The business of custom pharmaceutical chemical manufacturing has come into its own in recent years because many pharmaceutical companies are focusing their efforts on the research, development, and marketing of new drugs, leaving the unglamorous step of production to third-party chemical firms happy to do the job.

	FAIR PLAY Merck KGaA says products manufactured for external and internal customers get the same quality treatment. MERCK KGAA PHOTO

Yet a handful of drug companies are bucking the trend. Not only do these firms continue to manufacture the bulk of their own products, they are successfully competing in the $8 billion-per-year contract manufacturing arena against the growing number of "pure play" chemical companies that want a slice of what for them is a high-margin market.

Merck KGaA, Aventis, Pharmacia, Boehringer Ingelheim, Abbott Laboratories, Schering AG, and a few other drugmakers are active participants in the contract manufacturing market. Through an emphasis on quality manufacturing and regulatory expertise, they manage to overcome the perception that they are high-priced providers out merely to fill unused capacity in their drug manufacturing plants.

Indeed, some of them report strong growth this year in the face of an overall stagnant market for third-party pharmaceutical chemical manufacturing.

AT MERCK, for example, Burghard Freiberg, general manager for bulk pharmaceutical compounds, reports 50% growth in custom synthesis sales over the past year. "We are, despite the discussion in the industry about overcapacity and fewer new drug launches, optimistic about the business," he says.

Merck's recent sales growth is taking Freiberg a long way toward his goal, set out last year, of more than doubling the business' annual sales to $100 million over the next three to four years.

Aventis also has big expansion plans. Michel Prou, vice president for bulk sales in the French-German company's active pharmaceutical ingredient (API) operation, is targeting annual sales of $700 million within the next five years, up from more than $500 million today. Sales growth this year alone is more than 10%, he says.

Merck has long supplied APIs to companies such as AstraZeneca and Solvay but only launched a dedicated business--called custom synthesis and service--in October 2001. In the past, Merck manufacturing sites in France, Switzerland, and Germany pursued custom business independently; under the new organization, marketing for all sites will be consolidated, allowing third-party projects to be directed to the most suitable facility.

As a drug company that actively pursues custom synthesis business, Merck is going against the grain, Freiberg admits. "This is not a growing trend," he says. "There are a number of specific companies that like to control manufacturing."

It's no coincidence, Freiberg points out, that Merck, Boehringer Ingelheim, and Schering are all German companies with a high level of founding family involvement. Boehringer Ingelheim, which had third-party chemical sales last year of about $145 million, is still family-owned.

PUBLICLY TRADED U.S. and British drug companies, in contrast, tend to be the ones reducing their manufacturing presence or even, as in the case of GlaxoSmithKline, selling chemical synthesis plants. "The Anglo-Saxon companies' tendency is to focus on development and marketing, not synthesis and formulation," Freiberg says.

History also plays a big part in the modern-day strategy of several of the third-party players. Prou notes that Aventis is an amalgamation of four companies--Rhône-Poulenc, Hoechst, Marion Merrell Dow, and Roussel Uclaf--all of which were already participants in the merchant pharmaceutical chemical market.

Rhône-Poulenc, Hoechst, and Marion Merrell Dow mainly sold excess output of products made primarily for in-house use, Prou says, while Roussel was a more active merchant player, pursuing exclusive synthesis of new molecules for third parties. In the merged bulk sales organization, "the Roussel culture is stronger," says Prou, who himself is a Roussel alumnus. More than half of Aventis' current bulk sales originated with Roussel, he says, as do 70% of the employees of the API business.

The third-party business of Pharmacia has its roots in Upjohn, which pioneered the commercial manufacture of corticosteroids in the 1950s and parlayed this into a merchant business in subsequent years.

Although steroid manufacture is still the centerpiece of the business, Pete Stevenson, president of Pharmacia's contract unit, says the 1995 merger of Upjohn and Pharmacia brought dosage-form and packaging capabilities in Europe, while the 2000 acquisition of Searle added Heumann Pharma, a German contract manufacturer with a specialty in cytotoxics, plus significant dosage-form capability in Puerto Rico.

The contract manufacturing business was relaunched as Pharmacia CentreSource soon after the Searle acquisition and today, Stevenson says, has about $400 million in annual sales, about half of which come from the original Upjohn business. He says he is optimistic about the potential opportunities within Pharmacia's impending acquisition by Pfizer.

Stevenson and others bristle at the notion that their businesses exist mainly to maximize unused manufacturing facilities at their parent companies. "This is not a fill-excess-capacity business," Stevenson says. "It is in several specific technology areas where we have expertise."

In Pharmacia's case, the third-party business has very little excess capacity sales because it is explicitly focused on areas that don't conflict with the firm's core prescription pharmaceutical line. "It's important that a third-party business that sits in a pharmaceutical company be complementary to its overall goals," Stevenson notes.

At Aventis, in contrast, roughly one-half of bulk pharmaceutical sales is of APIs that were pioneered by the parent company but are now off patent and made for third parties as well as internal use. Examples of such standard products include metamizol from the former Hoechst, dextropropoxyphene and rifampicine from Marion Merrell Dow, and ketoprofen and phenothiazine compounds from Rhône-Poulenc.

However, competition from generics makers in the developing world is becoming fierce, so Prou's goal is to develop the custom synthesis side of the business more aggressively. "Standard product sales will remain, but they are definitely not the future," he says.

A drug company has most of the technical strengths necessary to compete in custom synthesis, but success is by no means a given, says Howard Foote, head of the consulting firm Meadowbrook Associates. Foote was manager of chemical development at Abbott Laboratories for several years until 1997, and he witnessed firsthand Abbott's internal struggle to define its role and succeed in the custom manufacturing business.

Drug companies have several advantages, Foote points out, including first-class compliance with current Good Manufacturing Practices (cGMP), substantial R&D capability, and many excellent chemists and chemical engineers recruited from the best colleges and universities. When he was at Abbott, the same chemists who worked on internal Abbott projects were available for contract manufacturing.

"We had a high-quality process development organization that we could bring to bear on these projects," Foote says. "We knew what it took to do process development and have a successful project." This know-how was particularly appealing to emerging drug discovery and small-molecule biotechnology companies that often had a lead compound but no clue how to shepherd it through the regulatory process or make it in large volumes.

THE DOWNSIDE, though, was that "all this high-powered talent was very expensive." The annual rate at which Abbott billed customers for process development and analytical chemists was higher than what many fine chemicals companies charged, Foote says. Plus, being a major drug company, Abbott wasn't willing to cut corners to bring costs down.

A separate issue at Abbott was internal conflict over the best use of company resources. For one, Foote says, the ethical drug business is accustomed to higher profit margins, so Abbott's custom synthesis group would be scrutinized for the lower returns it tended to bring. And executives on the ethical side would question the use of company resources for outside projects. "They were reluctant to commit capacity," Foote says. "They would ask, 'What happens if an internal project comes along?' "

Foote says the pros outweighed the cons during his tenure, and that at its peak the business logged some $50 million a year in sales. Today, according to Keith Kentala, Abbott's director of custom pharma sales and marketing, sales are even higher than they were in the late 1990s. He says Abbott continues to offer external customers pharmaceutical development and scale-up with the same resources that are applied to its internal pipeline.

The company practices most standard reactions used in pharmaceutical chemistry, Kentala says, and has a specialty in solid- and solution-phase peptide chemistry. However, companies in Asia-Pacific continue to apply price pressure to large pharma players like Abbott, he says, making it "challenging to continue to compete in this market segment."

	POTENT Part of Boehringer Ingelheim's investment in Petersburg, Va., is this kilo lab for highly potent compounds. BOEHRINGER INGELHEIM PHOTO

LIKEWISE, Pharmacia's Stevenson acknowledges that his company is not the place to go for cut-rate pharmaceutical chemical production. However, he says it is a place to turn to for companies that want to avoid regulatory and compliance risks. "Pure plays can have difficulty in this area. We are not the low-cost approach, but we bring reliability," he says.

Mike Kosko, vice president of Pharmacia's dosage-form contract manufacturing unit, points to a recent case where Pharmacia won a production contract in competition with several contract manufacturers. "The driving force was the regulatory status of our facilities and our expertise in processing," he says. "It gave the customer a certain comfort level. We weren't the cheapest, but we took risk out of the equation."

David McGee, marketing manager for Boehringer Ingelheim Chemicals, the U.S. arm of BI that concentrates on API manufacture, says his company takes the same approach to quality for all its pharmaceutical actives, whether they are made for internal use or external customers. "We designed our facilities and organization to ensure high quality--and quality and compliance have a cost," he says.

McGee admits that BI's cost structure can be higher than that of a chemical company that doesn't operate in a cGMP-compliant environment. Customers are concerned about costs, he says, but they are even more concerned that the facilities where their products are made pass the rigorous preapproval inspection (PAI) the Food & Drug Administration conducts before they are allowed onto the market (see page 59). "If a customer's supplier fails a PAI, the impact in terms of lost sales is dramatic," McGee points out.

In addition to the cost issue, the contract manufacturing arms of drug companies must also address the concern of potential drug industry customers that their trade secrets could leak to an arch rival--that is, the pharma side of the contractor.

Company executives are quick to declare this could never happen. "We supply the big five of our industry," Merck's Freiberg says. "They know if we would violate the rule of confidentiality just once, we would be persona non grata forever. The industry is very transparent that way."

However, Nick Hyde, director of the pharmaceutical services business of Dow Chemical, notes that the problem can be more subtle. Certain hard issues like composition of matter patents are easy, he says: You are either infringing or not.

More difficult are other elements of know-how that come along with a close relationship, because once they are with the contractor, they stay there. "You can't unlearn know-how," Hyde says. Hesitancy over these softer issues could lead a customer to hold back information, he notes, to the detriment of both the relationship and the solution the contractor delivers.

	COVERED Working with cytotoxics at Pharmacia's Heumann Pharma unit in Germany requires protective gear. PHARMACIA PHOTO

EXECUTIVES with drug company contract arms point to extensive investment in production facilities and other infrastructure as evidence that they are committed to serving all aspects of their relationships with outside customers. They also note that the investment can be synergistic, since it is often in facilities that serve their own businesses as well.

For example, Merck will open up two new multipurpose organic production plants at its headquarters in Darmstadt, Germany, next year at a cost of about $250 million. Freiberg says the plants are intended to serve Merck's own drug business, its custom synthesis business, and its liquid-crystal display business.

Because the plants are multipurpose, "we are not solely dependent on the ups and downs of the custom synthesis business," he says, adding that Merck is also developing new API chemistry in fields such as protected amino acids and oligopeptides.

McGee says BI has spent more than $70 million over the past three to four years just on its Petersburg, Va., facility, one of four BI API plants. The money went to expanding the site's manufacturing capacity for complex APIs, highly potent compounds, and Drug Enforcement Agency Schedule II controlled substances, both for BI's own business and its external customers.

In Pharmacia's steroids business, although the company has some internal demand, investment is largely driven by merchant market needs. Stevenson says the firm is in the midst of a 30% expansion program in Kalamazoo, Mich., that should be complete next year. "It was conceived and designed to meet growing third-party steroid demand in respiratory, hormonal, and other markets," he says. Heumann Pharma, the former Searle business, is expanding cytotoxics capability in Nürnberg, Germany.

At Aventis, which operates more than 10 chemical synthesis and fermentation facilities in France, Germany, and Italy, investment for the third-party business also comes in the form of groundbreaking R&D, according to Udo Hedtmann, head of business development for the API operation.

Hedtmann says Aventis scientists have been working for close to 10 years on a new route to corticosteroids, a class of compounds that are a legacy of Roussel Uclaf but are now only a minor part of Aventis' consumer drug business.

Historically, steroids were made from diosgenin, a compound derived from wild yams that grow mainly in Mexico. More recently, companies like Aventis and Pharmacia learned to derive the steroids from vegetable sterols. Now, Hedtmann says Aventis is getting close to a third route, based totally on fermentation, that promises to be inexpensive and free of raw material constraints.

DESPITE YEARS of market participation and investments such as these, drug companies still get questioned about their commitment to the third-party business. Competitors at pure contract manufacturers point to companies like Schering-Plough that have pulled back from the third-party market when corporate goals shifted.

Hyde notes that a dedicated contractor like Dow allocates resources with a consistent customer-focused mind-set. "A drug company with a contract manufacturing arm has to make resource allocation decisions from a more complex perspective," Hyde says. "Given that being a drug company is typically more rewarding than being a contract manufacturer, it is reasonable to assume that resource priorities will follow this difference."

Hyde says he experienced this conundrum himself when he worked for Zeneca Specialties, which in the 1990s was building a contract manufacturing organization while also participating in the pharmaceutical business. "The question of getting a slice of the corporate cake was very real," he says. Ultimately, Zeneca split, with the drug business becoming part of AstraZeneca and the chemical business becoming Avecia.

Prou counters that in the case of Aventis, his business makes a real contribution to corporate goals--a contribution acknowledged when it was retained during the merger of Hoechst and Rhône-Poulenc.

On the most basic level, Prou says, marketing of excess capacity in standard products keeps plants operating efficiently and contributes to sales and profits. In addition, his business provides Aventis with a window into the marketplace in case it needs to farm out manufacturing. "We provide market intelligence to our global purchasing and outsourcing organizations," he says.

At BI, McGee says manufacture of APIs is a core competency, with supply to third parties being key to maintaining that competency. "External customer expectations provide a benchmark for success," he says.

McGee and his drug company colleagues acknowledge that they are in the minority in the world of contract pharmaceutical manufacturing, making up less than 10% of the overall industry. But they are a persistent and, in many cases, growing subset.

Indeed, McGee expects firms like his to take on a bigger contract manufacturing role in years to come, especially as the pharmaceutical regulatory environment becomes more and more stringent for both customers and suppliers. "I see a continued role for drug companies that consider external customers to be a key element of their strategy," he says.

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Copyright © 2002 American Chemical Society