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Volume 84 Issue 7 | pp. 17-27
Issue Date: February 13, 2006

Cover Stories

Custom Chemicals

As the global paradigm for the custom manufacturing business continuesto shift, providers struggle to differentiate themselves from the competition
Department: Business

East has met West. The destiny of the custom chemical business is being shaped not only by the traditional powers in the West but also by emerging companies in the East. European and U.S. fine chemicals producers are fighting to get a foothold in Asia by putting assets there or tapping into low-cost supplies. In the meantime, Indian producers of advanced intermediates and active pharmaceutical ingredients (APIs) have created global stances by acquiring foreign operations.

The evidence is undeniable given the number of high-profile deals in just the past year. Among the larger ones is India-based Shasun Chemicals & Drugs' planned purchase of Rhodia Pharma Solutions' custom synthesis operations. Shasun will get two U.K. plants and hydrolytic kinetic resolution, aromatic-bond formation, and radical trifluoromethylation technologies. Rhodia will close operations at the Chambers Works site in New Jersey.

Two months earlier, Nicholas Piramal India Ltd. (NPIL) acquired Avecia's pharmaceutical custom synthesis business, which includes operations in the U.K. and Canada housing chiral, biotransformation, and high-potency API capabilities. Prior to this, Avecia had sold its other fine chemicals business to KemFine and spun off its specialty catalyst business as Reaxa, in which NPIL now holds a 25% stake.

"The major trend is globalization," says Peter Pollak, a fine chemicals business consultant. "A new world order is rapidly emerging." And it's one in which the center of mass has moved east. Other Indian companies recently completing deals include Dr. Reddy's Laboratories, Malladi Drugs & Pharmaceuticals, Dishman Pharmaceuticals & Chemicals, and Sun Pharma.

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Until recently, China and India were making simple intermediates for the big Western drug companies and conventional APIs for Western generics producers, Pollak explains. In the new global supply chain, China now supplies the simple intermediates and APIs for generics, and India provides advanced, regulated intermediates and APIs for generics. Major U.S. and European pharmaceutical firms are largely making APIs—often only conducting the last synthesis steps—for branded or innovator drugs.

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"The reluctance of major pharmaceutical firms to deal directly with Asian, particularly Indian, companies is melting like snow in sunny springtime," Pollak says. The changing paradigm stems from three developments: severe price pressures on pharmaceutical producers, India's adherence to international patent laws, and the demonstrated success of a few deals. The emerging trend of drug companies toward making "authorized" generics of their own products also favors direct deals with Asian fine chemicals companies.

Although China has many more suppliers than India, these firms lack differentiation. China also is lagging because its poor record on intellectual property (IP) protection keeps it largely a provider of basic production capacity and not of advanced technology. Indian firms have become more aggressive contenders, and an increasing number of their facilities are operating under Western regulatory standards and use newer technologies.

Merchant API sales have grown 5-7% per year over the past five years, reports Italy's Chemical Pharmaceutical Generic Association (CPA). Growth hasn't been uniform in all regions: Growth rates have reached 17-20% annually for producers in India and China, while stagnating in some European countries. The share of sales held by Western European companies also fell from about 60-65% in the early 1990s to 44% in 2004; meanwhile, the share held by China and India reached a combined 19%.

Drug companies make most of the world's APIs, about $41 billion worth in 2004, for their own use, CPA says. Many source intermediates from the outside. "Pharma companies have been getting much more cost conscious and therefore have begun to move into markets like India," says Michael J. Fernandes, executive director for NPIL Pharma's custom manufacturing group. He joined the firm in December 2005 after more than 12 years as a consultant with McKinsey & Co.

"As NPIL looked at the state of contract manufacturing, our sense was that the real answer is having a company with a solid global footprint," Fernandes explains. This would include not only assets in developed countries for making compounds used in the earlier stages of drug development but also reasonably large-scale assets in low-cost countries. Along with a range of technical capabilities, this proposition offers flexibility, enabling faster movement of products and better service offerings, he says, and differentiates the company from others.

The setup also matches what pharmaceutical companies desire. They want a presence in both Asia and Europe to get access to different cost structures across different geographies and throughout product life cycles. "We needed to think about a whole-life-cycle manufacturing strategy, which innovator companies were driving, in a more sophisticated fashion," Fernandes asserts.

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"There is a very clear need to access early-stage support out of Europe and the U.S. and a clear sense that for projects in launch mode, the preference is to have them closer to home," he says about the wishes of Western drug producers. But once a project has stabilized, depending on the technologies used, materials might be sourced from countries where costs are low. And as a product moves into even later stages of its life cycle, drug firms would start to expect significant cost reductions—something European API providers may or may not be able to offer, Fernandes adds.

He believes that the new global business offering should be a single entity because customers want to work with one partner, not loose alliances of many parties. "They don't need a contract manufacturer to tie up another partner and be an intermediary in the process," he points out.

Prashant Malladi, managing director of Malladi, agrees with this view as his company's new service model seeks to balance cost differences between the U.S. and India. About 80% of Malladi's revenues are generated outside India. Its purchase of Novus Fine Chemicals adds a U.S. operation with large-scale reactors to complement five manufacturing sites and an R&D center in India. The company has invested in a pilot plant in New Jersey to open in May. Customers needn't travel to India as there are operations "right in their backyard," he adds.

"To compete, API manufacturers in the U.S. and Europe try to source intermediates out of India and China and then make the product," Malladi says. Because the pharmaceutical customer's relationship is with the API manufacturer, it may never know the other sources. "In our case, the whole thing is transparent—Malladi will make the advanced intermediate, bring it into the U.S., and complete the last critical steps for the API."

"What we offer is a seamless company," he continues. "We want to work with the innovator companies and provide a platform where there is less 'leakage' in intellectual property." Confidentiality and IP remain significant concerns for innovator companies, and by limiting the number of technical handoffs and emphasizing IP protection, both Malladi and NPIL expect to attract big partners. NPIL, for example, recently signed R&D and supply deals with Pfizer and AstraZeneca.

Both Indian companies also believe in focusing on API production, rather than on both APIs and finished generic drugs, and thus avoid possibly competing with their customers. "There are very few good companies left in India that are strictly API producers," Malladi says. "Most of them have jumped into making generics, and we want to stick to our core competence in making APIs and intermediates."

Fernandes says it made sense to build a global business via acquisition because businesses were available that offered technology, plants, employees, and established customer relationships. Executives with the Avecia business, in turn, wanted access to the Asian market. "It was also quite consistent with conversations we've had with other contract manufacturers that are beginning to think about how they can reconfigure their assets."

To be a leader in the fine chemicals industry, a company can no longer simply be a regional player, many industry participants believe. And they expect that the fine chemicals industry, like other industries before it, will continue to move toward a global structure. "The challenge, given the nature of this industry, is in getting it to work," Fernandes remarks.

Complicating factors include Indian and Chinese companies' extensive exposure to the generics business, which will limit their ability to "sell their story and convince customers about IP protection," he says. Another issue is the ability of the large fine chemicals companies, given that they have unused assets in Europe, to begin developing new assets in Asia. Doing so would only further exacerbate their capacity utilization problems.

"These challenges will make it a more difficult path," Fernandes concludes. "The shift should have already happened, frankly, but it will happen and is happening."

For many years, Western companies dominated the API market with sophisticated custom synthesis technologies, regulatory compliance, reliable quality, and customer access; what they lacked was cost-effectiveness. Asian suppliers already have cheap capacity and are challenging the status quo by expanding their technology and asset base and moving closer to the customers. For these reasons, Pollak expresses concern for European and U.S. fine chemicals producers.

He says the outsourcing of low-value steps by Western companies is a temporary solution. Although it offers control over product quality, it can exacerbate the overcapacity situation. Over time, Pollak believes, it will also only serve to teach others how to be more competitive. For example, he sees the ability of India's Biocon to produce generic biopharmaceuticals such as insulin and the deals signed by three other Indian firms to use U.S.-based Codexis' emerging biocatalyst technologies for commercial applications as evidence that "India is catching up in the most modern technologies."

A worst-case scenario, Pollak suggests, is the end of the custom manufacturing industry in the U.S. and Europe. A more optimistic view is that once the rate of new drug approvals increases again, major pharmaceutical companies will stick with traditional suppliers because of their track records for service.

But he considers the prospects for a pickup in drug approvals and related outsourced projects from major pharmaceutical customers "not very good." In fact, much of the outsourcing business has shifted away from large pharmaceutical firms to emerging drug, biopharmaceutical, and virtual companies with very different needs and prospects for success.

The crowded European fine chemicals business has suffered many wounds over the past five years. Companies expanded, largely through high-priced acquisitions, during a peak period for pharmaceutical outsourcing. Subsequent product delays, failures, and approval shortfalls have left as much as 30-40% of general-purpose capacity unused. Low-cost competition has emerged. Demand for generic drugs is growing, but Asian suppliers provide nearly half the active ingredients for these products.

Between 1990 and 2000, the market for APIs used to make generic drugs increased an average 12.2% per year in value, while the market for APIs for branded drugs grew 5.5% annually, according to CPA. In the ensuing years to 2004, these growth rates dropped to 7.8% and 4.4%, respectively. Major European custom manufacturers have seen their earnings suffer. It is not surprising then, industry observers say, that companies have decided to make changes.

"The companies that have been sold or are selling their businesses bought companies at a very high price because the expectation at the time was 15-20% growth," says Antonio Germani, director for pharma solutions at BASF. "Now we know that this was unrealistic, and what they paid before, they cannot get paid back. So a lot of them leave and give the ball to somebody else who maybe is much better equipped."

Avecia, for example, paid $40 million in 2000 to buy Torcan Chemical, now just a part of the business NPIL bought for about $17 million. Likewise, Rhodia is handing off to Shasun a business that includes ChiRex, an acquisition that cost Rhodia $545 million in 2000.

Many companies that aren't getting out of the business are restructuring. Last year, Degussa took a $1 billion charge against its troubled fine chemicals business, a large part of which related to goodwill for its $2 billion purchase of Laporte in early 2001.

DSM is mothballing a biologics facility in Montreal this year and in 2007 is closing an API plant in Michigan acquired with its $800 million purchase of Catalytica in 2000. Seeing the generic API and early-stage intermediate markets commoditizing, DSM plans to focus on higher value advanced and regulated intermediates and APIs. It says it will source early-stage intermediates increasingly from China and India and, as a consequence, will scrutinize its asset base more closely and improve its capacity utilization and cost structure.

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Concentration
Custom manufacturing operations at Lanxess, including this multipurpose Good Manufacturing Practice plant in Germany, will become part of a dedicated company called Saltigo that will debut later this year.
Credit: Lanxess photo
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Concentration
Custom manufacturing operations at Lanxess, including this multipurpose Good Manufacturing Practice plant in Germany, will become part of a dedicated company called Saltigo that will debut later this year.
Credit: Lanxess photo

Meanwhile, Bayer's fine chemicals business has been put even further at arm's length. It once primarily served Bayer's internal needs, but during the boom years of the late 1990s, it took on external customers. By early 2005, fine chemicals went with Lanxess, the chemical company Bayer spun off. Nine months later, Lanxess decided to move fine chemicals into a separate dedicated company called Saltigo; it is to debut in the second quarter with a service-oriented emphasis, a broad range of capabilities, and annual sales near $450 million.

Lanxess has reported that the business posted hundreds of millions of dollars in losses over the past five years; its fine chemicals plants have been running below capacity and in some cases are obsolete. Saltigo is scheduled to shut plants and cut jobs to change its cost structure, increase efficiency, and improve profitability. Nevertheless, Lanxess plans to invest about $60 million in Saltigo by the end of 2007, with the option to invest the same amount again by 2010.

Although some companies have defensively thrown in the towel, others are taking the "if you can't beat them, join them" route. Even the Indian API producer Hikal, which acquired a European distributor in late 2004, has taken a stake in a Chinese company to provide low-cost sourcing for raw materials and intermediates.

Recently, Pfizer CentreSource (PCS) decided to pursue a new strategy for its more-than-50-year-old steroids business. "Over the years, we have seen market pressure and cost increases, resulting in a loss of market share primarily to Asian producers," admits Michael J. Kosko, PCS president. Pruning product lines had been one approach to focusing the business, but it wasn't practical long-term and didn't address getting costs in line. "In viewing the marketplace and listening to our customers, we decided to work on an outsourcing strategy," he says.

The steroids business is PCS's largest group, and its technology advantage lies in the initial bioconversion steps. It will maintain these operations in Kalamazoo, Mich., but have subsequent processing done at low-cost locations, says Doris S. Symonds, vice president for fine chemicals. "The downstream steps, involving more classical chemical synthesis that isn't protected by a lot of intellectual property and where the batch sizes get smaller, become more labor-intensive," she explains. "Clearly, we can't be as cost competitive as our Chinese competitors."

PCS has chosen two Food & Drug Administration-inspected partners in Asia and will ensure all regulatory compliance for its customers, including filing comparability protocols to demonstrate the equivalence of the Asian products with those currently produced in Kalamazoo. "The strategy, which offers long-term supply assurance as well as competitive pricing, has been extremely well-received in the marketplace," Symonds says. "Customers understand the rationale for it, the pressures to be competitive, and they are appreciative of our proactive approach."

The transition, involving about a dozen product families, is expected to take about four years, Symonds says, starting with commodity steroids now under the most competitive pressure. "Upon demonstrating the success of these moves, we'll then go deeper and deeper into the pipeline to more high-value and specialty advanced steroids." This year will be used largely for technology transfer and regulatory work, with the first commercial products from contracted suppliers available in 2007.

Competition and differentiation are on the minds of custom chemical producers as they try to succeed, or at least survive, in a difficult market (see page 34). The industry consists of a handful of large players, a few times as many midsized companies, and hundreds of niche players, many of which offer specialized chemistries.

Clariant has been working to reinvent its fine chemicals business for the past few years. It, too, has taken charges related to its business, the bulk of which came from the $1.8 billion purchase of BTP in 2000. Clariant recently announced further investments at facilities in France and the U.S., a new business model to aid process development, and developments in phosgenation, chiral, and organometallic chemistries.

To expand its business, BASF acquired the Swiss firm Orgamol in October 2005. The acquisition more than doubled BASF's custom manufacturing business and put it among the top 10 global providers. According to BASF, its business has been strengthened on a sustainable basis in what it calls "the attractive pharmaceutical contract manufacturing market."

Lonza also continues to grow, especially in the promising area of biologics (see page 58). Last year, it started expanding API production in Visp, Switzerland. This year, it will open research laboratories for process development in Nansha, China. In January, it announced plans to add reactors at its biologics facility in Portsmouth, N.H., to accommodate preclinical production needs and paid $145 million for UCB-Bioproducts, the peptide-drug-manufacturing arm of Brussels-based UCB.

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As companies restructure their operations or combine operations to create totally new businesses, they want to shape their competitive positions. Delineating a single winning strategy in pharmaceutical fine chemicals can be difficult. Whether it's technology or service depends on a customer's specific requirements, but developing a track record for delivering whatever it is a customer needs is key, companies executives say.

"There are perhaps more differences appearing between companies that are being successful and those seeing a gradual deterioration in market share," suggests Nick Hyde, global business director for Dow Chemical's Dowpharma unit. Companies with general-purpose capacity are being hit hardest. Those seeing more reasonable market conditions, he says, "offer something truly differentiated that the customer will recognize and pay for."

Dowpharma, Hyde explains, concentrates on API manufacture based on 30 years of experience working with regulators and on technology-advantaged intermediates created with chiral chemistry. He believes that to stay in the forefront a company must commit to investing in R&D. "In the chiral area, you have to have a solid technological base, otherwise somebody else is going to undercut you," he says. "And in APIs, a lot of what you bring is track record, project execution, and close relationships with customers."

Responsiveness is crucial, suggests Guy Villax, chief executive officer of Hovione. When an early-stage project comes on board, the income tends to be small. "You need to be very nimble to welcome 20 half-million-dollar projects so that for two of them, four years down the line, you can invoice $5 million or $10 million," he says. Projects only become manufacturing relationships much later, and therefore, he believes what's needed upfront is communication, demonstrated know-how, some risk taking, and trust building.

"The added value comes from many more things way beyond just manufacturing capacity and being the lowest cost provider in a given technology," Villax says. Still, he acknowledges that technology is important and says Hovione's approach is to have a range of expertise along with the willingness to invest what's needed for a project.

Consolidation among fine chemicals producers has been widespread and, along with new owners for other firms, is fashioning a new industry landscape. New entities consist of Excelsyn, which includes Great Lakes Chemicals' business; KemFine, formed in a buyout of Kemira's fine chemicals unit that then acquired an Avecia business; Novasep, from the merger of Novasep and Dynamic Synthesis; WeylChem, uniting five Rütgers Chemicals businesses; and SAFC, created within Sigma-Aldrich.

Another "new" company with a 54-year history is France's Minakem, the former SEAC business that was bought by investors last year. "You don't improvise in the fine chemicals world; it requires a lot of experience," says Pierre Charrier, Minakem's chief operating officer, who's happy about having the same operations under new owners committed to the business. The company focuses on complex starting materials, intermediates, and APIs and has key technologies in chiral synthesis, hydrogenation, cyanidation, and extreme-temperature reactions.

The nature of the business means that many projects die or are put on hold, and a provider needs to be ready to "restart at any time from scratch," Charrier points out. "But that doesn't mean we have a short-term view—we want to work with the partners long-term." To be closer to its customers, Minakem has expanded its marketing presence in the U.S. Like many small companies, it offers the kind of technologies pharmaceutical companies often want done externally on an as-needed basis because of the requisite expertise, high cost of equipment, technical challenges, regulatory issues, and safety concerns.

Similarly, Dottikon Exclusive Synthesis, spun off as a public company by EMS Group in 2005, has its roots going back to 1913 in the Swiss Explosive Works. The spin-off was "driven by the goal to enhance the development of a pure player specializing in hazardous reactions," says Dottikon ES CEO Markus Blocher. "Our strategic differentiation is a combination of specific technological know-how in handling hazardous reactions, dedication to performance leadership, and our aspiration for continuous improvements," he says, along with an established safety culture.

"Having the appropriate mind-set and safety culture allows you to use hazardous reactions to take shortcuts in chemical synthesis and therefore improve costs and impurity profiles," Blocher says. "But it can also open up economical ways to produce new bioactive chemical structures."

The company invests an average of 10% per year of its revenue, or about $8 million this year, to expand its portfolio; it recently added capabilities for high-purity primary amines and for tetrazole and indole derivatives, as well as reactor capacity for continuous hazardous reactions. It also purchased a stake in Systag, a developer of automated chemical process instruments.

Ampac Fine Chemicals (AFC), formerly Aerojet Fine Chemicals, was acquired in late 2005 by American Pacific (Ampac), a developer of chemical products used in aerospace and defense systems. "Ampac is committed to the continued development of AFC as a key platform for its long-term growth," says AFC President Aslam A. Malik. "We hope to take advantage of their knowledge and capabilities to complement those at AFC."

AFC specializes in energetic chemistry, including diazomethane and azide reactions; high-potency compounds requiring specialized containment; and separations using simulated-moving-bed (SMB) chromatography. This year, it will begin operating one of the world's largest SMB systems, employing five 1,000-mm columns that can process about 200 metric tons of material per year. The company added capacity for energetic reactions in 2004 and anticipates the need to do so again soon.

AFC's areas of expertise are "really taking off with customers," Malik says. As costs have declined, separations have become more popular as unit operations in production to make high-purity and optically pure materials cost efficiently. He says this technology platform is likely to become even more attractive when used in combination with asymmetric synthesis. Likewise, many more compounds are emerging that are high-potency or require specialized chemistries.

According to CPA, the Italian trade association, as many as 25% of the 7,000 compounds in development are highly potent, compared with less than 10% of drugs now on the market. On the downside, although they are high-value products, high-potency compounds by definition are made in small volumes.

Although pharmaceutical companies can afford to acquire the expertise and install technology in specialized areas, providers suggest that they find value in working with suppliers they trust. "Years ago, people thought we were crazy talking about niche technologies, but that's what the customers want," Malik says. He believes that pursuing such high-tech routes can be a differentiator, especially from competitors in low-cost regions that offer undifferentiated services.

It doesn't take much research to see that capabilities for chiral-chemistry, high-potency, hazardous, and extreme reactions are becoming popular niches to pursue. Most major suppliers and many small tech-focused firms mention one or more of these areas as a core capability. APIs for biologics are another attractive niche with few players and very high entry barriers.

Although niche areas continue to present growth opportunities, the writing may be on the wall. Capabilities once considered attractive niches just several years ago, such as having Good Manufacturing Practice facilities or hydrogenation capabilities, are now ubiquitous. "Any technology that is a niche technology today can be a standard technology tomorrow," BASF's Germani cautions. "So you always have to identify which technology will be required in the future and then pursue the right one."

Many niche technology providers are having no problem filling their capacity, but they could easily see their advantaged positions threatened. "Typically, there are a few niches, and everybody sees they are growing more rapidly, and so they jump on these niche markets," Pollak says. "And all of a sudden they are no longer niche markets, and there will be too many players, and it's going to be very competitive in a short period of time."

Although competition can be grueling, Dottikon ES's Blocher sees it as a challenge to improve. "In the long run, there is only one recipe for success: Be different and better in what you do," he says. "Economic evolution follows the law of survival of the fittest."

 
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