Considerations Impacting the Make vs. Buy Decision

Transcription

1 Considerations Impacting the Make vs. Buy Decision Thomas C. Ransohoff BioProcess Technology Consultants, Inc. INTRODUCTION AND BACKGROUND D ecisions related to manufacturing are among the most important ones faced by biopharmaceutical companies. Biopharmaceutical products are among the most technically complex produced in any industry. They are complex macromolecules, stable under a limited range of conditions, and they must meet very high purity and quality standards. The earliest biopharmaceuticals were manufactured by the companies who developed them by necessity there was no other route to produce these compounds. Many of the standards still in use today for biopharmaceutical manufacturing were set by the initial manufacturing processes and facilities developed by companies such as Genentech, Eli Lilly, Amgen, and Merck. All of these factors contribute to the extraordinarily high cost of construction of a state-of-the-art biopharmaceutical manufacturing facility. These costs are estimated at over $700 per sq.ft. and over $2,500 per L of installed bioreactor capacity [1,2]. To make matters more challenging, the timelines for construction of this type of facility range from 30 to 48 months from project initiation to production of drug substance [2,3]. When superimposed on a typical clinical development timeline, it becomes clear that a decision to construct a commercial production facility to support the launch of a biopharmaceutical product must be made around the time a product is in Phase II clinical trials [4]. Based on industry average success rates [9,10], the probability of a successful launch is only 26% at this point, so if a company decides to build there is approximately a 74% chance that the facility will not be needed when it is started up! The financial perils associated with investment of significant capital in a manufacturing facility prior to reducing product approval risk were highlighted several high-profile product failures in the early 1990s. Few were more publicized than the failure of Synergen s Antril (anakinra). This product failed to demonstrate efficacy in treating sepsis in a Phase III trial in 1994 after the company had made a substantial investment in a manufacturing facility. The resulting financial distress soon led to an acquisition of Synergen by Amgen [5]. (Anakinra was eventually approved as Kineret and is now marketed by Amgen to treat rheumatoid arthritis.) These types of failures led the industry, particularly less well-capitalized firms, to consider contract manufacturing of 1 their products prior to product approval. Shortly afterwards, one of the first make vs. buy analyses for biopharmaceutical products was published, a result of a collaboration between one of the earliest contract manufacturers and MIT Sloan School [6]. In spite of the compelling rationale to support outsourcing manufacturing of biopharmaceuticals though, significant regulatory hurdles still remained. The method of regulating all biologic compounds, which included traditional biologicals, such as vaccines and blood products along with most modern biopharmaceutical products, was based on the premise that the process defines the product. Therefore, licensure of a biological product required a product license (held by the owner of a product) that was tied directly and uniquely to a separate establishment license (held by the owner of the facility used to manufacture the product). Therefore, a biopharmaceutical firm would need to relinquish an unacceptable level of control to a contract manufacturer in order to outsource commercial manufacturing. In 1997, the ability for a biopharmaceutical company to retain control of its product while outsourcing manufacturing was dramatically improved through enactment of the FDA Modernization Act (FDAMA). The new regulations and associated guidance documents included two major changes with considerable impact on biologics manufacturing: Implementation of a new license application format, the Biologics Licensing Application (BLA), replacing the old PLA/ELA format A formalized approach for implementing and gaining approval for process changes (including manufacturing facility and cell line changes) for biologic products through the use of comparability protocols These changes fundamentally improve the ability for biopharmaceutical companies to change manufacturing sites and companies for their products and to take calculated risks with respect to capital investment during development and commercialization of their products. This is one factor contributing to the growth of contract manufacturing for biologic products, resulting in a broader, more robust biopharmaceutical contract manufacturing sector [7]. As a result, qualified service providers now exist for out-

2 Figure 1. Key Elements of the Make vs. Buy Decision FEASIBILITY: IS BUY AN OPTION? For any given product, the make vs. buy decision may be made several times during the product life cycle. The decision and requirements for a product entering Phase I clinical trials will be very different from the decision and requirements for commercial supply of an approved product. In each case, though, the feasibility of the outsourcing option must be considered from a number of perspectives including: Manufacturing scale Manufacturing technology requirements Availability of qualified service providers Capacity availability sourcing manufacturing of most types of biopharmaceutical products over a wide range of process scale and development stage. Even so, there are still advantages and disadvantages for outsourcing manufacturing. The decision of whether to build in-house capability ( make ) or contract out ( buy ) for production of your product is important and can have longterm and strategic ramifications for the company. Once almost exclusively a decision for smaller, thinly capitalized companies, the make vs. buy decision is now being made by biopharmaceutical companies of all sizes across the supply chain [8]. KEY ELEMENTS OF THE MAKE VS. BUY DECISION This article explores some of the key elements that should be considered in the make vs. buy decision. While each manufacturing requirement is unique, there are a number of factors in the decision process that are common to most cases. We have grouped these elements into four major categories (see Figure 1): outsourcing feasibility, strategic fit, risk, and financial considerations. Figure 2. Distribution of Cell Culture Manufacturers by Installed Bioreactor Capacity As mentioned above, qualified contractors now exist with the appropriate technologies for production of a wide range of biologic products, from small recombinant proteins to monoclonal antibodies to gene and cell therapy products. However, if a company is developing a product using a unique and proprietary manufacturing technology, then outsourcing manufacturing is often not an option and the company must construct manufacturing capabilities internally. For example, this is the case for companies who manufacture and develop autologous therapeutics. It is also true for transgenic companies who are developing novel production methods for their own and third party products. Particularly for more commonly used production methods, such as microbial fermentation and mammalian cell culture, contract manufacturers offer capacity across a wide range of production scales. For products requiring large scale manufacturing, relatively few choices exist, but this situation is also changing as the industry matures. Figure 2 shows the forecast increase in the number of large scale (>5,000 L installed reactor volume) cell culture contract manufacturing organizations (CMOs) from over the period 2002 to This increase is driven by increasing demand for cell culture capacity, largely created by the current (and forecasted future) success of monoclonal antibody therapeutics. A difficult element to forecast is the availability of capacity in the future. A growing number of reports have addressed this topic [9-11] with a range of predictions. In our recently presented capacity analysis for mammalian cell culture capacity [12], we forecast that the industrywide expansion currently underway will be adequate to meet the growing demand for mammalian cell culture capacity over the coming five years, but that utilization 2

3 Figure 3. Mammalian Cell Culture Supply/Demand Analysis [12] Figure 4. Forecast Distribution of Cell Culture Capacity by Reactor Volume (2006 Estimate) rates will remain high. Importantly, this analysis also demonstrates the enormous range of possible outcomes with respect to demand for capacity (see Figure 3 for summary of results), so that the risks of a moderate industry-wide shortage and an industry-wide glut of capacity are both significant in the time frame. Additionally, while these analyses address reactor capacity, they do not address other aspects of manufacturing capacity, such as skilled and qualified labor, which some argue is the most critical shortage facing the industry [13]. While industry-wide analyses are useful for understanding the overall environment, they are far less useful in addressing the needs of a firm facing a make vs. buy decision. Here the relevant question is not Will there be capacity available industry-wide? but Will there be capacity available to me? This is important because manufacturing capacity is not a highly liquid commodity. While more large-scale manufacturers are coming on line over the next few years, the vast majority of fermentation and cell culture capacity will still be controlled by a relatively small number of companies in 2006 (see Figure 4). Therefore, particularly for products with large volumetric requirements, early planning for a partnering or outsourcing strategy is critically important. Finally, even after identifying contractors with the appropriate scale, technology and capacity, the potential providers must still be qualified with respect to a number of additional important criteria, including GMP compliance of the facility, organization and quality systems, project management and technical transfer capabilities, and financial strength. A wide range of capabilities in these areas exist within contract organizations, just as a wide range of risk tolerances and expectations exists within client organizations. It may make sense for a client firm to invest capital, resources and expertise in addressing deficiencies within a contract organization if all other criteria are met. A preliminary feasibility analysis covering the criteria outlined above can be done relatively quickly by those familiar with the biologics contract manufacturing field. Through this process, the long and growing list of biotech CMOs can be reduced to a manageable list of service providers likely to have appropriate capabilities for the specific requirement. From this list, the company can conduct further discussions with a limited number of pre-qualified providers, typically under a non-disclosure agreement, to obtain the information necessary to determine whether or not a viable buy option exists. 3 STRATEGIC FIT Increasingly, biopharmaceutical firms are viewing manufacturing decisions as strategic because of their long-term organizational, financial and competitive implications. The strategic fit of a potential manufacturing capability with the company s overall business needs to be considered in the make vs. buy decision. The following questions are among those addressing this issue:

4 Does the company have a pipeline of products that will require similar manufacturing capability? Can the company establish and maintain a competitive advantage through establishing strong process and manufacturing capabilities for this type of product? Is there a potential to develop proprietary manufacturing technology? Are there unique or difficult aspects to the manufacturing requirements? Will manufacturing capacity and capability help enhance the company s ability to in-license new products? At what development stage are the products that could utilize in-house manufacturing facility? Does the company have an organizational or cultural bent towards in-house manufacturing or outsourcing? Obviously, one benefit of establishing manufacturing capacity in-house is that the company can control an important and enabling capability for its business. While this is clearly an advantage, there are costs to obtaining this control. An important element to the make vs. buy decision is determining how strategic the manufacturing capability being considered is to the company. RISK: MANAGEMENT AND ASSESSMENT Understanding the risk associated with any decision is the first step in managing it. The risks relevant to the make vs. buy decision are numerous, ranging from risk of product failure (or greater than anticipated success) to risk of delays in construction or poor execution in manufacturing. The pitfalls associated with deciding to invest in facility construction early in the clinical trial process were described above. For make vs. buy decisions to support products in clinical development, the risk of product failure (or greater than anticipated success) to risk of due to delays. A range of estimates for product success rates as a function of development phase have been published for biopharmaceutical products [9,10]. Using data from these and other sources, we have developed a composite estimate for product success rates, which is provided in Table 1 below: Table 1. Industry Average Success Rate Estimates Development Success Rate Overall Probability Phase to Next Phase of Success Pre-clinical 30% 6% Phase I 76% 19% Phase II 45% 26% Phase III 64% 58% BLA 90% 90% In addition to the obvious risk of product failure, the company faces other risks that may be estimated. If the company decides to build its own facility, the risk of delay for the facility coming on-line or of cost overruns due, for example, to unforeseen regulatory requirements must be assessed. If the company decides to outsource, the risk of delay due to manufacturing execution failures or GMP compliance issues must also be assessed. 4 One highly useful technique for estimating risk is Monte- Carlo simulation. The purpose of this technique is to forecast a range of possible outcomes for multivariable problems. As an example of the use of this technique, we have applied it to forecast the range of possible outcomes for industry-wide demand for cell culture capacity. In this forecast of capacity requirements, we varied only three inputs for each product (overall process yield, approval yes/no based on probabilities, and patient population) and studied the impact on range of forecast output (cell culture capacity required). The results are provided in Figure 5 and demonstrate the wide range of potential outcomes for cell culture demand. A similar type of analysis can be done for individual company capacity requirements [14] or for many other outcomes for which an assessment of risk is desired. Not only does the risk of possible outcomes need to be assessed, the cost of these outcomes must also be estimated if the company is to develop a true picture of the potential impact of various risk factors. One example in the area of capacity planning is the relative costs of underestimating vs. overestimating capacity requirements. To illustrate this, we conducted a simple analysis for a hypothetical monoclonal antibody product for an oncology indication. In this analysis, we compare the cost to a company of 50% under-utilization of capacity with the cost of a 50% shortage of capacity. The results are shown in Table 2 below. Case Figure 5. Results of Monte Carlo Simulation for Mammalian Cell Culture Capacity Demand Over capacity: 50% under-utilization of capacity Table 2. Cost of Inaccurate Capacity Planning Under capacity: 50% shortage of capacity Impact on Operating Costs Estimated carrying cost of facility operating at 50% capacity: $2-3M/month Estimated loss of operating profit: $40-50M/month Comments Based on proprietary model of capital and operating costs for 500 kg/yr facility Based on typical oncology MAb pricing. Does not include value loss due to reputation damage, enablement of competitors, etc.

5 Figure 6. Relationship between Development Phase and Project Discount Rate Similar analyses can be found elsewhere [15]; as is well appreciated by most in the industry, the cost of being short is far greater than the cost of being long. Once the proper assessment of risk has been completed, steps can be taken to properly manage risk. These may involve measures to improve the probability of a satisfactory outcome (as is possible in the case of reducing the probability of schedule delays for construction projects) or measures to minimize the damage caused by a negative outcome where probabilities cannot be easily influenced (as in the case of planning for manufacturing requirements of products in clinical trials). In any event, assessing and managing risk is undoubtedly a very important element of the make vs. buy decision. FINANCIAL CONSIDERATIONS: OPERATING AND CAPITAL The decision to make or buy will have a significant impact on a company s capital requirements and operating cost structure. Even though financial considerations often are not the primary driving force behind make vs. buy decisions, conducting sound financial analyses is an important part of the decision process if only to clarify the decision s financial ramifications. One method for comparing alternative approaches to manufacturing is to use discounted cash flow (DCF) analyses to estimate net present values for each approach. An important assumption in any DCF analysis is the discount rate that should be used for discounting future cash flows back to present dollars. As the risk of the project increases, the discount rate used should increase. There are many different ways of 5 estimating appropriate discount rates, which is beyond the scope of this article, but clearly the project discount rate decreases as the probability of success increases. One estimate of this variable as a function of product development stage is shown in Figure 6. Therefore, any technology or strategy that can defer capital commitments until risk is reduced (e.g., past Phase II or even interim Phase III results) will have significant value. Outsourcing is one such strategy, enabling biopharmaceutical firms to defer large capital investments in manufacturing facilities until after the product risk has been reduced. Typically, however, this benefit comes at the expense of reduced operating margins after approval. The reason for this is that the cost of production for firms who outsource manufacturing includes the cost of manufacturing a product plus the CMO s profit margin plus the company s internal costs associated with production. Many companies make the mistake of assuming that outsourcing requires no internal resources. (While certainly less resource-intensive than in-house manufacturing, successful outsourcing will require the use of significant internal resources, and these costs should be included in calculating manufacturing expenses.) Assuming the selling price of the product is fixed by market forces, this will generally result in higher operating expenses and lower gross margins for the biopharmaceutical firms who outsource. The decrease in gross margins resulting from the use of CMOs may be less than anticipated for several reasons. First, a high percentage of operating costs for biopharmaceutical products are fixed or only semi-variable (i.e., labor). Figure 7 shows the breakdown of operating costs by category, forecast by a state-of-the-art process economic model for a monoclonal antibody product. Since CMOs would be expected to operate at higher utilization rates than product companies, the overhead contributions to manufacturing costs for individual products would be lower than for a product firm with less incentive to maximize utilization efficiencies. Second, CMOs with significant manufacturing experience and knowhow may be able to operate at improved cost efficiencies, par

6 Figure 7. Operating Expense by Category for Typical Monoclonal Antibody Process at Varying Scales (courtesy Biopharm Services, Acton, MA) ticularly in comparison to firms with little in-house biopharmaceutical manufacturing expertise. In this case, even after adding back a CMOs profit margin, the difference in costs between in-house and outsourced manufacturing may be less than anticipated. The outsourcing trade-off between capital cost savings and increased operating expenses will be different for each make vs. buy decision because it depends on a number of factors, including: Scale requirement for manufacturing Manufacturing process Type of product Cost structure and business model of potential service providers Cost structure of in-house manufacturing capability Manufacturing capital requirements Development stage of the product Therefore, financial analyses should be conducted ab initio for each make vs. buy decision. Significant emphasis should be placed on development of thorough and accurate process economic models. This can be accomplished by working with a qualified firm specializing in this field or by developing of in-house models, using internally-derived or off the shelf process simulation packages. SUMMARY In recent years, the contract manufacturing sector of the biopharmaceutical industry has matured to the point where outsourcing manufacturing is a viable option for most products. As a result, the make vs. buy decision is a relevant decision for a large percentage of products and, increasingly, for firms of all sizes. In this article, we have reviewed some of the critical elements to consider in the make vs. buy decision, including: Outsourcing feasibility Strategic fit for in-house manufacturing Risk assessment and management Financial analyses 6 Some of the many factors that should be considered in each of the above elements have been described. Importantly, each company and product manufacturing requirement is different, so there is no generic correct answer for these decisions. In some situations either outsourcing or in-house manufacturing is so clearly favored that little analysis is required to support a decision; however, in many instances, this is not the case. The implications of the make vs. buy decision are often profound for the organization, in financial, strategic and other ways. Therefore, except in cases where the make or buy route is overwhelmingly obvious, investment in a thorough analysis to support this decision is easily justified. REFERENCES 1. Jackson, F. Genentech s Large Scale Cell Culture Facility at Vacaville, presented at Antibody Production and Downstream Processing, IBC USA Conference, Jan. 31- Feb. 2, 2001, San Diego, CA. 2. Machulski, J. Case Study: Lonza Biologics Cell Culture Contract Manufacturing Facility; Portsmouth, NH USA, presented at BioLOGIC USA 2003, Terrapin Ltd, Oct , 2003, Boston, MA. 3. Williams, G. Large Scale Manufacturing Facility Development: Balancing Speed, Cost, and Quality, presented at BioManufacturing, Barnett International Conference, Sep. 30-Oct. 1, 2002, Boston, MA. 4. Seymour, P. and Galliher, M. Make Versus Buy: The Continuing Debate of Managing Manufacturing Capacity. American Pharmaceutical Outsourcing, 3(1): (Jan/Feb 2002). 5. Herrmann, M. When Products Fail, Nature Biotechnology Supplement, 19(6), BE37-38 (2001). 6. Nicholson, I. and Latham, P. When Make or Buy Means Make or Break, Nature Biotechnology, 12(9) (1994). 7. Lias, R. Biopharmaceutical Contract Manufacturing at the Crossroads, BioProcessing Journal, 2(3): (2003). 8. Ottmer, M. Strategic Supply Chain Management at Biogen, presented at BioLOGIC USA 2003, Terrapin Ltd, Oct , 2003, Boston, MA. 9. Molowa, D.T. The State of Biologics Manufacturing, J.P. Morgan Securities, Inc., NY (2001); also Molowa, D.T. The State of Biologics Manufacturing: Part 2, J.P. Morgan Securities, Inc., NY (2002). 10. Ginsberg, P.L., Bhatia, S., and McMinn, R.L. The Road Ahead for Biologics Manufacturing, US Bancorp Piper Jaffray, NY (2002). 11. Chorav, M. Q Series: The State of Biomanufacturing If You Build It, Will They Come?, UBS Investment Research, NY (2003).

7 12. Levine, H.L. The Capacity Crunch Reality or Myth, presented at Production Economics & Manufacturing Strategies for Biologics, IBC Conferences, June 16-17, 2003, Brussels, Belgium. 13. Taylor, S., The Real Biomanufacturing Capacity Crisis Stainless Steel or Flesh and Blood, BioProcess International, 1(6): (2003). 14. Brastow, W.C. and Rice, C.W. Planning Pharmaceutical Manufacturing Strategies in an Uncertain World, BioProcess International, 1(6): (2003). 15. Mallik, A., Pinkus, G.S., and Sheffer, S. Biopharma s Capacity Crunch, The McKinsey Quarterly, 2002 special edition: Risk and Resilience: Thomas C. Ransohoff, M.S., is a Senior Consultant at BioProcess Technology Consultants, Inc. providing consulting services to companies involved in developing and manufacturing biopharmaceutical products. Mr. Ransohoff has over fifteen years experience in the biopharmaceutical industry, including management of process development, engineering, and cgmp manufacturing operations and development of novel purification technologies. He has held senior level positions at TranXenoGen, Dyax, and Repligen with significant business unit and operational management responsibilities. Mr. Ransohoff has a Bachelor s degree from MIT and a Master s degree from UC-Berkeley, both in chemical engineering. Thomas Ransohoff's article was printed in the March/April 2004 issue of American Pharmaceutical Outsourcing. Copyright rests with the publisher. For more information about APO and to read similar articles, visit and subscribe for free. 7