Applied Project

The Changing Biopharmaceutical Business Model: Contract Research Organizations in the Face of Economic Downturn

Name: Kyle Abuarjah Course: APRJ-699 Word count: 15,974 Applied Project Supervisor: Lee Ann Keple Submission date: December 8, 2009 Abuark-aprj-app Page 2

ABSTRACT

The current financial crisis has negatively impacted many corporations, consumers, and even governments. The impact of this crisis has been shown in several ways, some of which include depressed funding, inadequate access to capital and credit, and job losses. Once considered invincible to such economic downturn given its strong financial position and the constant need for drugs, the pharmaceutical sector has suffered a great deal this time around. The major challenges facing the industry can be predominantly attributed to increased regulatory scrutiny, reduced R&D funding, decline in drug output as a result of paten expiry, and lack of innovation. These challenges have been met by drastic changes in the industry business dynamics including consolidations, mergers and acquisitions (M&A), layoffs, partnership deals, and licensing deals.

Contract research organizations (CROs) provide a wide range of services for pharmaceutical and biotechnology companies in support of their drug development as they have developed the capacity, resources, and expertise to handle complex drug development projects. Contract organization’s main source of revenues is dependant on outsourced work by the pharmaceutical and biotechnology sectors. As a primary outsource partner, it is therefore natural that CROs macroenvironment be directly impacted by the changes taking place in the pharmaceutical and biotechnology sectors. The recent changes in the pharmaceutical and biotechnology sectors involving consolidations and M&A have influenced outsourcing resulting in project delays and halting of some distressing CROs quarterly revenues. This trend, however, is expected to last and outsourcing will continue if not increase upon completion and settling the logistic of these consolidations. Contract organizations are not nearly under the same pressure as their outsource partners in that they get paid whether the drug makes it to market or fails.

The purpose of this study is to examine the positioning of CROs in the context of the changes taken place with their outsource partners, the pharmaceutical and biotechnology sectors. In addition, the study explores the appropriate marketing and value proposition that will generate the best returns to CROs. The findings suggest that taking into account that drug development is a continuous process and that outsourcing will remain intact places CROs in a winning position, almost “recession proof.” Moreover, CROs will need to be more than ever customer centric and provide their customers with greatest value for their dollar.

The research design is based on secondary data sources and interpretive qualitative data. The study is based on environmental analyses and frameworks. The DEPEST framework was used to study to study economic, demographic, political, social and technological factors influencing the CRO industry. Strengths Weaknesses Opportunity and Threats (SWOT) were used to compare and contrast the industry. A competitor analysis was used to highlight the strength and weaknesses of Abuark-aprj-app Page 3 the major players in the CRO industry. The value discipline framework was used to provide a suggestive model for CROs to achieve leadership position in the current financial crisis. Finally, risk analysis was used to highlight the changing business dynamics as a result of the economic downturn and provide suggestions as how to mitigate the risks facing the industry.

The study proposes that revolutionary change in processes and organizational design is indeed essential in these times. Some of the major key findings suggest that companies need to be innovative in these times more so than during stable economic conditions to sustain their existence and customer base. Companies need to refrain from the old ways of doing business and follow drastic strategies such as continued growth through focused diversification, joint R&D, investing in emerging markets, and partnering. Through forward integration, companies can prosper and achieve economies of scale and scope they may not otherwise have been able to achieve on their own. Unexpectedly, CRO industry leaders appear optimistic in terms of expected increase in outsourcing by pharmaceutical and biotechnology companies. This positive has been supported by pharmaceutical companies increased focus on new therapies and technologies presenting new growth opportunities in an almost maturing market. Abuark-aprj-app Page 4

TABLE OF CONTENTS

ABSTRACT...... 2 INTRODUCTION...... 6 Figure 1: The Impact of the Economic Downturn ...... 6 Figure 2: Top 20 US Branded drugs ...... 7 INDUSTRY ENVIRONMENT ...... 8 Figure 3: Drug Discovery & Development Continuum ...... 9 Figure 4: Estimated CRO Total Market Revenue...... 10 Figure 5: CRO Market share 2006...... 11 RESEARCH QUESTION ...... 12 LITERATURE REVIEW ...... 13 ECONOMIC DOWNTURN...... 13 KEY LEARNING ...... 24 INNOVATION ...... 25 KEY LEARNING ...... 29 VALUE DISCIPLINES...... 30 INDUSTRY REPORTS...... 31 RESEARCH DESIGN AND METHODOLOGY ...... 33 ANALYSIS ...... 34 MACROENVIRONMENT...... 34 Demographics...... 34 Economics ...... 34 Political-Legal ...... 34 Ecological...... 35 Socio-Cultural ...... 35 Technological...... 35 SWOT ANALYSIS ...... 35 Opportunities ...... 36 Threats ...... 36 Abuark-aprj-app Page 5

Strengths...... 36 Weaknesses...... 37 COMPETITOR ANALYSIS...... 37 Covance Inc...... 37 MPI Research ...... 38 HLS ...... 38 VALUE DISCIPLINES...... 39 Figure 6: Pyramid of Value Disciplines...... 42 RISK ANALYSIS...... 42 Figure 7: Dynamics of CRO Business...... 43 RECOMMENDATIONS...... 44 Strategic Partnering ...... 44 Focused Diversification ...... 45 Expanding Portfolio...... 45 Global Reach...... 45 Mobilizing Human Resources...... 46 Customer Intimacy...... 46 CONCLUSION...... 47 REFERENCES ...... 48 APPENDICES...... 52 Appendix 1: CRO Classification ...... 52 Appendix 2: CRL Business Segments ...... 53 Abuark-aprj-app Page 6

INTRODUCTION

During 2007, the pharmaceutical and biotech sectors enjoyed booming success in terms of profitability and access to capital. The industry consumed a decade of healthy venture capital financing reaching up to $8 billion. When the 2008 global financial crisis approached on the horizon, it became clear that neither the pharmaceutical nor the biotech sectors would remain unscathed. The situation changed during the remainder of 2008, in which access to capital became limited and venture capitalist funding in biotech declined by 54%. In response, the industry has also seen several restructuring measures involving consolidations via merger acquisitions and extensive layoffs. In addition, it is expected that new drugs coming to the market will be put under increased scrutiny and potentially comparative-effectiveness challenges before accessing the market. This may further impact the number of new drugs to market (Bellott, 2009).

The impact of the global financial crisis has been severe and has affected various sectors of the pharmaceutical industry including innovation, outsourcing, investments, patients, generics, and sales and marketing, Figure 1. Innovation has been impacted due to cutbacks in R&D budgets resulting from decline in the number of new drugs approved. The reduction in R&D spending has also reflected on the amount of work outsourced, and thereby driving pharmaceutical companies to seek low cost countries for their research. Moreover, investors and venture capitalists have become reluctant to invest in start-up biotechnology companies given their low valuation in the current state of economy. The economic impact has gone as far as causing patients to delay their refills and resort to generic brands, and ultimately leading to growth in the generic segment. The aforementioned factors have lead drastic to restructuring measures in both the pharmaceutical and biotechnology sectors (Findlay, 2009).

Figure 1: The Impact of the Economic Downturn

Source: Frost & Sullivan (2009) Abuark-aprj-app Page 7

Ever since early 2008, many changes have taken place in the pharmaceutical and biotech sectors. The biggest problem facing the industry is the decrease in drug output with one third of drugs nearing patent expiry in three years, Figure 2. The industry’s initial response to this anemic pipeline is increased acquisition by buying smaller companies with promising drugs. An emerging trend has also been observed, where large pharmaceutical companies merging in attempt to aggressively expand their present drug pipeline. These changes and others such as layoffs, outsourcing and R&D spending cutbacks are inaugurating a new business model and a new era for the pharmaceutical and biotech sectors (Bellott, 2009).

Figure 2: Top 20 US Branded drugs

Source: Seeking alpha (2008

A common phrase has been coined, which seems especially appropriate: “Winners don’t do different things, they do things differently.” The economic crisis has forced executives, managers, and business owners to adopt new strategies to navigate through the current business downturn. Traditionally, during times of crises, companies tend to stay under cover and implement survival strategies to ride out the storm rather than taking the innovative approach. Survival strategies such as not acting, diversification, and focus on short-term goals; while conservative, have an underlying Achilles’ heel. Given the nature of our interconnected global economy, crises are note long-lasting and more often than not, unravel quickly. Therefore, businesses that remain stagnant and conservative during these times are ill-equipped to face the aftermath. Even though business may be slow during these times, the economy is bound to return to normal, hence promising future profitability. Therefore, companies need to recognize that they must re-evaluate their strategies and implement the appropriate contingency plans to prepare for the worst situation (Rigby, 2001). Abuark-aprj-app Page 8

Contract Research Organization (CRO) refers to service organizations that provide support to the pharmaceutical and biotechnology sectors. Contract Organizations offer wide range of outsourced services in support of drug development and advancement ranging from research and development (R&D) to clinical services. Over the years CROs have built considerable capabilities and have proven themselves to be able to expedite drug development and its time to market. By outsourcing their work to CROs, the pharmaceutical and biotechnology sectors have been able to convert their fixed cost to variable cost; and thereby focusing on core competencies (Kaiser, 2005). Contract Research Organizations (CROs) have enjoyed lucrative growth over the decades in support of the drug development process. Despite the economic downturn, CROs continue to build on their capabilities since they acquire their primary income from outsourcing by pharmaceutical and biotech companies. With all of these changes taking place in the pharmaceutical and biotech sectors involving expenditure cut backs, layoffs, consolidation, and restructuring; how will these changes impact the CRO industry and its operational environment?

This paper will examine CROs growth measures and niche-resilience within the harsh business conditions associated with the changing environment of the pharmaceutical and biotech sectors in terms of organizational restructuring, cost cutting on R&D, and outsourcing trends. In addition, the paper will assess the appropriate value added proposition framework with the best return on investment and sustainability for the CRO industry.

INDUSTRY ENVIRONMENT

The pharmaceutical industry is engaged in a highly competitive and risky market more so now than ever with constantly rising pressures. Some of these pressures facing the industry include regulatory scrutiny of price and quality, expensive trials, expiring patents, and the need to reduce time-to-market of new drugs. These pressures have resulted in hypercompetition in the drug discovery arena and include main players such as Pfizer, Johnson and Johnson, Bayer, Novartis, Eli-Lilly, and many others (Kaiser, 2005).

The drug development process is extremely intricate and involves six phases: discovery, preclinical, phase I clinical trials, phase II-III clinical trials, phase VI trials, and FDA submissions, Figure 3. The discovery phase involves the identifying a lead compound aimed at specific therapeutic target. In the preclinical phase, the lead compound undergoes safety and efficacy testing in laboratory animals. Phase I clinical trials is the “first-in-human” safety testing of the drug under controlled conditions in a small group of volunteers. Phase II-III clinical trials involve a broader population range to evaluate the drug safety, efficacy, dosage, and side effects. Phase VI trials involve post-marketing of the drug to support extended drug application. FDA submissions constitute the final stage, where the conclusion of each phase is submitted for FDA review and approval prior to commercialization of the drug (Kaiser, 2005). Abuark-aprj-app Page 9

Figure 3: Drug Discovery & Development Continuum

Source: UBS Investment Search (2008)

The drug development cycle is laborious and expensive, with pharmaceutical companies spending over $800 million over at least 10 years for each new drug developed. Of those drugs developed, only 5 are approved by the FDA, with 80 to 90% of the total $7 billion spent annually not reaching the market and a loss of $6 billion on patent expiration. These cost pressures lead to the need for process improvement through outsourcing the work to CROs (Noffke, Nikel, & Sullivan, 2004). As Käkönen (2008) describes, the increase in the outsourcing activities of biopharmaceutical companies is primarily due to pressures to reduce time-to-market of new drugs resulting from hyper-competition in the drug discovery arena. Outsourcing has allowed pharmaceutical companies to: . Focus on new drug innovation in order to sustain competitiveness and reduce time-to-market . Decreased spending on in-house facilities and expertise by converting fixed cost to variable costs . Use of state-of-the-art facilities and expertise provided by CROs

For many years, Contract Research Organizations have played a key role in support of drug discovery and development through their outsourced services. The CRO market has expanded dramatically in recent years driven by stringent preclinical Abuark-aprj-app Page 10 testing requirements by the Food and Drug Administration (FDA) and enhanced outsourcing activities by biopharmaceutical companies. The market as described by Arun Bhatt (2005) is segmented as follows:

. Pre-clinical: 17 % . Phase I clinical: 6 % . Phase II-IV clinical: 36 % . Central Lab: 12 % Central labs analyze samples to determine efficacy and safety of drugs being evaluated for clinical trials (UBS Investment Research, 2008) . Other: 29 % (ie, niche laboratories)

The CRO market is comprised of approximately 12 major CROs and approximately 800 smaller ones worldwide, Appendix 1. The CRO market is presently worth $10-14 billion a year with a growth rate of 10-16% annually; surpassing the overall annual drug development spending of 10%. The total CRO market is projected to reach $24 billion by 2010, Figure 4 (Greener, 2006).

Figure 4: Estimated CRO Total Market Revenue

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The CRO industry has many prominent players and is highly competitive. This promising industry is heavily reliant on biopharmaceutical outsourcing, and therefore their marketing strategies are directed at winning biopharmaceutical contracts. In 2005, the largest 10 CROs captured around 80% of the market share (Getz & Wagner, 2007). Abuark-aprj-app Page 11

The CRO outsourced market is growing exponentially and therefore large CROs are investing heavily on capitalization and maintaining long-term relationships with clients. The main competitors with respect to their market share are shown in Figure 5. The top four competitors based on market share include: Charles River, Covance, MPI, and Huntingdon Life Sciences (HLS).

Figure 5: CRO Market share 2006

Covance Other 20% 19% WIL 5%

RCC 5%

SNBL Charles River 6% 21% MDS MPI 6% Huntingdon 8% 10%

Source: CRL internal presentation (January 21, 2008)

Charles River Laboratories:

Charles River Laboratories (NYSE: CRL) founded in 1947, based in Wilmington, Massachusetts, is a Contract Research Organization (CRO) and one of the world’s leading fully –integrated providers of products and services to support the advancement of the drug discovery and development process. Charles River currently employs approximately 8700 employees worldwide, with more than 80 facilities in 15 countries. Charles River’s client base includes pharmaceutical companies, biotechnology companies, government organizations, hospitals, and academic institutions (www.criver.com).

Charles River has undergone several strategic changes throughout the decades initially as a product company then reinventing itself into both a product and services organization. This exponential growth is attributed to Charles River’s early vision, which was to ensure that it met clients’ drug development needs through a forward integration strategy and investing in growth by launching new businesses, expansion programs, and aggressive acquisition. The continuing success of this strategy was attributed to providing leadership products and services as well as focusing on core competencies. Charles River’s core competencies are concentrated in the following three segments, (Appendix 2): Abuark-aprj-app Page 12

. Animal Research Model Services (RMS) . Regulatory compliant preclinical services . Phase I clinical services

Charles River’s total revenues for 2008 were $1.343 billion with a 9.2% increase compared to 2007 despite macroeconomic slowdown. Charles River is financially stable with $82 million of free cash flow in 2008 (CRL Annual Report, 2008).

To win the hearts and business of biopharmaceutical companies and their multi- billion dollars of outsourced contracts, the successful CRO must provide a complete solution or act as a one-stop-shop for drug discovery trials. The criteria for choosing a CRO, as described by Arun Bhatt (2005), are based on:

. Expertise and diverse portfolio that can provide wide range of services to support large trials and different therapeutic areas . Strong reputation with superior quality standards to ensure regulatory compliance . Ability to meet timelines in delivering reports to allow for timely submission to regulatory agencies . Cost advantage given the size of patient pool, especially in phase III clinical trial, cost savings are essential . Financial stability of the CRO to ensure its stability and sustainability . Global presence to support pharmaceutical companies in their global expansion to low cost countries such as China and India

RESEARCH QUESTION

The research study will examine the following questions pertaining to the fields of strategy and marketing:

. How well-positioned is the CRO industry to deal with drastic changes in the pharmaceutical and biotech industry? . What marketing and value added propositions offer the best ROI (return on investment) in the CRO industry?

The research project will take into account well-positioned, ill-positioned, and start up CROs. Noteworthy is that the majority of examples referenced in answering those questions will utilize first hand experience and metrics from Charles River Laboratories. Abuark-aprj-app Page 13

LITERATURE REVIEW

While conducting literature review using online engines, a number of publications were found discussing the global financial crisis in relation to the pharmaceutical and biotech industry and management strategies to implement amidst crises. The literature review articles were categorized into three themes: economic downturn, innovation, and value disciplines. These three categories will provide a comprehensive overview of the financial crisis, general and industry specific, and how organizations need to respond to economic crisis to maintain a competitive edge. In addition, the value discipline model will be utilized to propose the appropriate value for the CRO industry to remain competitive and sustain its competitive edge.

ECONOMIC DOWNTURN

In the article “Moving Upward in a Downturn,” Darrell Rigby (2001) provides a comprehensive analysis on what successful executive should do in economic recession. In this article, 377 fortune 500 companies were analyzed and 200 executives were interviewed. The research concluded that economic downturn involves three phases: the gathering storm, eye of the hurricane, and clear skies on the horizon. For each phase, the article provides a comparison between the conventional approach and the contrarian approach. Rigby (2001) highlights that contrarians do realize that downturns are impermanent, and therefore prepare for ‘clear-skies’ with the following protocols:

. Building contingency plan into the culture . Avoiding diversification in other businesses and focusing on core business . Focusing on long-term solutions rather than quick fixes for survival . Making friends with stakeholder trapped in the same position . Spending on bargain acquisitions

Rigby (2001) argues that contingency planning is a critical factor in good and bad economic times. Under the conventional approach, executives do not act and are under the false impression that their company is safe. The contrarian approach advocates the importance of contingency planning and do incorporate it in their strategic planning and budgeting process to prepare for the worst despite its effect on organization’s morale. Contrarian executives plan ahead and account for potential economic mishaps well in advance as it is virtually impossible to plan in the midst of a downturn attributing to the stress factor involved. At Charles River, for example, contingency planning is essential and integrated into the budgeting process and marketing plans. This is accomplished through monthly reports forecasting the remaining quarters of the fiscal year as well as the first quarter of next fiscal year. These reports act as performance indicators and they allow business development and operations to act sooner by improvising the marketing plan and the strategic direction.

Diversification has traditionally been the logical approach to gaining market shares. Although appropriate for individual investors, for corporations it can lead to Abuark-aprj-app Page 14 diluting market share and increase vulnerability as a result of shift in focus away from core business. Rigby (2001) strongly recommends that in downturns companies need to concentrate and pour their resources on core strengths and competencies. Charles River has developed an outstanding reputation in animal research models and preclinical testing, and therefore has concentrated its resources and focus on these areas by building in-house capabilities and acquisition. Ever since the financial crisis of 2008, Charles River has completed three merger acquisitions including Molecular Imaging Research (MIR), Piedmont Research Center (PRC), and Cerebricon Ltd; respectively. The three acquisitions will complement CRL’s core business focus on animal research model and will strengthen its position in drug discovery services and its commitment to support the drug development continuum.

In downturns, companies fall into the trap of seeking short-term solutions involving aggressive cost cutting measures such as drastic reduction in budget and capital expenditures, service offering, and staff to improve the bottom line. While effective cost management is essential and integral part of any operation, companies need not to be myopic and must act consistently in both downturn and upturn. The author highlights that contrarians recognize that downturns are temporary and seek long-term solutions such as lean operation, inventory reduction, improving cycle times, and building strong relationships with stakeholders. In response to the current downturn, Charles River has applied several restructuring measures. For example, to achieve lean operation, CRL has implemented Six Sigma initiatives. In its restructuring efforts as a result of business slowdown and approximately 13% decrease in sales, CRL has laid off 115 employees. This layoff is expected to provide cost savings of $40 million.

One cannot overemphasize the importance of relationship building to ensure customer loyalty. In downturns, companies need to maintain good relations with employees, partners, customers, and suppliers. Rigby (2001) argues that layoffs can offset the intended savings in the long run as a result of incurred costs such as severance, talent loss, reduced morale, rehiring, and retraining. Companies such as Southwest Airlines, FedEx, and Harley Davidson have been able to build impeccable relationship with their employees by having a “no layoff” policy. For example, Charles River has focused its attention on the customer by building partnerships through preferred customer agreements, primary point of contact, and fast response time. These relationships will pay off once the storm has blown over.

In downturns, companies tend to steer away from acquisition giving the limited resources in the face of the unknown. Rigby (2001) contends that, “clear winners in a downturn don’t lock their purses; they spend on bargain acquisitions” (p. 103). These acquisition are thought to reduce risk and volatility if they were focused and in line with the core business. As indicated above, CRL has completed three focused acquisition during the current downturn. These acquisitions believed to strengthen CRL’s market position in drug discovery. Abuark-aprj-app Page 15

By utilizing the above measures, businesses should be able to thrive above the storm. Rigby (2001) contends that “failure to strengthen a company during downturn can leave it in a much tougher position afterward “(p 104). The article concludes by stating that in economic downturns, successful progressive companies maintain a long- term view and work hard to gain the loyalty and trust of their stakeholders. Following the downturn, those companies maintain their leadership position as they have surpassed the competition.

The article by Rigby provides a thorough analysis based on the perspective of 200 executives and companies that were able to whether the crisis. The article will provides an excellent resource with regards to what is normally done by conservative companies versus progressive ones. The article by Rigby further highlights the measures taken by progressive companies to weather economic bad times. While the article provides a promising general analysis of the three value disciplines, it lacks the specific metrics required for performance measures that are essential for the purposes of this analysis.

In his article “A Season of Turbulence,” independent consultant Dr. Emile Bellott (2009) thoroughly examines the changing biotech industry in response to the global financial crisis and further discusses the potential implications for the advancement of the global pharmaceutical and biotech industry. Dr. Bellott illustrates how the financial crisis has adversely affected the biotech and pharmaceutical sectors, especially emerging biotech companies with negative cash flow, limiting access to capital. As a result of limited capital funding, small and medium biotech companies have adopted various cost containment measures to survive including layoffs, acquisition, and shelving or selling programs. In contrast, large biotech and pharmaceutical companies, who are well-positioned with high revenues, are capitalizing on these emerging biotech companies through acquisition, partnering, and licensing. Consequently, biopharmaceutical companies are consolidating to build up their own capabilities and improve their anemic drug pipeline through merger and acquisition (M&A) to respond to the growing demand for healthcare and pharmaceutical drugs. This growing demand is in response to an aging population, increased penetration of developing markets, and increased worldwide population. Dr. Bellott provides several examples of current significant M&A to include: Lilly-Imclone, AstraZeneca-Medimmune, Merck-GlycoFi, Merck-Sirna, and Roche-Genentech. He concludes with an overview of the industry in the New Year as follows:

. Continued trend toward M&A and partnering by larger companies . Venture capitalists will be very selective in their investment strategies . Large biotech and pharmaceutical companies will continue to seek acquisition deals to improve their capabilities and drug pipeline

In another article “Adaptation to the New Industry Landscape,” published July 2009, Bellott examines the strategies taken by industry leaders to reposition their Abuark-aprj-app Page 16 organization and create value in these challenging times. Until recently, the pharmaceutical industry has always been considered “recession-proof” given the nature of the industry and that there will always be need for drugs. Due to the fact that the current recession occurred much more rapidly compared to the previous downturns, immediate action to implement safe-guarding strategies is even more essential to rise from the cycle on the upswing.

Bellott references Lynda Applegate, of the Harvard Business School, who states that “disruptions in the economic and competitive business environment present an opportunity to identify and implement value-creating innovation. Successful organizations do so by identifying the areas they can utilize, and focusing their energies on innovations that produce economic value” (p. 14). Applegate argues that these innovations include not only product, but intangible assets such as intellectual property, business practices, and alliances.

Bellott illustrates that in order to maximize value creation and competitive advantage in the present chaos, industry leaders need to take advantage of the situation using strategies that are in line with the industry. Bellott highlights some of these strategic options taken including consolidations, M&A, cost control, new product strategies, and investing in emerging markets. These strategic options will enhance financing activities as well as build external drug pipelines.

The article provides a vivid overview of the pharmaceutical and biotech industry’s response to the current crisis complemented by current changes taken place in the industry. It will support the scope of this paper since CROs are the primary outsource partner and its environment is directly impacted by the changes that take place in the pharmaceutical and biotechnology sectors.

In his article “Build Up in Down Time: Use this Economic Downturn to Become a Stronger Competitor,” Mark Smith (2009) examines the present dilemma of economic downturn. Smith (2009) compares this recession period with the Great Depression taken into account soaring GDP growth (gross domestic product), stock market decline, consumer spending, personal consumption, unemployment, and inflation. He concludes the article by emphasizing that during economic downtime; companies should reengineer processes to come out stronger competitors by looking for means to be more effective and efficient, controlling costs, and adding value to clients. He also makes the following recommendations during these times:

. Maximizing personal resources . Improving employees’ morale . Investing in process improvement . Completing unfinished projects or ones that have been previous put on hold . Making strategic investments Abuark-aprj-app Page 17

The article by Smith provides excellent general recommendations as to how to weather the economic downturn. The main limitation to this article as it applies to this proposal is that the article primarily deals with printing companies rather than the area of this research. The strategies outlined in the article are related to both industries despite that it does not address the service sector to which CROs belong.

In his interview with Charles River Laboratories Chief Executive Officer Jim Foster on Reuters titled “Charles River a Recession Proof Safe Haven?” Bill Berkrot (2009) presents Foster’s views on why he believes that Charles River is recession proof in light of the economic crisis. Charles River Laboratories (NYSE: CRL) founded in 1947, based in Wilmington, Massachusetts, is a Contract Research Organization (CRO) and one of the world’s leading fully –integrated providers of products and services to support the advancement of the drug discovery and development process. Charles River currently employs approximately 8000 employees worldwide, with more than 80 facilities in 15 countries. Charles River’s client base includes pharmaceutical companies, biotechnology companies, government organizations, hospitals, and academic institutions. Berkrot (2009) describes that while pharmaceutical and biotech companies are undergoing expenditure cut back and layoffs, many CROs have been growing at an exponential rate in spite of the financial crisis. Jim Foster explains that since the CRO industry is heavily reliant of outsourcing, the changes impacting the pharmaceutical industry are working to the CRO’s advantage. Changes such as expenditure cut backs or layoffs will result in steady if not increased outsourcing trends by pharmaceutical companies. Foster highlights that the pharmaceutical industry is suffering through another dilemma involving anaemic drug pipeline with one third of the drugs coming off patent in the next three years resulting in the present trend of consolidation. In response, CROs have been building up more capacity and hiring new staff to be able to accommodate anticipated increased outsourcing. Jim Foster concludes by stating that Charles River has a 5-year strategic and expressed confidence in maintaining steady growth for the next 3 to 5 years.

The interview provides essential information regarding the changes facing the CRO industry both structural and environmental. While this short interview is very forward looking and optimistic, and supports the argument of this proposal that CROs are well- positioned and are sustainable in the midst of such crisis, it fails to provide insights on the competition and the fact that pharmaceutical companies are becoming more sensitive to price. In addition, this article overlooks factual data and only focuses on a biased individual perspective of an optimistic CEO.

In his article “Contrasting Strategic Response to Economic Recession in Start-Up versus Established Software Firms,” Scott Latham (2009) analyzes the relationship between firm size and organizational response to changing environment. In this study, Latham surveys 137 software executives and their strategic response to the economic recession of 2001-2003 drawing upon Hofer’s model for turnaround strategies. Hofer’s Abuark-aprj-app Page 18

model suggests that strategic response to internal or external threats can take the form of three operating strategies involving revenue generation, cost reduction, or asset reduction.

The article highlights the variation in response the firm size plays. Larger firm, on one hand, leverage on competitive advantages gained through economies of scale, economies of scope, and experience. On the other hand, smaller firms leverage on flexibility in structure and processes. In this study, Latham examines three hypotheses (H) regarding firm’s response to economic recession using Hofer’s framework as follows:

. H1: Smaller firms have higher tendency to apply operating strategies involving revenue generation than larger firms . H2: Larger firms have higher tendency to apply operating strategies involving cost reduction than smaller firms . H3a: Smaller firms have higher tendency to apply operating strategies involving asset reduction than larger firms . H3b: Larger firms have higher tendency to apply operating strategies involving asset reduction than smaller firms

The study findings concluded that H1 and H2 were supported (p < 0.01 and p < 0.05, respectively) indicting that in economic recession smaller firms do have higher tendency to apply revenue generation strategies, while larger firms have higher tendency to apply cost reduction strategies. As for H3a and H3b, the findings indicate that there is no difference between smaller and larger firms, hence it is not supported.

The article provides valuable information and validated empirical data regarding Software firms’ response to economic recession using Hofer’s model. In spite of that, there were several limitations to this study. These limitations were as follows:

. The study design was primarily focused on firms that survived the recession creating a bias . The study scope was concerned only with software firms during the 2001 recession lacking generalization and other recession periods . The majority of smaller firms were privately held, and therefore data was not easily available. This could have impacted the comparison between larger and smaller firms

Overall, the findings of the study provide a great guidance to managers in smaller firms and how to weather economic downturn.

In their article “Managing in Difficult Times: Lessons from the Most Recent Recession,” Ronald Bigelow and Peng S. Chan (1992) provide an overview of how businesses react to economic downturn and highlight important strategies that should Abuark-aprj-app Page 19 be considered during these harsh times. Of these strategies, the article highlights the following: planning, cost-cutting measures, core strategy versus diversification, and restructuring. As well, it touches on some positive aspects associated with recession.

The authors present the main problems facing organizations when dealing with recession. They compare the differences between US firms and Japanese, arguing that Japanese firms are better positioned to weather economic recession than US firms. They reason that Japanese firms are typically concerned with long-term growth as opposed to US firms, where they are concerned with quarterly profits to satisfy their shareholders. Another problem the authors indentify is that businesses, American firms in particular, lean towards traditional solutions to major problems as a result of increased competition as opposed to Japanese strategy which aims for long-term solutions. Some of the traditional solutions employed involve drastic cost cutting measures to improve the bottom line, which will ultimately lead to loss of market shares such as layoffs and budget cutbacks on R&D and advertising. The authors highlight that cost reduction is necessary in recession times but must not be the only recessionary strategy. They move on highlighting strategies to consider in economic downturn.

Bigelow and Chan (1992) argue that planning before the crisis is very critical and use Delta Airlines as an example. Delta airlines includes recession contingencies in its ten- year plan, which has allowed it to be better positioned than competitors in those times. They recommend that such plan should include cost-cutting methods and components as soon as recession takes place. Even though cost-cutting is an ongoing process to improve efficiency, when cutting costs and changing prices firms should be cautious and ensure that the changes would help preserve market shares and long-term growth. In doing so, companies need to be conscientious not to compromise customer service, advertising, servicing, and R&D. In addition, the authors suggest another cost cutting method, where managers need to trade prices for volume as well as reduce debts.

The authors discuss whether companies should choose core versus diversification strategies. Bigelow and Chan (1992) highlight that such decision will impact the company in good and bad times; therefore, it must be well calculated decision. A core strategy is a long-term deal and requires commitment, while diversification involves buying and selling business depending on changing environment. Furthermore, the article provides an overview of the most common restructuring methods, which involve investing in technological changes and downsizing. Investing in technological changes is highly preferred by Japanese firms, while downsizing is more commonly applied by US firms.

The authors conclude by highlighting some positive aspect to recession for those firms who view recession as an opportunity. Some of these aspects are as follows: Abuark-aprj-app Page 20

. Companies with cash and low debt ratio may be better positioned to occupy market shares from those unfortunate firms . Companies may be able to improve their employee pool with top talents resulting from lay-offs or fear of losing jobs . Finding investment opportunities that are non-existent in good times

Overall, the authors provide a great general analysis of how to weather recession, yet the scope was myopically focused on strategies applied to Japanese and US firms and did not account for the global interdependence of economies and how management is applied in these diverse situations, .

In “No Time to Panic,” Matt Semansky (2008) provides a Canadian perspective on the current recession. Semansky uses differing opinions from the Canadian marketing community on how this recession will impact Canada. Semansky references Howard Breen, chair and CEO of MacLaren McCann in Toronto, who believes that Canadians conservative attitude towards taking debts as opposed to Americans might lessen the impact of this downturn. On the other hand, Geoffrey Roche, founder and chief creative officer at Toronto's Lowe Roche, believes that Canada is not immuned to recession its largest trading partner is facing. In addition, Roche believes that despite their negative impact, recessions are necessary for businesses to evolve as a form of business Darwinism.

Semansky highlights the importance of increased marketing activities during these times and references Ken Wong, marketing professor at Queen's University in Kingston, who argues that during bad times and the cost-cutting measures that follow; marketing budgets and staff are the first to be slashed. Wong contends that such short-term fix will have great ramifications in the long run leaving those companies in a bad position. Arlene Dickinson, president of Calgary's Venture Communications states that, “A recession's not the time to hide, it's the time to get aggressive, assuming you have a strategy that's lined up to your business” (p 30). In addition, Dickinson refers to several recession studies in the Harvard Business Review, where each of these studies demonstrated that companies that cutback on advertising in downturns did not perform as well as companies that did not.

Semansky uses Nissan Canada as an example for their recession strategy for 1992. During this period, Nissan Canada launched it “satisfaction commitment” campaign. This campaign positioned Nissan Canada as a service-oriented company and resulted in 12% increase in market share, while the overall automotive market dropped by 10%. Additionally, a McGraw-Hill Research study of the activity of hundreds of U.S. companies during the recessions of 1974 and 1981 showed that companies that maintained or increased advertising spending during 1974 recession gained 132% growth by 1978 as opposed to 79% for those that decreased advertising budget. The study demonstrated that Marketers who were aggressive during the 1981 recession Abuark-aprj-app Page 21

gained 275% sales growth by 1985, while companies that decreased spending averaged at 19%.

Semansky concludes by emphasizing that during bad times, marketers should not hide. Instead, they should be aggressive. The article provides a great view with differing opinions from America’s closest trade partner. However, the article is narrow in scope and limited to marketing activities discounting other cost-cutting measures that take place during recessionary periods.

In their article “Moving Ahead Amid Economic Uncertainty,” presented at the Informex conference held in San Francisco, Vincent Valk and Alex Scott (2009) provide an overview of the chemical industry’s response to the economic downturn. The article conveys that despite the industry’s concerns over the current market conditions, the fine and specialty chemical suppliers do feel that they are well-positioned to ride out the storm. According to a survey by consulting firm BioPlan Associates, biopharmaceutical manufacturers are expected to spend more on downstream technologies than capital equipment for 2009. Valk and Scott, on the contrary, argue that as a result of restructuring programs by many pharmaceutical companies accompanied by cost cutting measures; outsourcing work to contract manufacturing partners has increased presenting growth opportunities. The article highlights examples of Contract Manufacturing Organizations (CMOs) who have actively pursued capacity expansion such as Wuxi AppTee (Shanghai), Bachem (Switzerland), CiVentiChem (Cary, NC), Almac Sciences (UK), and Sigma-Aldrich Fine Chemicals.

The article provides an outlook into the impact of the downturn on another pharmaceutical outsource partner, CMO. Valk and Scott demonstrate how this crisis indeed benefited the CMO industry leveraging on increased outsourcing trend by the pharmaceutical industry. This is comparable to the impact on the CRO industry, and therefore will support the scope of this paper.

In his industry outlook report “Down But Not Out,” Jim Miller (2009) provides a comprehensive overview of the CRO position in light of the present economic and financial crisis using survey results from a sample of 250 respondents (25% from service providers and 75% from biotechnology and pharmaceutical companies). In this report, Miller highlights that “the contract services industry may not be as robust in 2009 as it has been in previous years, but it's not as bad as many people think” (p.1). As a result of decline in early development outsourcing attributing to funding cutbacks and restructuring measures, the CRO market has experienced turbulence. Based on the survey results, Miller states that the years to come will be very challenging given all the changes taking place in the pharmaceutical industry; especially involving R&D spending. Nevertheless, opportunities are existent and that CROs need to be vigilant and understand client needs and expectations. Abuark-aprj-app Page 22

Miller provides a great overview of the CRO industry environment in light of the changes taking place in the pharmaceutical industry. The article provides data collected from the survey evaluation. Since the data were collected from respondents from within the industry, the article will support the scope of this paper. In “Limits to Growth?,” Jim Miller (2009) a new strategic direction of one leading CRO, Pharmaceutical Product Development Inc. (PPD). PPD, based in Wilmington, NC, is a top player in phase II-IV clinical research with $1.5 billion in revenues. On April of 2009, PPD announced an acquisition of Magen Biosciences and a divestiture to sell its Piedmont Research Center (PRC) to Charles River Laboratories. Magen Biosciences is a biopharmaceutical company that specializes in dermatology compounds. PRC is a small CRO that provides in vitro and in vivo discovery-stage research and evaluation of anticancer agents and therapies. This move by PPD, aimed at long-term growth, indicates diversification into proprietary drug development. Fred Eshelman contends that, “But with big Pharma radically restructuring its pipelines and outsourcing most clinical research, PPD's growth opportunity is probably declining. Further, given PPD's large revenue base, acquisitions in other service areas such as Phase I won't "move the needle" on revenue growth” (Miller, 2009, p.1). The compound partnering program was initiated in 1998, where PPD absorbs the costs of early development and generates revenues through licensing fees, milestone payments, and commercial royalties. This program has only generated $33 million from Dapoxetine, licensed to Johnson & Johnson for genitourinary indications, and Alogliptin, licensed to Takeda (Tokyo) for diabetes indications. Despite the low revenues generated from this program, it presents a low risk given the low costs of early development. This type of partnership may become a new venture for other CROs. This article provides a great example of a top player who sought a strategic option for long-term growth and competitive advantage sustainability. This scope of this article is pertinent to clinical and does not assess the impact of this strategic direction on the preclinical segment. This is a novel partnership idea in the CRO industry and may be utilized more so now in light of the financial and economic downturn.

The pharmaceutical sector has traditionally been less affected by fluctuations in the economy due to the inelasticity in demand for healthcare. Booz & Company (2009), a leading global consulting firm, conducted a study to examine the impact of the current economic and financial crisis on the pharmaceutical sector. The study provides also suggestive strategic moves, in which pharmaceutical companies can adapt to manage their business during the crisis and strengthen their position.

Many industries such as the automotive, chemicals, and construction have been severely impacted as a result of the financial crisis and its ramifications including capital shrinkage. The pharmaceutical industry, on the other hand, remains resilient and attractive to investors. For example, the revenues for the top 20 pharmaceutical Abuark-aprj-app Page 23 companies increased by 9% between 2007 and 2008, and projected to increase by 3.5% in 2009. The current downturn is different; however, and will potentially impact the pharmaceutical sector. This can be attributed to the fact that governments are looking for ways to contain healthcare budgets by restraining expenditures and patients cutting back on out-of-pocket spending.

To respond to increased pressures by governments to reduce healthcare budget, increase generic replacement, and stringent regulatory requirement; the study suggests that pharmaceutical companies must lower their cost structure and improve variability. In order to do so, no cost should be fixed but rather flexible using such measures as outsourcing, channel substitution, and enhancing R&D efforts. The average net debt for the top 20 pharmaceutical companies is 6% with access to $7.5 billion in cash, cash equivalents, and short-term investments; the article suggests that pharmaceutical companies should leverage on their strong financial position to develop innovative products to replace the ones going off patent. Noteworthy is that 50 pharmaceutical companies will experience patent expiration by 2012 for a total value of $84 billion. The article recommends licensing, acquisition of small biotech and pharmaceutical companies, as well as partnerships as means of strengthening their position and replenishing the anaemic pipeline. The article concludes by emphasizing that pharmaceutical companies need to have an overall game plan to effectively take advantage of opportunities.

The study provides a great insight on the current economic downturn and its impact on the pharmaceutical industry. The article will be of great value for the scope of this paper in providing issues, statistics, and recommendations on how to move forward.

In Frost and Sullivan, a global consulting firm, market insight “What Does the Global Economic Downturn Mean to the Pharma Industry?;” Sylvia Findlay analyzes the impact of the economic downturn on the pharmaceutical and discusses the trends that came about as a result. In this report Findlay provides an overview of the pressures facing the industry such as pricing, regulatory, and pipeline shortage. In addition, Findlay illustrates other factors impacting the industry involving innovation, outsourcing, investments, patients, generic substitutes, and organizational structure. Findlay concludes the report by stating that government intervention is essential to resolve this crisis that could last otherwise for 5 to 6 years. Some of the suggestive government actions include increasing liquidity to support drug development, tax benefits, and rat cuts to venture capitalist to encourage investment in the biotech sector.

As the CRO industry environment is directly affected by the pharmaceutical and biotechnology sectors, this article provides a great insight into the parameters that could impact the CRO industry as well. Abuark-aprj-app Page 24

KEY LEARNING

Downturns are naturally recurring fact of any business impacting both service and product industries alike. The symptoms of downturns include demand shrinkage often resulting in price decline, limited access to capital and credit, and soaring GDP. These symptoms have been well noted in the current economic crisis, which is thought to be the worst global financial crisis since the Great Depression of 1929. Demand has reached its lowest and in some instances almost obsolete as observed in China’s exports biggest decline in a decade by 17.5% in January of 2009. With Banks being exacerbated with debts, access to credit has become scarce despite government efforts to infuse capital into the system. The global GDP growth for 2009 as indicated by the International Monetary Fund (IMF) is projected to be at 0.5% well below the standard recessionary GDP of 3%. These signs do not spark optimism but rather gloomy future ahead (Foo, 2009).

A common oversight is to believe that any industry is safe in normal or turbulent economic periods although the impact is noted the most during economic recessions. Given the severity of downturns noted above, companies need to be prepared to deal with such debacles at all times. Unfortunately, most companies believe that they are in good condition and continue to operate in the same manner as they always have. The most common approaches to economic crises are conventional in nature and short term involving drastic cost cutting measure across the board ranging from R&D spending to employee headcount. Although these approaches are logical in the short run, they have an adverse effect in the long run damaging the company’s competitive position (Rigby, 2001).

Downturns are evolutionary and signal a time for change in processes and ways of doing business. In spite of the common belief that the pharmaceutical industry is immune to recession given its strong financial position and the continuous need for drug development; many changes have taken place ever since the financial crisis of 2008. The industry’s response has been shown through restructuring and cost containment measures coupled by increased M&A, partnering, and licensing deals. The main goal of these actions have primarily concerned with improving drug pipeline to maintain a strong competitive position (Bellott, 2009). These restructuring measures and spending cutbacks have resulted in decreased early drug development outsourcing, and ultimately impacting the CRO industry as whole (Miller, 2009).

Upon review of the various literature articles regarding economic downturn as shown in the above section, several strategies have been provided in dealing with a downturn with a common theme emphasizing revolutionary change that is long-term oriented as the old ways of doing business no longer apply. For example, Rigby (2001) argues that downturns are temporary and that companies need to prepare during downturns to prosper in upturns; and therefore he suggests swaying away from the conventional approach towards a contrarian standpoint. To strengthen ones position in Abuark-aprj-app Page 25 preparing for the upturn, the contrarian approach recommends the following strategies: implementing contingency plans as part of company culture, focused diversification through bargain acquisitions, focusing on long-term solutions, and ensuring good relations with all stakeholders. Such drastic changes do require enormous amount of resources and capabilities mainly possessed by large corporations. Overall, companies need to consider a downturn as an opportunity to reevaluate their current strategies to weather the storm and prepare for the upturn.

INNOVATION

The world is experiencing an unprecedented financial crisis shown in decreased demand, limited access to capital and credit, bankruptcies, and increased unemployment rate. In response to reduced sales, many companies have adopted traditional cost cutting strategies to be more efficient and survive the storm such as budget cutbacks, reduced R&D spending, and layoffs. Today, more than ever, companies need to be proactive in thinking differently and strategically to withstand the competition and overcome the economic downturn. With limited resources, companies have to do more with less, and therefore Innovation has become critical means of survival in these times. Crisis brings change, and therefore no time is better than now to innovate, as the Eskimo proverb says “the storm is the time to fish.” The following selected articles will shed some light on innovation and will offer innovation strategies companies can adapt.

In BusinessWeek’s article “Innovate Out of the Economic Downturn,” Sami Mahroum argues that economic downturns can indeed be positive in that they drive companies to become more efficient, effective, and change their old ways of doing business. Mahroum (2008) begins by summarizing how companies react to recession starting with downsizing and cost-cutting. Mahroum contends that spending on innovation is the first victim of such cost-cutting measures even though it is the most important factor to transforming this predicament to an opportunity. As a result of resource constraints, companies need not to stand still or delay less promising projects but rather need to be creative by investing in innovative capabilities during economic downturns to prosper when growth returns. The article highlights the role of governments in supporting companies to remain innovative during these bad times. Mahroum argues that governments should realize the importance of these enterprises as a whole and protect them as much as a financial sector. These innovation systems are highly influential, in which economies are dependant upon. Mahroum provides two examples, in which governments have played an important role in supporting small businesses during bad times. First, the British Innovation Advisory Services model, where government-supported consultants are loaned to companies. Second, the Dutch voucher system, where the government provides small companies with vouchers allowing them to utilize the expertise they need from public research institutes. Abuark-aprj-app Page 26

Mahroum recommends four ways in which governments can help their countries recover from a downturn: . Injecting capital: increase funding for science and technology (S&T) . Globalization: leverage on cash-rich countries such as China, the Gulf, and Japan for international investments in S&T . Focusing on public programs: increase funding for public S&T programs . Supporting talents: support potential entrepreneurs of skilled workers made redundant in specific sectors The four ways recommended by Mahroum are highly relevant and essential to contract organization’s health and sustainability. The government role as a salient stakeholder in drug development cannot be underestimated in stimulating the industry by infusing cash, attracting foreign investment, supporting public programs, and supporting skilled talents and availability. The biotechnology sector accounts for 32% of total R&D market share up from 23% in 2003. Since the biotechnology sector does not have the same infrastructure enjoyed by the pharmaceutical sector, they rely heavily on government funding and external investors. Therefore, if biotechnology companies are not able to secure enough funding for their drug development, this resource constraint will impact CROs by halting development and trials. Since 2008, government funding has experienced a decline, and therefore pharmaceutical companies partnering with smaller biotechnology and pharmaceutical companies has provided small players with access to cash (UBS Investment Research, 2008). The government can play a crucial role in attracting foreign investments to enrich economies in terms of drug development and research. The Canadian government both federal and provincial, for example, has pursued this strategy in 1985 by providing tax credits to fund scientific and technological R&D through a program called Scientific Research and Experimental Development (SR&ED). The objective of this system is intended to provide reduction in tax payable and cash benefits to individuals, private, and public corporations conducting R&D work in Canada. This system contributes $3 billion per year in R&D funding and has benefited the CRO industry by increasing development work (Hearn, 2003). In addition, the government can stimulate the scientific sector by funding S&T educational programs. Government funding of such programs can create a rich pool of skilled talent. The CRO depends heavily on the availability of skilled workers to conduct trials effectively. The lack of human resources can result in study delays, and ultimately impacting growth (UBS Investment Research, 2008). As shown above, the government’s role cannot be dismissed as a key player in drug development and CRO growth. The article provides a very positive perspective on recession and what governments should do to support companies in these bad times. Abuark-aprj-app Page 27

The recommendations provided in the article are general in nature and may not apply to countries that lack the capacity and resources. In a recession, companies tend to cut back on research and development in attempt to focus on core projects. The drawback to this focus is that while companies prioritize only revenue-generating projects, they may leave out many promising projects; thus halting growth. To counter this problem, open innovation has been suggested as a solution. Open innovation involves the free flow of intellectual property (IP), people, and ideas into and out of the organization (inside-out) as opposed to the traditional outside- in open communication, where companies rely on outside sources to create ideas. For example, Eli-Lilly launched a project called Bounty Chem, which became known as Innocentive to improve the sourcing of ideas for the development of new drugs. This program was a source for multiple customers including academic institutions, public organizations, and non-profit organization, who are seeking breakthrough innovation. The risks and costs of this program were shared by multiple customers and Eli-Lilly only paid for the services it used.

In their Harvard Business Review (HBR) “Web Exclusive: Use Open Innovation to Cope in a Downturn “ (2009), Henry Chesbrough, of Berkeley's Haas School of Business, and Andrew Garman, of New Venture Partners, suggest five strategic moves that open up the door to inside-out innovation: (1) become a customer or supplier of your former internal projects by establishing close business relationships with outside firms that would take over projects and allows you to benefit from any future success; (2) let others develop your nonstrategic initiatives by licensing out projects to outside investors who can carry out the project and lessen your load. The secret is retaining some equity; (3) make your intellectual property (IP) work harder for you and others. This unused IP can generate licensing income when placed at other companies; (4) grow your ecosystem, even when you are not growing. This can be accomplished by being a visible part of the value chain and becoming a preferred partner, which would strengthen ones relationships. The CRO industry has experienced a new trend moving towards preferred vendor agreements and partnership deals, as noted in the recent partnership deal between Eli-Lilly and Covance. This trend will uniquely position CROs to leverage on pharmaceutical companies shift towards outsourcing (UBS Investment Research, 2008); and (5) create open domains to reduce costs and expand participation by bringing projects into a public domain. For example, to prevent biotechnology companies and other organizations from patenting key parts of human genome sequences, Merck launched its Gene Index project. Through this project, Merck funded several university human genome projects and made the findings available to the public domain, where it can be used by everyone but no single sequence can be patented.

The article goes in more depth to include the human factor and does emphasize the difficulty in implementing the aforementioned moves. Unlike the article by Sami Mahroum (2008) that was limited in scope, this article does provide a great insight about the advantages of innovation and its impact on the organization as a whole as well as Abuark-aprj-app Page 28 how to implement those moves. The article does, however, lack the application of this concept to service industries.

The current economic downturn has presented many challenges to companies, especially with regards to innovation strategies. As most companies decrease their R&D budgets during bad times, the literature argues otherwise and rather reiterates the importance of remaining innovative in good and bad times. One topic that has become popular in recent days is open innovation. In his article “How open innovation can help firms during the downturn” (2009), Wim Vanhaverbeke, Professor of Strategy and Innovation at Hasselt University, Belgium, builds on Chesbrough and Garman’s HBR article (2006) by providing five additional benefits to open innovation in bad economic times. Open innovation is defined as “the use of purposive inflows and outflows of knowledge to accelerate internal innovation, and expand the markets for external use of innovation, respectively” (Chesbrough, 2006, p.1).

In this article, Vanhaverbeke provides insights on how can open innovation help companies reduce costs and bring forth growth opportunities. He highlights the following five benefits of open innovation: (1) cash is not only king, but opens new strategic options for financially sound companies; (2) profiting from a depressed venture capital market; (3) increasing R&D efficiency through joint R&D; (4) profit from the emerging technology markets; and (5) use open innovation to speed up your globalization strategy. The article expands further on how to create open innovation community in Europe and how to teach this subject matter. Overall, the article recommends leveraging on start-up companies in need for cash, co-operation, joint ventures, and strategic alliances.

The aforementioned benefits of open innovation presented by Vanhaverbeke have significant application in the pharmaceutical industry at large; especially in the current turbulent market conditions. As pharmaceutical companies strive to improve their drug pipeline and expedite product time to market, open innovation has become integral part of the industry business model. Open innovation strategies pursued by large pharmaceutical and biotechnology companies to augment their drug output and generate continuous revenue growth have been noted in increased M&A, partnering, and licensing. To capitalize on innovative discoveries, the industry has recently increased its reliance on external R&D, global reach, and emerging companies; which constitute 30-50% of major companies’ pipeline (Bellott, 2009).

This article by Vanhaverbeke is complementary to the HBR article by Chesbrough and Garman in providing a comprehensive overview of the importance of remaining innovative in bad times to grow in good times. The topic of open innovation is fairly new and there is more than can explored with this regard such as how can open innovation be applied to service industries and how can governments apply this model. Abuark-aprj-app Page 29

KEY LEARNING

During turbulent economic periods, companies tend to act apprehensively by immobilizing resources and capital in anticipation of the outcomes. This passive reaction combined with severe cost cutting measures is common during these times. One of the first cost containment initiatives companies apply involve cutbacks on R&D spending and halting non-revenue generating projects. Cost management and control are necessary at all times for companies to remain competitive and profitable. The literatures suggest that companies need to view economic downturns as opportunity to introduce change to their organization by cultivating an innovative culture and simply being “daring.” In addition, the literatures highlight the role of the government in driving innovation.

Open innovation has been suggested as means to weather economic storms through free flow of IP, people, and ideas into and outside of the organization referred as inside-out innovation. For example, through open innovation companies may consider licensing out old projects that have been put on hold in good economic times to outside investors to carry out the projects. This approach can benefit companies in two fold: reducing the workload and retaining equity on these non-strategic projects. Chesbrough and Garman (2009) provide five open innovation strategies, in which companies can apply as follows:

 Becoming a customer or supplier of your former internal projects In down times  Letting others develop your nonstrategic initiatives  Making your intellectual property (IP) work harder for you and others  Growing your ecosystem, even when you are not growing  Creating open domains to reduce costs and expand participation by bringing projects into a public domain

Further to Chesbrough and Garman’s five strategies to open innovation, Vanhaverbeke (2009) provides the following five additional benefits to open innovation:

 Cash is not only king, but opens new strategic options for financially sound companies  Profiting from a depressed venture capital market  Increasing R&D efficiency through joint R&D  Profiting from the emerging technology markets  Using open innovation to speed up your globalization strategy

Governments and businesses coexist symbiotically in this global economic ecosystem. Businesses enrich economies by providing products, services, and jobs acting as a government financial sector. Therefore, governments must recognize the significance and contributions of these systems and need to ensure that they remain Abuark-aprj-app Page 30 intact and sustainable. Mahroum (2008) points out the importance of governments in supporting businesses to remain innovative in downtimes by taken such measures as increased funding by infusing capital, attracting foreign investment, funding public programs, and supporting talents.

As shown above, economic downturns are not necessarily bad if organizations can view it from an optimistic standpoint and use it as an opportunity by leveraging on being innovative and thinking outside of the box. Some of the strategies suggested by the literatures have been observed in the current crisis such as increased partnership deals, mergers and acquisitions, licensing agreements, and government stimulus packages to the public sector. The outcome of these actions will be better noted once this gloomy storm has passed over.

VALUE DISCIPLINES

As the competition intensifies and world economy faces near collapse, companies need a new approach to marketing and competitive strategy to sustain market leadership and build customer loyalty. Value Disciplines is a term used to describe three dynamic business leadership strategies comprised of operational excellence, product leadership, and customer intimacy that companies apply to differentiate themselves and provide value to their customers. In the article “Customer Intimacy and Other Value Disciplines,” Michael Treacy and Fred Wiersema (1992) examine three value discipline models and they could gain a company a strategic leadership position. The value discipline framework links operational excellence, product leadership, and customer intimacy. Each of the three value disciplines suggests different requirements:

. Operational excellence strategy is achieved by providing products and services at the lowest costs with the least amount of complexity in terms of cost management and operational effectiveness. Operational excellent companies deliver standard products or services at competitive prices, low cost, and good quality. The operational excellence culture concerns itself with standardization, processes, disciplined teamwork, and quality control. . Product leadership strategy is innovation driven and constantly raises the bar for competitors by offering more value and better solutions. The product leadership culture is concept and future driven, action oriented, with an “outside the box” mindset. . Customer intimacy strategy is concerned with building a long-term relationship with clients rather than a single transaction based on their lifetime value to the company by tailoring products and services to fit the customer’s needs. Customer intimate companies pursue the deepest level of understanding of customer needs both technical and political. The customer intimacy culture is customer driven, focused on communication, with a “have it your way” mindset. Abuark-aprj-app Page 31

The article also provides examples of successful companies who have applied the value discipline framework such as Wal-Mart and Home Depot. Treacy and Wiersema (1992) contend that companies achieve a strategic leadership position by narrowing rather than broadening their business focus. In other words, successful organizations need to focus on one value discipline as their core, while meeting industry standards with the remaining two. The implementation of the value disciplines can be complex and expensive requiring dynamic organizational change and process reengineering. Therefore, the appropriate value discipline vary between different organizations depending on their vision, core capabilities, company culture, and business goals, Like the previous article by Rigby (2001), the article provides a great general analysis of the three value disciplines, yet it lacks the specific metrics required for performance measures that are essential for the purposes of this analysis.

INDUSTRY REPORTS

In the CRO industry update “Opportunities in uncertain times,” Kristin Brooks (2009) provides an overview of the preclinical market past and present. The article highlights the impact of the economic crisis on the preclinical CRO market given the changes taking place in the pharmaceutical and biotechnology sectors such as outsourcing trends, restructuring, and drug development stage prioritization. Brooks examines how CROs are coping with the downturn and what actions have been taken thus far supporting by industry executives opinions and views. The article points out that the pharmaceutical industry is shifting it focus towards biologics such as vaccines, blood components, recombinant DNA technology used for novel biomedical therapies, as it presents high growth market. This point is significant in showing the industry’s move towards creating value innovations and was supported by Bellott’s article “Adaptation to the New Industry Landscape.” The article concludes by highlighting the future direction of the preclinical market segment moving forward including partnerships, global expansion, and specialty testing. The article provides a great overview of the CRO market environment, the preclinical segment in particular, under the current economic pressures. In addition, it provides an in depth analysis of how the CRO leaders are coping with these circumstances supported by current examples of their actions. The article will be of great value in supporting the scope of this paper as to the positioning of CRO in the present economic and financial crisis. A study was conducted by Life Sciences Strategic Group LLC (LSSG), by Jon Meyer, in February, 2009 to examine the perceptions and future trends of preclinical and clinical R&D budgeting and utilization of CROs for outsourced services. This quantitative study includes the perception of 113 key decision makers within pharmaceutical and biotechnology companies in North America and Europe. The outcome of the study concluded the following: Abuark-aprj-app Page 32

. Half of study respondents predict a shift in R&D spending from preclinical to clinical in the next 2-3 years . Less than 10% predict a shift in R&D spending from clinical to preclinical . Majority of respondents anticipate a positive preclinical R&D budgets in near term and 40% anticipate modest growth . Over 75% anticipate clinical development budgets to increase in 2-3 years . About 70% expect increase in CRO utilization in the next 2-3 years . More than two third expect increase in CRO utilization for preclinical R&D in the next 2-3 years . Greater than 70% expect increase in CRO utilization for clinical R&D in the next 2-3 years

The article indicates that for CROs to remain competitive, the will need to provide competitive prices, value added offerings, and improve service delivery and timelines. The report provides a great insight into the future of pharmaceutical and biotechnology companies outsourcing trend and CRO utilization. The study sample selection provides a great credibility to the aforementioned conclusions made, as all participants were screened to ensure their knowledge of trends in R&D budgeting and CRO utilization.

An industry report by UBS Investment Research, published on August, 2008 provides a comprehensive analysis of the CRO market. The report looks at the benefits CROs are gaining from pharmaceutical companies shift towards outsourcing, CROs volatility in terms of trial delays or cancellation, and how CROs are becoming an essential partner in pharmaceutical companies “pump the pipeline” strategy. The report provides coverage on the two CRO giants Covance and Charles River Laboratories. The report indicates that pharmaceutical companies outsourcing will benefit CROs over the next 5 years and highlights the following drivers:

. 5-6% annual R&D spending . Increased pharmaceutical outsourcing . Biotechnology companies reliance on CROs

The report highlights also that diversified companies along the drug development portfolio are less impacted by trial delays or cancellations. In the coverage of Covance and CRL, UBS favors Covance as it provides both preclinical and clinical services. This report will supplement the scope of this paper in terms of defining the future outlook of the CRO market environment. In addition, the report will provide essential data and in depth analysis of this industry.

The articles selected for the literature review include hard copy journal articles (ie, Harvard Business Review), online sources using Athabasca University data base and other credible research engines, as well as industry magazines (ie, European Biopharmaceutical Review). The materials used are current and some pertain to the former financial crisis of the early 90’s. The authors selected are well-renowned in their Abuark-aprj-app Page 33 field of study, so their argument supports my proposal with experiential knowledge and is backed by peer review adhering to academic and industry standards. Some of sources may not be industry specific but do provide a general theme to support the research objectives of this project.

The above literature review articles are only a sample of what will be applied in this research project. The articles chosen will provide a detailed presentation of the current economic situation and its impact on the industry as a whole. The articles pertaining to economic downturn do provide important tools on how to prepare for after the storm blows over. The article on value discipline will be used in conjunction to provide recommendations in terms of the applying the most appropriate leadership strategy during harsh times. These articles and others including industry reports will provide supportive evidence of pharmaceutical and biotech environment surrounding the CRO industry and its impact. The results of the applied project will be drawn based on the evaluation of the secondary data collected in the literature review articles to support or disprove the research objective.

RESEARCH DESIGN AND METHODOLOGY

The research design of this conceptual paper will utilize secondary data sources and based on interpretive qualitative data. The literature review will address topics related to the research objective involving industry environment (pharmaceutical, biotech, and CRO), economic downturn, strategic growth, and innovative change.

Information gathering will include literature review data, which consists of academic papers, online sources, industry reports, books, current affairs through news paper articles, and magazines.

The literature review and analysis will utilize the following:

. Macroenvironment analysis using DEPEST framework (demographics, economic, political, ecological, socio-cultural, and technological) . SWOT analysis (strength, weakness, opportunity, threat) . Competitor analysis . Value discipline framework . Risk analysis

Since the source of data is secondary, no ethics approval will be required for this applied project research paper.

While researching the topic of interest, number of publication regarding the research questions were found and they will be used in this analysis. The results of the applied project will be analyzed using the secondary sources of data accumulated from any of the aforementioned sources. The results of the applied project will address the Abuark-aprj-app Page 34 positioning of CROs in their environment, how to grow in midst of crisis, and applying the appropriate value model that will generate positive ROI.

ANALYSIS

MACROENVIRONMENT

Charles River and other CROs operate in a highly complex environment vulnerable to changes in environmental sectors surrounding its domain, particularly ones affecting the biopharmaceutical industry. Despite the complexity and volatility in its environment, biopharmaceutical companies are more disintegrated than ever and have grown extremely dependant on CROs to execute their projects from discovery to market; and therefore providing a stable source of revenues to CROs. The CRO operational environment is directly related to forces shaping biopharmaceutical companies outsourcing and spending trends. These macroenvironmental factors can be illustrated by utilizing the DEPEST framework (demographics, economic, political, ecological, socio-cultural, and technological), which can influence the CRO industry are as follows:

Demographics

The aging population in North America, Europe, and Japan has led to a major demographic shift and increased spending in healthcare. The aging baby boomers along with increased life expectancy and the simultaneous development of new emerging diseases have driven the biopharmaceutical industry to focus more on drug discovery and disease of the elderly. Contrary to the traditional focus on cancer and heart disease, the industry has been targeting their research on aging disorders such as Alzheimer’s, osteoporosis, and diabetes. This long-term trend has provided the biopharmaceutical industry with sustainable growth and has allowed it to become well positioned (Douglas, 2007).

Economics

In response to increased competition, low productivity, and increased cost of drug development; the biopharmaceutical industry has relied on CROs to carry out their work. Outsourcing activities by biopharmaceutical companies has been the primary driver of the CRO growth; and therefore any change in their outsourcing activities due to economic downturn or reduced spending can directly impact the CRO industry (Boyle, 2006).

Political-Legal

With a substantial portion of the drug discovery process being funded by the federal government, any fluctuation in the biopharmaceutical research and development (R&D) budget or government funding can adversely affect CROs (Boyle, 2006). Abuark-aprj-app Page 35

Favorable tax laws can act as an incentive for businesses to place work in certain countries.

Special interest groups such as, PETA, and Animal Right Activist group has and will be of concern to the industry and its image (Boyle, 2006).

Ecological

Full-scale CROs that provide services involving animal dosing, animal disease models, and radioactive testing might face intrinsic risks such as contamination or outbreak; thus adversely affecting income and image (Boyle, 2006).

Socio-Cultural

The change in population demographics and internet accessibility has increased the level of awareness and knowledge of the disease process, drugs, and different therapies. This has resulted in the demand for more effective medicines and faster market availability (Douglas, 2007). Hence, there has been an increased demand for full-scale CROs that can act as the biopharmaceutical “one-stop-shop”.

Technological Constant technological advancement can impact the CRO industry positively or negatively. Through progressive advancement in medical devices and medical software systems, the industry can benefit from increased throughput and lower cost per batch analysis. However, the development of alternative testing methods may not require the use of animal models; thereby negatively impacting the preclinical segment of the CRO market (Boyle, 2006).

SWOT ANALYSIS

SWOT (Strength, Weakness, Opportunities, Threat) analysis is a very useful strategic planning tool that helps companies understand their overall environment and allows them to sustain their competitive advantage in the market place. The SWOT analysis provides a comprehensive assessment of the firm’s internal and external environment, and helps identify critical factors on which the firm must focus. The SWOT analysis classifies the company’s internal environment in the form of strengths or weaknesses, and the external environment in the form of opportunities or threats. The four aspects of the SWOT can help a firm leverage its strength, build its weaknesses, exploit opportunities, and deter possible threats. The following SWOT analysis provides a deeper insight into the CRO business by identifying the opportunities and threats, as well as the strengths and weaknesses of the four major players (Raturi & Evans, 2005). Abuark-aprj-app Page 36

Opportunities . Emerging companies such as the case with small biotechnology companies, limited in-house resources has increased outsourcing channels (Greener, 2006). . Preclinical outsourced market is growing at 11-12% per annum . Increased regulatory pressures on the preclinical segment requiring enormous capital and compliance have created a barrier to the entry of smaller CROs and benefited the large ones (Greener, 2006). . Biopharmaceutical global expansion to Europe, India, and Asia in search for cheaper regions and suitable patients has provided growth opportunities for global CROs (Greener, 2006). . Establishment of Good Laboratory Practices (GCP), China’s entry into the World Trade Organization (WTO), and the Chinese government promise to increase IP protection will allow for continued growth opportunities in China (Zhou, 2006). Threats . A large number of CROs may result in more CROs for the demanded service. . Growing industrial countries, like China and India, may be able to produce results at cheaper rates. . Foreign conflicts such as terrorism, economical changes, and currency exchange rates might pose a threat on cost and pricing. . Special interest groups may create scepticism through ethical arguments.

Strengths and Weaknesses Charles River Laboratories has witnessed a drastic growth over the years by capitalizing on growth and focus on core competencies in animal research models and preclinical services. The strength and weaknesses of CRL are summarized below:

Strengths . Well-positioned in the CRO industry with an outstanding reputation among customers. . Large preclinical capacity with 8 sites occupying 1,930,000 sq ft. . Global presence . General and specialty Toxicology laboratory services including inhalation, infusion, and reproductive studies, which require enormous capacity and resources. . Diverse portfolio of products and services ranging from drug discovery to clinical phase I. . Significant presence in key technologies such bone research and imaging. . Expedient reporting timelines with 98% on-time reporting slogan. Abuark-aprj-app Page 37

Weaknesses . Large number of acquisitions with multiple sites that requires uniformity in customer service. . Fragmented IT infrastructure across different sites . Higher prices due to high overhead expenses.

COMPETITOR ANALYSIS

The research and development sector is highly competitive and comprised of three collaborating industries: pharmaceutical companies, biotechnology companies, and contract research organizations (CRO). The CRO industry is classified into three tiers based on size and revenues as shown in Appendix 1. Pharmaceutical companies prefer to deal with larger Tier 1 providers as they act as a one-stop-shop to facilitate the flow of their studies from start to end. The following section will examine Charles River’s main competitors with respect to their market share shown in Figure 5. The top three competitors based on market share include: Covance, MPI, and Huntingdon Life Sciences (HLS).

Covance Inc.

Covance Inc. (NYSE: CVD) based in Princeton, New Jersey, founded in 1997, is one of the largest CROs serving drug and development companies in both preclinical and clinical services. Covance operates globally in over 20 countries with annual revenues over $1 billion and employs more than 8100 employees. Covance’s net revenues for 2008 were at $1.728 billion with 11.7% increase from 2007 (Covance Annual Report, 2008). Covance’s preclinical revenues for 2006 were at $497 million and total preclinical capacity of 2,225,000 sq ft as of 2008 (CRL internal source).

Strengths: . Longevity in the preclinical business . Wide range of services . General Toxicology services only . Six sigma initiatives . Central laboratory services . Strong link to clinical studies (from preclinical to clinical)

Weaknesses: . No FDA experience on consulting team . Lack of specialty expertise . Lack of capacity in Asia Abuark-aprj-app Page 38

MPI Research

MPI Research is a privately held company based in Mattawan, Michigan and founded in 1995. MPI Research provides preclinical and early clinical research services to the biotech, pharmaceutical, medical device, animal health, and agrichemical industries. MPI operates primarily in North America and employs more than 1400 employees. MPI’s preclinical revenues for 2006 were at $160 million and total preclinical capacity of 958,000 sq ft as of 2008 (CRL internal source).

Strengths: . Privately held company, so less financial pressures . Customer service orientation . Strong sales and marketing . Single site . Low price

Weaknesses: . Lack of global presence . Inconsistent quality reputation due to lack of experienced technical staff

HLS

Huntingdon Life Sciences is a privately held company based in Huntingdon, England and founded in 1952. HLS is one of the world's largest contract research organizations, providing a comprehensive range of non-clinical development services. HLS employs more than 1400 employees operates primarily in U.S. and the UK. Huntingdon’s preclinical revenues for 2006 were at $179 million and total preclinical capacity of 830,000 sq ft as of 2007 (CRL internal sources).

Strengths:

. Improving inhalation expertise . Low price

Weaknesses:

. 80% of capacity in Europe . Animal welfare perception . Food and crop offerings dilute biotechnology/pharmaceutical market focus . Questionable financial stability Abuark-aprj-app Page 39

VALUE DISCIPLINES

In light of today’s turbulent economy and increased competition, customers’ perception of value is no only limited by price and quality but by strategic partnership as well. Companies are now facing more challenges in retaining existing customers and building new customer base. In striving to differentiate themselves and to set a competitive advantage with an unmatched value-added service, companies need a comprehensive model that would align their vision, targeted customers, and various functional departments. The value disciplines framework is an aggressive approach to leadership and is key to defining ones competitive advantage and positioning in today’s competitive arena. The value disciplines framework was developed by Michael Treacy and Fred Wiersema and comprised of three dynamic leadership strategies involving operational excellence, product leadership, and customer intimacy, Figure 6 (Treacy & Wiersema, 1992).

Treacy and Wiersema (1992) define operational excellence as, “a specific strategic approach to the production and delivery of products and services” (p. 3). The main objective of companies pursuing operational excellence involves price and convenience, and therefore they seek ways to reduce overhead costs and optimize production processes to reduce overall transactional costs. Operational excellence companies provide products and services at the lowest costs with the least amount of complexity in terms of cost management and operational effectiveness. Operational excellence companies deliver standard products or services at competitive prices, low cost, and good quality. The operational excellence culture involves standardization, limited product line, disciplined teamwork, and quality control with a “one size fit all” mindset. Dell Computer, for example, has been able to undercut its main competitors by focusing on operational excellence. Dell has revamped its distribution system by selling directly to customers and simultaneously reducing inventory. This approach has gained Dell $1.7 billion increase in revenues in less than 10 years. Other operational excellent companies include Wal-Mart, American Airlines, General Electric, and Federal Express (Treacy & Wiersema, 1992).

The product leadership approach involves providing continuous flow of cutting- edge products and services. Product leadership companies are innovation driven and constantly raise the bar for competitors by offering more value and better solutions. Companies that pursue this strategy constantly launch new products or services and improve mature ones, embrace new ideas, encourage risk taking, and promote flexible processes to adapt to changing conditions. The product leadership culture is concept and future driven, action oriented, with an “outside the box” mindset. An example of a product leadership company is Johnson & Johnson (J&J). Johnson & Johnson has created the environment that supports new ideas such the case with Acuvue contact lenses. A Danish ophthalmologist envisaged a way to manufacture disposable contact lenses inexpensively. When J&J Vestakon Inc. heard of this Danish invention, it took an interest in this idea and supported it all the way to market. In taking this risk, J&J was Abuark-aprj-app Page 40 able to sustain market leadership surpassing competitors such as Bausch & Lomb and Ciba-Geigy (Treacy & Wiersema, 1992).

The customer intimacy approach involves a comprehensive understanding of the customer and requires defining and segmenting customers according to products and service benefits that are most valuable to them. Customer segmentation strategies are based on predefined metrics such as pipeline history, purchasing history, profitability, and size. The goal of customer intimate companies is to build a long-term relationship with clients rather than a single transaction based on their lifetime value to the company by tailoring products and services to fit the customer’s needs. Companies that pursue this strategy act as a one-stop-shop covering all the needs of their customers, provide one point of contact with unparalleled expertise and response time, command a premium, and strive to build customer loyalty to generate repeat business. The customer intimacy culture is customer driven, focused on communication, with a “have it your way” mindset. Home Depot, for example, is a leader in customer intimacy in which the clerks spend the time to understand the customers’ home improvement needs and provide them exactly with what they need. Other leaders in customer intimacy include Nordstrom, Staples, Ciba-Geigy, Kraft, and Frito-Lay (Treacy & Wiersema, 1992).

The three value disciplines provide the means for companies to establish leadership position in the marketplace. Customers on the other end do value companies that are well-positioned and provide added-value products or services. Treacy and Wiersema (1992) explain that customers can be segmented based value preference and identify three value preferences involving total cost, product feature, and total solution. For example, customers who are concerned with cost and expect standard service will prefer to deal with operationally excellent company. Customers who value product features are willing to pay the premium to a product leadership supplier. Finally, customers who require customized products and personalized service will seek a customer intimate supplier. In order to successfully implement the value discipline model, companies must select and excel at one value discipline while remaining adept at the other two disciplines. In selecting the appropriate value discipline, companies must opt for the one that align with their core capabilities and culture as it is crucial to gain company wide buy in for a successful implementation of this leadership strategy (Treacy & Wiersema, 1992).

In response to increased competition among CROs and the drug development process in general, Charles River Laboratories has differentiated itself by launching the customer intimacy initiative in 2005. This value discipline has been chosen to forge strategic partnerships with its clients and to accommodate its client segment largely comprised of pharmaceutical and biotechnology companies who tend to be less price sensitive and require customized drug development services. To successfully accomplish this change, modifications to internal processes including global customer centric vision and building effective information technology (IT) infrastructure were essential to ensure the proper execution of this initiative company wide. Abuark-aprj-app Page 41

Charles River has been able to successfully build dynamic customer partnerships by gaining deeper insight into the customers’ needs through the use of data management systems such as customer relation management (CRM) and enterprise resource planning (ERP) to generate integrated view of customer information. The information obtained from the data management systems has allowed for the segmentation and profiling of customers based on their pipeline opportunities, sales history, lifetime value, and size. Some of the customized services implemented to satisfy clients’ needs were as follows:

. Single point of contact to facilitate communication . Customized reports and data collection . Secure access to data through the use of portals . Single approach to quality in compliance with FDA requirements . Portfolio management based on program size and duration . Single invoice using ERP

In driving the customer intimacy strategy, fundamental organizational and IT changes were incorporated. In organizational change, Business Development reorganization was implemented to create a powerful regional management structure that can act globally and provide unified service. In IT infrastructure changes, standardized IT solutions were of essence using enterprise systems such as ERP and CRM. The customer intimacy approach has enabled CRL to understand its customers, build loyalty, and effectively manage its operation to maximize profits. Abuark-aprj-app Page 42

Figure 6: Pyramid of Value Disciplines

Grow the business

Customer Intimacy

Value Disciplines

Operational excellence Product Leadership

Cost/Efficiency Management

RISK ANALYSIS

The pharmaceutical and biotechnology sectors have experienced dramatic changes in recent years involving consolidation, increased regulatory pressures, cost containment measures, and R&D spending. These changes have resulted in staff reduction, cutting costs, shifting to later-stage drug development programs, and delaying projects. Overall, these changes are bound to impact the dynamics of the CRO industry as a primary outsource partner. As a result of increasing pressure on pharmaceutical and biotechnology companies to successfully get their drugs to market, increasing pipeline by spending on R&D, and the cost involved in development; outsourcing to CROs has become the most common approach. Outsourcing has allowed companies to leverage on CROs expertise and capabilities, while concentrating on core competencies and retaining ownership of their product. In selecting a CRO, pharmaceutical companies tend to look for the CRO that has a full range of capabilities, high quality, able to meet timeline, and to lesser extent price. Following the current economic recession, the competitive ground has changed drastically impacting those business dynamics; in which the CRO of choice will rank high on quality, ability to meet timelines, and competitive pricing; Figure 7. The main important challenges facing Abuark-aprj-app Page 43 the CRO industry today are pharmaceutical consolidation, increased regulatory requirements, and pricing pressures (Bellott, 2009).

Figure 7: Dynamics of CRO Business

Quality T imeliness Price

Pharmaceutical consolidation has become a concerning matter for the CRO industry given their heavy reliance on pharmaceutical companies outsourced activities. When pharmaceutical companies consolidate, they prioritize their drug pipelines and terminate less promising compounds. In addition, such consolidations may affect outsourcing trends and relationships attributing to who has the upper hand in the merger and their preferred CRO. Program termination or project cancellation negatively impacts CROs in term of revenue stream disruptions until the logistics of the merger have been settled. For example, on the day the merger between Pfizer and Pharmacia was announced in July 2002, Kindle Inc. shares were down by ~17% and reported a - 2% revenue decline for 2003 (UBS Investment Research, 2008).

The CRO business depends on the effectiveness of its regulatory compliance and the strength of its quality systems. Worldwide regulatory agencies are increasingly demanding rigorous safety testing and longer trials to ensure the safety of the final drug product. These stringent requirements are becoming global standards, which have presented pressures on CROs in terms managing study designs and the need to have broader and global regulatory expertise. These requirements and the resulting complexity in trials have acted as a growth driver for CROs by fuelling the backlog. In order to meet these adept and be able to meet study timelines, CROs must always anticipate and plan for continuous changes in the regulatory environment and ensure that they posses the capability to handle the studies to ensure meeting the timelines of their clients (Indigo Research, 2008).

The CRO market is highly fragmented and competitive with over 1000 CROs worldwide. At no time has pricing been a critical issue for the CRO industry as it has in recent years, especially in the current economic downturn. This fact can be attributed to cost containment as a result of limited access to capital funding impacting the Abuark-aprj-app Page 44 biotechnology sector in particular and increased competition. Given the limited capacity of the biotechnology sector and their heavy reliance on outsourcing to CROs, this limited access to funding may lead to halting of projects due to limited access to resources. The increased competition amongst CROs and their need to maintain certain level of occupancy rate leaving many with excess capacity has resulted in dramatic price slashing ranging from selling at cost to below cost; hence changing the overall industry pricing structure and heightening competitive ground (UBS Investment Research, 2008).

To mitigate the aforementioned challenges, CROs will need to meet clients’ expectations of high quality, aggressive timelines, and competitive pricing. In order to achieve these objectives and win the outsourced bids, the winning CRO will be required to have high-level scientific teams with great expertise that are current with industry standards. In addition, the winning CRO must improve its internal processes and apply best practices to drive cost efficiencies and maintain high quality, and ultimately be able to compete in the current turbulent market. Overall, the CRO industry is well positioned to capitalize on robust market opportunities resulting from pharmaceutical companies move toward outsourcing of non-core activities to expedite drug-to-market and focus on improving their pipeline.

RECOMMENDATIONS

The CRO industry, as a primary outsource partner, has been impacted as much by the changes taken place in the pharmaceutical and biotechnology environment. These changes may affect or delay pharmaceutical and biotechnology sectors outsourcing, which is the lifeblood of CROs. Contract research industry leaders anticipate that such cost containment measures to reduce the cost of drug development will more likely lead to increased outsourcing to CROs once the acquisitions have been stabilized. This continued outsourcing trend will sustain CROs positioning in this competitive market. To survive the economic storm, the following recommendations provide innovative solutions, which will allow CROs to strengthen their market position and provide value to their customers through strategic partnering, focused diversification, expanding portfolio, global reach, mobilizing human resources, and customer intimacy.

Strategic Partnering

Strategic partnering has become the new paradigm to progression in modern day. Partnerships have advantages, where they provide companies with access to new markets, products, technologies, and knowledge. This accessibility to resources can gain companies competitive advantages against rivals otherwise they may not have the time or capabilities to achieve on their own. Building partnerships have grown dramatically in recent years in the pharmaceutical industry in search for new innovative ideas to fill in drug pipeline gaps. To achieve this objective, pharmaceutical companies Abuark-aprj-app Page 45 have partnered with small biotechnology companies and academic research laboratories (Zabrowski, 2007).

Strategic partnerships have not been limited to the pharmaceutical industry, but also observed in the CRO landscape as well. These partnerships have been shown in the form of strategic outsourcing partnership such the case Covance and Eli-Lilly’s partnership and drug development as with PPD’s drug partnership program. Noteworthy is that for such partnerships to be sustainable, the goals and objectives will need to be synergistic.

Focused Diversification

Diversification provides companies with access to greater capacity to capture larger market shares and benefit from the resulting economies of scale to lower their cost structure. With pharmaceutical companies increased expansion to lower cost countries, diversification provides a viable growth strategy for CROs to be close to their customers. When considering growth through diversification, CROs need to ensure that it is focused and complementary to their core business competencies. This growth strategy through focused mergers and acquisition will prove to place CROs in a leadership position within the industry.

Expanding Portfolio

With pharmaceutical companies increased focus on new therapies, biopharmaceutical products (antibody-based compounds), and biologics; they are requiring more specialized services to support their drug development pipeline. Biologics, for example, will account for 50% of newly approved drug in the next two to three years. This evolution presents new opportunities for CROs to expand their services by investing in these emerging markets since the CRO with those expertise and capabilities will be an attractive alternative for such outsourced services. In response to the increased demand for specialized testing, some of the large CROs are expanding their bioanalytical services such as immunology, toxicology, and pharmacology. Biosimillars present another new venue for growth for CROs. Biosimilars refer to the generic version of the original biopharmaceutical product after patent expiry. Although it is a newly emerging market with only 10 approved biosimilars in Europe, it will act as a source of revenue for CROs once the FDA has established the guidance for biosimilars (Brooks, 2009).

Global Reach

As pharmaceutical companies strive harder to manage costs of drug development, many have expanded their operation to low cost countries such as Asia Pacific representing the region with the highest growth. For example, pharmaceutical companies have been dealing with China since the 1980s, but have remained reluctant to the idea of opening manufacturing plants in China given their ineffective laws Abuark-aprj-app Page 46 regarding intellectual property rights (IPR). As of 2005, the Chinese drug market was at $15 billion market and expected to quadruple by 2010, and then double by 2020. China’s appetite for Western drugs, large patient population suitable for clinical trials, lower clinical trials costs (20% of other countries), and their giant intellectual talent pool have balanced those concerns of pharmaceutical companies and ultimately leading to their global reach to China. In 2002, Novo Nordisk changed this trend by opening the first research laboratory in Beijing. This trend was followed by other pharmaceutical giants such as AstraZeneca, Eli-Lilly, Roche, Novartis, and GlaxoSmithKline (GSK) (Yidong, 2005).

As a result of growing demand from their multinational clients to help support their objectives and strategies for drug development, and in an effort to operate in close proximity to their clients; CROs have begun expanding globally to leverage on these opportunities. For example, Charles River has increased its global reach by opening the first FDA compliant preclinical CRO in China. The China facility will provide a comprehensive portfolio of services ranging from discovery to developmental toxicology under Good Laboratory Practices (GLP). Global expansion will allow CROs to capitalize on new emerging markets and build closer relationship with their clients.

Mobilizing Human Resources

Organizations initial response to recessions involves staff reduction and increasing workload of the remaining employees to cut costs. Layoffs, in fact, can be quite costly for organizations in the long run considering the loss of existing talent and moral. Employees constitute the intellectual capital of an organization, and therefore it is advantageous to retain them. During recessions, companies need to reassure their employees and integrate them in the cost saving initiatives through empowerment. In addition, companies need work smart by mobilizing their resources to ensure lowering operational costs to pool resources through interdepartmental/interdisciplinary collaboration

Customer Intimacy

Customers are the reason why businesses exist and they the lifeblood of any business in any economic climate. In economic downturn, especially, where competition is fierce and demand is in decline; companies need to differentiate themselves to retain their existing customer base. In these times, companies need to do the utmost to establish long-lasting and dynamic relationships with their customers. One way to achieve these partnerships is through customer intimacy. Customer intimacy allows companies to develop a through an understanding of their customer’s needs and segment their customers based on predefined metrics, as it provides a 360°C view of important information about the customer. To achieve customer intimacy, companies need to be innovative by listening to their customers and further invest in powerful enterprise systems that will allow them to gain an integrated view of their customers such as ERP and CRM. These systems are expensive but nonetheless Abuark-aprj-app Page 47 can process variety of information to assist in generating a comprehensive view of the customer.

CONCLUSION

Ever since the global financial crisis in 2008, the global economy has been in turmoil affecting all industries. The impact of this recession has been significant as shown in declined demand, bankruptcies, increased unemployment rate, and difficulty acquiring capital and credit. Although traditionally thought of as immune to recession due to its strong financial position and stable demographics, the pharmaceutical and biotechnology sectors have experienced challenges in acquiring funding, reduced R&D, patent expiry, and decreased drug output. These challenges have triggered drastic responses, which have lead to changing industry dynamics through increased cost containment, M&A, partnerships, and licensing deals.

A literature review of articles about economic downturns, showed a strong trend indicating that companies need to consider recessions as an opportunity for organizational change rather than an ordeal. In these times, companies need to seek innovative means to sustain their existence. One way to do so is through open innovation, which allows for the free flow of information, patents, and ideas into and out of the organization. Open innovation can help organizations grow in bad times by creating partnerships and joint R&D. Moreover, companies need to be more attentive to their customer’s needs through product quality and superior customer service. The value discipline model suggests companies can achieve market leadership by providing value to their customers through three dynamic strategies involving operational excellence, product leadership, and customer intimacy. The value discipline model is meant to revolutionize an organization through process reengineering, and therefore it is complex and expensive. Companies cannot possibly implement the three value disciplines simultaneously, and thereby must focus on one value discipline that aligns with the organization’s goals and objectives while maintaining industry standards for the other two value disciplines.

As a result of the changes taking place in the pharmaceutical and biotechnology sectors, CRO’s, in their role as outsource partners, have also been impacted. The impact has been shown in delayed projects and halting of lesser priority studies. However, this trend is not projected to last for a long time and industry leaders anticipate that outsourcing will continue once pharmaceutical companies have worked their mergers. In addition, pharmaceutical companies increased focus on new therapies, biologics, as well as biosimilars will present new opportunities for CROs. Moving forward, CROs need to approach the new era ingeniously through means such as strategic partnering, focused diversification, expanding portfolio, global reach, mobilizing human resources, and customer intimacy.

Abuark-aprj-app Page 48

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APPENDICES

Appendix 1: CRO Classification

Frost & Sullivan, (2003). World Contract Research Organizations (CROs) Abuark-aprj-app Page 53

Appendix 2: CRL Business Segments

Source: Internal presentation; Charles River Laboratories, October 2005, Brand Identity Guidelines