May 1, 2005 (Vol. 25, No. 9)
Companies Looking to Cut Costs Are Enticed by Offshore Service Providers
Recently the Marshall School of Business at the University of Southern California hosted a one-day symposium discussing the “opportunities, challenges, and needs” facing the healthcare and life science industries as a result of a rapidly changing global economy.
One of the presenters was Vikram Chhatwal, Ph.D., CEO of Apollo Health Street (Chennai, India) and CIO of Apollo Hospital Group (New Delhi, India). Apollo Health Street is an offshore service provider of low-cost management systems, offering back-office support to healthcare providers or payers for their noncore business activities.
Apollo Hospital Group, Asia’s second largest integrated healthcare provider with its base of 7.4 million patients, is well positioned to become a major player as a clinical research organization (CRO) for the pharmaceutical companies that are contemplating offshore clinical studies.
Most Americans view this as just another industry outsourcing jobs, though many considered the life science industry to be immune to outsourcing because of its dependence on innovative technologies and a highly educated labor force.
In fact, many states and municipalities identified the life science industry, and particularly biotechnology, as a high-growth economic engine that could staunch the erosion of their tax-based revenues. State legislators were passing bills that created lucrative tax incentives in order to attract biotech and medical device companies to their region.
Similar to the information and high-technology industries, life science jobs are now migrating offshore. This phenomenon is mainly attributed to life scientists returning to their native countries, such as India, China, and Eastern Europe, to start companies, with governments enticing them back with research grants and a funding source for their enterprises.
In the 1980s and the early1990s, foreign students (especially from India and China) were coming to the U.S. and Western Europe to earn their undergraduate and graduate degrees. It was estimated that in our top universities, 50% of the science students were foreign nationals.
After earning their degrees, many of these students were able to remain in the U.S. and work in pharmaceutical and biotech companies. However, these scientists over time became frustrated with their inability to advance to higher paying positions within these companies. They viewed certain issues such as language, citizenship, and racial bias, whether perceived or real, as creating an invisible barrier to advancing their careers.
Meanwhile, countries such as India and China were actively replicating the Singapore model for their life science initiatives. Over the last decade, the Singapore government focused on establishing a region of excellence for the life sciences by forming world-class life science research institutes and attracting top scientists from overseas with large research grants.
Additionally, the Singapore government is providing a pool of funds for startup companies, which has spawned a major biotech hub in Southeast Asia.
Of particular note is Singapore government-sponsored research in human embryonic stem cells. Unencumbered by the ethical and philosophical considerations impacting such research in the U.S., the Singapore government wants to be a world leader in the field. It appears they are close to reaching their goals with worldclass scientists moving operations to Singapore.
Scientists and entrepreneurs are being actively recruited and returning to their native countries in various value chains within the life science industry. A well-educated and well-trained labor force, particular in Asia, will result in bench-work jobs migrating to companies in countries having equivalent technical skills and providing such services at a much lower cost.
Similar to the information technology industry where the competitive environment resulted in the outsourcing of software development jobs to India, drug companies are now using Indian chemists to develop new molecular entities. India is known for having a pool of highly talented and trained medicinal chemists. Manufacturing generic drugs is already a major industry sector in India.
Venture capitalist Charles Hsu, Ph.D., of A.M. Pappas & Co. (Palo Alto, CA), noted that, inevitably, pharmaceutical companies will outsource many of their drug development programs as pressures mount to drive down costs.
In the past lofty profit margins provided little incentive for pharmaceutical companies to control their costs, according to Dr. Hsu. Currently, however, with politicians campaigning on a platform of controlling healthcare costs through government-regulated drug price controls, drugs being taken off the market because of adverse events, blockbuster patents expiring, and, shallow product pipelines lacking blockbuster products, Dr. Hsu opined that it was a logical step for pharmaceutical companies to take some belt-tightening measures and retool their R&D programs through outsourcing.
Last month, Pfizer (New York City) reported its first quarter earnings and told Wall Street analysts that it planned a $4 billion cost-cutting program. Recent FDA actions, including a recommendation that the company pull Bextra from the market and Celebrex include a stiff warning label linking it to possible heart attacks, no doubt played a role in this decision.
Wall Street analysts are speculating that Bextra and Celebrex could meet a fate similar to Merck’s (Whitehouse Station, NJ) Vioxx. Such a measure could have a major impact on Pfizer’s bottom line. However, the company insists it still intends to invest approximately $8 billion in its research programs.
With Merck’s Vioxx pulled from the market and its cholesterol-lowering drug, Zocor, due to come off patent in a couple of years, rumors are rampant that Pfizer will make a hostile take-over bid for Merck. A few years ago, speculation about a merger of the two pillars of the American pharmaceutical industry would have been considered sheer lunacy.
Dr. Hsu insisted that any cost-cutting strategy employed by large drug companies such as Pfizer must include a change in the company’s infrastructure and business model, making them more nimble and flexible in a rapidly changing business environment.
Developing countries are home to many life science companies, many of which have reached critical mass. They will, most likely, become the low-cost service providers for pharmaceutical companies looking to outsource some of their internal programs in the development chain from optimizing lead candidates to offshore clinical trials.
Biotechnology companies, on the other hand, are less vulnerable to outsourcing because the companies are heavily reliant on innovation in developing new technologies and therapeutics, explained Dr. Hsu.
Until there is global harmonization of intellectual property protection, Dr. Hsu doesn’t believe that biotech research programs will migrate offshore.
As pharmaceutical companies change their business model, Dr. Hsu added, they might become more dependent upon biotech companies for research and preclinical development of novel therapeutic products.
If this is indeed the case, the pendulum may be swinging back to where investors focus their attention toward biotech companies with innovative and strong technology platforms as well as toolbox companies. The storm clouds over the large pharmaceutical companies could give rise to the silver lining for the cash-starved biotech industry.