How can early-phase CROs stay afloat in a changing market?

They don't make compounds like they used to--or at least at the same rate. And with fewer and fewer early-stage molecules moving through pipelines, some discovery-focused CROs have been left in the lurch.

The number of molecules coming down the pike has declined about 35% since 2008, said John Watson, chief commercial officer at Covance ($CVD), and it looks to remain about flat. Furthermore, Big Pharma, battered by costly development failures, has largely turned off the spigot and focused instead on late-stage candidates, he said.

"There was a day when small and emerging biotechs were putting forward two, three, four, 5 molecules; now they're putting forward one," Watson said. "There were decades when (Big Pharma's) R&D spend grew 10% a year; now it's flat to declining."

That means CROs that used to count on early-phase business are having to get creative, and for Charles River Laboratories ($CRL), which specializes in preclinical services, the key to success in an evolving market is delivering consistent quality, Vice President Mike Luther said.

Over the past 25 years or so, drugmakers have slowly warmed up to outsourcing, Luther said, starting with Phase III and gradually expanding all the way to the earliest stages. "As that space has opened up, everybody hung a shingle out and said they were open for business, and what we saw over time was consolidation among the players that actually had the capacity," Luther said.

That meant a lot of over-promising and under-delivering, he said, which, coupled with the aforementioned decline in newfangled drug candidates, left a lot of quick-to-expand CROs out in the cold, saddled with too much capacity and not enough demand.

Charles River Laboratories' Vice President Mike Luther

Charles River, on the other hand, has spent its money expanding its expertise and honing its value proposition, Luther said, focusing on consistent quality to drive repeat business. And, at least in the short term, it seems to be working: Last quarter, Charles River posted $292.9 million in net revenue, a 2.9% year-over-year increase driven by driven by 2.6% growth in its preclinical services division.

For Covance, braving the change in preclinical demand has been a matter of getting its capacity in order, Watson said. Back in 2008, the CRO paid Eli Lilly ($LLY) $50 million for a 450-acre early drug development campus, an investment Covance figured would give it the heft it needed to capitalize on the exploding demand for outsourced discovery services.

That explosion never quite came to be, of course, and, over the past year, Covance has been paring down its early-phase spending and closing a few sites around the globe to adjust, all a matter of getting its footprint under control, Watson said.

Covance Chief Commercial Officer John Watson

"It's a classic supply and demand issue," he said. "Preclinical has a high fixed cost, and if you can get 65%, 70% capacity filled, you can make money in this business, but if you're below that, you're going to struggle."

Now, after absorbing millions in restructuring costs, Covance is much better sized for the new market, Watson said. Last quarter, early-stage services generated $215 million in revenue, down 2.3% from the same period last year but up about 3.1% over Q1.

Growth in the company's nutritional chemistry, clinical pharmacology and toxicology businesses has so far made up for a continued slump in discovery support and pharmaceutical chemistry services, and each of the units has its own market dynamics, Watson said. Moving forward, Covance expects early phase revenue to stay about flat, but the rise in biotech funding over the past three quarters is an encouraging sign for the future rate of molecule development.

For Charles River, having no late-phase business means it has to leverage its history and breadth of capabilities to cash in on that dwindling preclinical demand. But, as Big Pharma whittles its budgets and looks for more and more outsourcers, the CRO believes its investments and acquisitions will stand out and keep enticing partners.

"We're not blind to the fact that we're in an evolving marketplace, and we have to be adaptable and flexible," Luther said. "... We have to keep our science relevant, and not just the science but the business model."

-- Damian Garde (Twitter | email)

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