Guest Column | April 7, 2017

Do You Make These 3 Mistakes In Your CDMO Contract Negotiations?

By Kevin Haehl

Do You Make These 3 Mistakes In Your CDMO Contract Negotiations?

Developing and launching a pharmaceutical product is a highly risky venture. Recent studies show that the overall success rate from Phase 1 to FDA approval is now less than 10 percent (Seaton, 2014), and many of those do not achieve commercial success. At the same time, the pharmaceutical industry is moving toward an outsourced manufacturing model using CDMOs (contract development and manufacturing organizations), which further compounds the risks by adding knowledge transfers, competing priorities, and lack of control. Building strong and mutually beneficial outsourcing partnerships is crucial to achieving success for small, midsize, and even Big Pharma companies.

Outsourced development and manufacturing is nothing new, and it is usually advantageous for gaining access to technology, improving timelines, and reducing costs. But there are pitfalls, especially in the selection and agreement phases, that can take that risky venture and make it a near impossibility. Potential partners often take positions during a contract negotiation that at best delay the project, and at worst, scuttle the partnership. Here are three examples of short-term thinking that are common in both the customer and contractor sides of the negotiation that make any partnership an uphill climb.

Putting Too Much Emphasis On Price

The tried-and-true approach for an outsourcing project is to place a request for proposal with multiple qualified partners, compare the price quotes received, and choose the lowest bidder. While pricing is a key factor, too narrow a focus on this one variable is like only considering the waist size when ordering a tailored suit — it is unlikely to give the desired outcome.

There is no doubt that the cost of an outsourced development or clinical supply project can be critical, especially to a startup company with limited funds. Therefore, it only makes sense for the customer to comparison shop by getting multiple quotes. But the cost of delays or failures is high. So is external oversight. Choosing the right partner -- and thus increasing the chance of avoiding those costs -- is worth a premium of 10 to 20 percent, or even more.

The customer must weigh each contractor’s technical capabilities, project management skills, quality systems, and communications transparency. It takes time during the proposal stage for both parties to evaluate each other, but it is time well spent. A myopic focus on price alone leads to longer-term problems resulting from incompatible cultures and differing expectations.

From the contractor’s perspective, business deals that hinge solely on price make it tempting to low-ball the proposal and leave out necessary work that is not mentioned in the request. This leads to difficult debates regarding change orders and frequent rehashing of what “was in the contract,” rather than a strong collaboration leading to success.

Taking this approach might earn a CDMO one contract, but that contractor is unlikely to see repeat work. No business can afford a reputation as a company that thrives on expensive change orders. It is far better practice to make clear and fair proposals and even occasionally accept lower margins on the expectation that learning curves will increase profit over time. It is easier to keep a customer than to find new ones.

Holding IP Hostage

Another stumbling block that often trips up a smooth negotiation is ownership of intellectual property that arises during the course of the relationship. As a customer paying for development or manufacturing, it is common to assume that any IP that is formed during work done under that contract is the property of the customer. However, this misses a key point. The contractor typically provides a technology platform and underlying know-how, which is why the customer needs it in the first place. If the CDMO broadly surrenders IP on any improvements to its platform, it would soon be out of business.

It is appropriate for a customer to insist that it be granted a license for any technology improvements that arise from the development of its product. In some situations, it is even possible for the customer to be able to use that license with another CDMO to manufacture the product. But unless the contract work was intended to be purely for research with the intent to develop a new technology, it is incorrect to assume that full ownership of arising IP should belong to the customer.

Likewise, the CDMO needs to understand that a customer cannot pay for development work without having the rights to port its product to another supplier for any variety of reasons, such as failure to supply, capacity constraints, or new market entries. The practice of attaching IP to a customer project then holding it hostage will hinder the contractor from securing future business in the industry.

The bottom line is that the agreement needs to lay out clearly what is being paid for, and who owns what as a result. The simplest way to start the discussion is to state that “what I bring to the table is mine, what you bring is yours, and what is created is shared appropriately.” For the latter, a good rule of thumb is that arising IP related exclusively to the product typically stays with the customer, and IP related to the process or technology platform remains with the CDMO.

Insisting Upon Exclusivity

Exclusivity is a point of contention that can kill an outsourcing arrangement. The customer usually wants assurances that the contractor will not manufacture its product for others, while maintaining the right to contract with multiple vendors for supply. The CDMO prefers to have 100 percent of the business, while also desiring the right to sell the same or similar products to other clients. These opposing positions must be resolved for the partnership to succeed.

In the case of a new chemical entity that is technically challenging or small volume, exclusivity often makes sense for both parties, at least while the product is patent-protected. It can be too costly to develop the product twice, and with appropriate risk mitigation, a second source is not required.

One of the drivers for outsourcing is to reduce costs and investment by using a CDMO’s capabilities and capital resources. If the customer prohibits the CDMO from selling competing products or even the same product once the product is generic, it is essentially converting the CDMO into a captive resource. This is counterproductive, as it ultimately leads to higher costs and encourages the competition to create additional sources of the product.

Neither is exclusivity always the best arrangement for the contractor. The customer may express a need for a backup supply strategy or simply some leverage over pricing. As the product grows in volume and revenue, allowing a second source is not only prudent, it can be critical to avoiding substantial liability for the contractor if problems arise. If the contractor is good at its business, it should not fear competing with other contractors.

Exclusivity requirements can be complex and difficult to negotiate. It is usually best to be exclusive (with regard to the specific product) for both parties early in the life cycle, but as the product becomes generic or a commodity, the case for exclusivity declines.

A Win-Lose Relationship Loses Every Time

Whether the partners are big or small, moving smoothly through the contract negotiation to start the project is a key to success. While there are many details in a contract that require discussion, the topics of price, intellectual property, and exclusivity will often become stumbling blocks to a successful venture. When potential partners take unrealistic positions and delay or kill the project, everybody loses, from the partners, the investors, and ultimately the patient.

About The Author:

Kevin Haehl has a career's worth of experience in pharmaceutical drug substance and drug product, from big pharma to contract development and manufacturing.  He was most recently the general manager for Unither Pharmaceuticals’ U.S. subsidiary, responsible for introducing the French company's brand in the U.S. market.  Prior to that, Kevin held leadership positions in business development, manufacturing and supply chain, and quality for Evonik and Eli Lilly, in both the U.S. and U.K.