allowing a high guarantee of success." Texas Molecular/Sea Lion Technology's Mr. Fernandez points to the advantage of smaller staffs having greater ease to provide that extra measure of service and response throughout the organization that often makes a difference in choosing and staying with a supplier.

"We also do not need large products to survive, but can work on a project portfolio with small and mid-sized projects where chances are still better to get to business," says Helsinn's Mr. Laforce.

Peakdale's Mr. Jenkins agrees. "Smaller players can survive on smaller contracts with shorter lead times and project times, whereas the larger manufacturers need to fill their plant continuously," he says. He also notes that smaller players are used to reacting much faster and are more adaptable to losing a project, either by finding many smaller projects to fill the plant time or by having their own product lines that they can look to develop.

"By offering additional services, particularly early stage and business process development services, a supplier automatically becomes more valuable to the customer," adds Mr. Fernandez. "This value can be increased to the point where the customer willingly sheds some or all of these capabilities internally and grows reliant on the supplier to fill these important business needs. Making product then becomes but one element of value in the total benefit equation to the customer."

Refining Models

That value proposition is employed by Dynamic Synthesis, the brand name for marketing the technologies of Dynamit Nobel Special Chemistry, Finorga and Rohner. "This strategy allows Dynamic Synthesis to offer solid process expertise for the whole pipeline along the way from R&D to the marketing of new drugs," says Dynamic Synthesis' Mr. Schulte. "Using the skills of each unit in a synergistic manner, Dynamic Synthesis guarantees tailor-made solutions to its customers."

Dynamit Nobel Special Chemistry is expert in hazardous reactions under cGMP, including the use of sodium azide as a key starting material. Finorga has expertise in chiral chemistry, and offers multi-column chromatography (MCC) and other separations technologies for lab-scale to industrial size custom synthesis. Swiss-based Rohner is a one-stop-shop for a range of highly sophisticated multi-purpose equipment used for the manufacture of advanced fine chemical intermediates and active pharmaceutical ingredients (APIs).

In 2002, Rohner commissioned a state-of-the art facility to expand capacities in cGMP production to manufacture advanced intermediates and APIs. Core technologies comprise the chemistry of substituted aromatics, hydrogen transfer catalysis, cyanation and metal organic chemistry. Dynamic Synthesis has also begun to establish borane technology at Dynamit Nobel Special Chemistry. The company is also planning to expand Finorga's MCC technology for harvesting enantiomerically pure compounds and to broaden its range of chiral capabilities including stereo/enantiospecific reactions, chemical resolution, enzymatic resolution and asymmetric synthesis.

Through an integrated approach to project management, Dynamic Synthesis had a very successful business year in 2002 with growth of 14.5 percent. "Dynamic Synthesis will increase its customer basis, regional presence and technology know-how in the future," says Mr. Schulte. "We want to operate in small and flexible product teams and increase business in the early phase of the pharmaceutical product chain and thus increase added value to our customers." Dynamic Synthesis will also be looking to apply its core technologies to other markets such as food, catalysts, plastics, flavor, fragrances and cosmetics.

Halocarbon Products Corp., which has a core competency in fluorine chemistry, has refined its business model for small-scale projects. "In the past, we have had a problem when customers have come to us for smaller volume products. These products fit with our interests but making them would have been too disruptive to our normal plant operation," says Mr. Murin. "We are just completing what we call our 'semi-works plant' for smaller scale production, which will enable us to respond to our customers' needs," says Mr. Murin.

Helsinn is an expert in handling potent compounds from low kilograms up to low ton quantities, a capability not offered by many custom manufacturers. Recently the company formed an alliance with Cardinal Health Pharma-ceutical Technology Services (formerly Magellan Labs, Research Triangle Park, N.C.) and now offers a development and manufacturing chain from early-stage synthesis and analytical development up to launch and commercial final dosage forms. Helsinn has put in place a project management function coined the Technology Mall that guarantees the smooth transition from phase to phase and from operation to operation, says Helsinn's Mr. Laforce.

The company has also begun offering networking solutions for drug substance and drug product development and production. It invested in a new containment API plant that was completed by Helsinn in 2002. The plant offers options for further investments including dedicated product areas and an increase of manufacturing capacity. Helsinn Chemicals Ireland is also now fully involved in a contract business with a focus on Ireland.

For the future, the company will stay focused on the small molecule market. "In this field, more and more molecules are becoming more highly potent, and we already have responded by setting up new manufacturing and laboratory operations that allow us to handle such compounds," says Mr. Laforce. The company has designed its facilities to meet the increasing regulatory requirements for segregation of these types of compounds. Helsinn is interested in manufacturing anti-cancer compounds, which require containment manufacturing. "Helsinn steps beyond the chemical field and offers integrated solutions together with our partner Cardinal Health," notes Mr. Laforce.

Peakdale Molecular, a contract chemistry company based in Derby-shire, UK, provides laboratory scale research chemistry to pharmaceutical, life science, agrochemical and related chemical industries. A significant proportion of its business is custom synthesis of new chemicals from gram to small kilogram scale. The company also has a growing catalogue of unique intermediates for research use and is expanding its contract research offering, especially in drug discovery support.

"Peakdale operates at the early, laboratory research stage, and we are involved in helping customers to design and develop the chemicals that the custom manufacturers will be producing in a few years time," says Mr. Jenkins.

In February, Peakdale announced that it has entered into a multi-year agreement to provide contract discovery chemistry services to Pfizer. The compounds, synthesized by Peakdale, will augment Pfizer's existing internal drug discovery programs. Last month it also launched a new intermediates catalogue, which now includes 465 compounds.

Over the last 18 months, the company relocated to a 40,000 square foot research facility and has grown from a staff of 12 to 120 employees. Peakdale also just completed installing a small kilo lab housing 30 liter and 50 liter reactors with all the additional equipment necessary to scale processes to batch sizes of one to five kilograms

In 2002 the company entered into a collaboration with Harwich, UK-based Exchem Organics to offer bis(methylsulfonyl)aryls at laboratory research scale from Peakdale and at the 10 kilogram-plus scale from Exchem Organics. Peakdale is also accelerating its plans to fit out more laboratories and intends to develop more services in the area of drug discovery research. "We are developing services that will help companies to increase the efficiency of drug discovery research and take steps to reduce the attrition rate of drug candidates entering clinical trials," says Mr. Jenkins. "We are able to achieve this goal through the quality of staff we recruit, our entrepreneurial culture, a team-based approach and good lines of communication between our scientists and our customers."

Sea Lion Technology/Texas Molec-ular provides synthesis and distillation services for a wide range of fine chemicals and other products such as polymers, cross-linking agents, additives to coating and films, as well as additives for lubricants and oil products. The company has pilot plant to large-scale production facilities including synthesis, distillation and process engineering and process development expertise. The company has high quality lab capabilities and an on-site deepwell and treatment, storage and disposal facility, which allows the company to treat and recycle or dispose of hazardous and non-hazardous wastes and by-products from various production processes at very competitive costs.

Sea Lion Technology/Texas Molec-ular currently has an active program underway to review its strategic direction, which may result in increased emphasis in the fine chemicals market, says Mr. Fernandez. "Starting in late 2001, the company implemented a new business model that combines pilot scale works, commercial production, chemical transportation and environmental services (chemical waste treatment) to deliver a full chemical process development, manufacturing, delivery and waste recycle and/or disposal service to the major chemical producers," he says.

Plant investments have been above average while the company modifies equipment and processes to obtain the benefits of the synergy between Sea Lion Technology and Texas Molecular staff and equipment. Since Texas Molecular acquired the GNI assets in Deer Park, Tex., there has been a major reorganization to combine the services of Sea Lion Technology in Texas City with those of the new acquisition.

"This reorganization includes a major change in the business model, management, vision, direction and improved services to the customer," says Mr. Fernandez. "The heart of our business strategy is customer service. From this basic underlying strategy flows everything else we need to do to be successful." Plans include cost management, changing the product mix over time from campaign style work to more long-term contracts, focusing on higher margin, performance-enhancing products and becoming the recognized experts and leaders in particular chemistries.

Madison, Wis.-based Tetrionics, which exclusively manufactures APIs, emphasizes its ability to work on difficult technologies and make challenging chemical processes work at commercial scale. The company maintains two business models that offer customers a set of options not traditionally offered by others, says Mr. Czarny. The first is the traditional relationship offered by most companies that perform custom manufacturing activities. The second is a shared risk model for compounds that fit Tetrionics' long-term strategic business. "In this case, Tetrionics assumes some of the development risk, thereby offering a company reduced costs in the short term in exchange for future opportunities and simplified pricing," says the company.

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