Lessons Learned. Providing a price in the Pharmaceutical CDMO Industry.

Outsourcing the manufacturing of a product comes at a price. Sometimes metaphorically but always literally. What is the right price to pay to outsource your product? Who decides the price? Is it the CDMO who sells or the pharma company who buys? At the end of the day which factors affect pricing in the pharmaceutical CDMO environment?

It seems that those questions did not matter for the CDMO of the story. Pricing policy became as straightforward as it could be. The guidelines were that all new RFQs should have minimum 10% EBITDA, no matter how EBITDA was calculated, and no matter what was the nature of the product to be quoted. And of course it did not matter if the quotation included material cost or not.

But first things first. Price is different than cost, and although sometimes they are related, it happens very often that they are not. This article tries to explain why this may happen and give some food for thought for different parameters affecting the price that a CDMO charges (or the pharma company pays to outsource the product).

There are two perspectives of this topic. First is the angle of the CDMO and then there is this of the pharma company who outsources. Let’s start with the first one. When a CDMO offers a price for a product, probably the first parameter that considers is its cost. What is the cost of materials, the direct cost, the fixed cost etc. It is not uncommon that this is the only parameter that CDMOs take into consideration and this is what I call Cost Plus pricing strategy, where a cost is calculated and then a specific margin is put on top in order to calculate what price to offer to the customer. This is the easy but at the same time more simplistic approach, which sometimes leaves some money (value) on the table or in other cases may lead to rejection of the offer due to uncompetitive price. This is because the Cost Plus pricing strategy does not take into account market related factors.

Market related factors include what competition offers for the same product but also what the customer (the pharmaceutical company which outsources) is willing to pay for the specific product. It is the combination of these 3 three elements that should be considered when a CDMO offers a price. CDMO’s internal parameters, Competition offering and Customer’s willingness to pay.

CDMO’s internal parameters should not include only cost related factors. There is so much more than the cost that should be considered. Imagine that a CDMO wants to propose a price to a customer which asks for a price without API. Let’s assume a low annual volume product (couple of batches per year), difficult to produce and API to be provided by the customer free of charge. In situations like this, since the API is provided free of charge by the customer, it is not uncommon that CDMOs do not bother to try to find its value.

But now think of this. The CDMO makes the analysis and turns out to be that the API value is double than the value of the remaining batch cost. What will happen if a batch fails due to CDMO’s fault? It might be the case that if the CDMO has to pay for the value of one rejected batch, this would mean that not only the profit of one year will be evaporated but also that the CDMO may produce at a loss the specific product. It feels to me that this is a nice example explaining why cost should not be the only parameter that should be considered when a price is about to be offered to a customer.

But of course, there are more. Free available capacity, difficulty of manufacturing the product, complexity, expectations of more business from the specific customer are some of the internal parameters that should be considered. It maybe the case that the CDMO charges a premium for a product that is difficult to manufacture, especially if competitors cannot cope with it. Similarly, if free capacity is limited, maybe it makes sense to charge a premium for giving away this limited free capacity. On the contrary, if the specific project is a door opener for a new promising customer, then it might be wise to consider sacrificing part of the margin, in order to bring the customer in. This of course is related to the strategy of each CDMO. Some have a growth strategy, for some others next year’s EBITDA is more important.

And then there are market related factors. Factors like what competition offers for similar products and factors like what is the customer willing to pay for the specific product that is about to be quoted.

Since what price competition is offering for similar products is difficult to know, unless maybe you ask for external advice of industry specific experts, lets jump to what the customer is willing to pay for the specific product. CDMOs should, in my opinion, put themselves in the shoes of their customers for a while.

Is the customer willing to pay more because the CDMO has limited free capacity? Does the customer care if the CDMO has a growth or an EBITDA related strategy? Probably not, but maybe a difficult manufacturing process plays a role in the price that pharmaceutical companies are willing to pay. Of course there are more important parameters that the latter consider, when deciding on what is a fair price to pay. The most important of which is what margin this price (which is a cost for the customer) leaves them on the table. And this is where it starts to get difficult for the CDMO. Defining what is the margin of the customer, letting alone what margin is enough for their customers might be seen as a long shot. Nevertheless, there are some ways to approach it. And the closer they get, the better the chances are for defining the right price for the product.

Is it the same if a product is a commodity, like generic paracetamol tablets as if the product is an innovative lyophilized vial, patent protected? Manufacturing technology, therapeutic area, competition in the market of the pharma company (how many other pharma companies market this product) and country of sale are some of the parameters that affect what is the willingness to pay.

A good approach for the CDMO to define the margin that its price will leave to its customer, is to see what is the price of the specific product in the pharmacies in different markets, remove taxes, pharmacy margins and distributor margins and get a flavor of the margin that its customer will have. Of course this is not enough. Different pharmaceutical companies have different expectations on their margins but in general there are specific patterns. For a commodity like a generic paracetamol tablet probably something around 60% is fair enough. On the other hand, for an innovative lyophilized patented vial, they would expect something around 90%. These figures exclude rebates and marketing costs that pharma companies need to pay. If the CDMO does not consider factors like this, providing a price only based on internal parameters, significantly reduces the chances to provide the appropriate price. Although it is difficult for many CDMOs to run this exercise, it probably worth the time and the effort.

Yet, margin is not the only factor affecting what is the willingness of a pharma company to pay. Culture, location, quality, cooperation, responsiveness and flexibility of the CDMO also affect customers’ willingness to pay. If the pharmaceutical company is satisfied with the service level they get from a CDMO, if they feel that they are important and their supply is secured, they are probably ready to sacrifice part of their margin as opposed choosing a CDMO with a lower price but also a lower service level and higher supply risk.

And of course, the better the pharmaceutical companies outsourcing their products are informed about what is the average price in the CDMO market for the specific product, the more ready they are to answer what is the fair price to pay.

So, answering the question what is the right price to pay (or to charge) it needs market knowledge. Knowledge of the CDMO market but also knowledge of the pharmaceutical market. CDMOs should put themselves in their customers shoes but the opposite is also true in order to have a healthy long-standing cooperation.

Knowledge of the market is important. Get to know your market but also get to know your customer’s market. Combining both will make you better prepared to answer the question of what is the right price to charge in the CDMO environment.

Unfortunately, many CDMOs do not spend time in understanding the market in which they operate, and they just provide offers to their customers, hoping that they will be lucky. Because if you are a CDMO and ask for 10% EBITDA for every quotation, without considering if this is a conversion only quotation (i.e excluding materials cost), or the value of the API, or the nature of the product etc. and you hope to fill with business your unutilized sites, then it is better to think twice before you provide a quotation to the customer.