# The fine and specialty chemicals business: how it really works: Business models and how deals are made Source page: https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/p4/ [Understanding Chemicals](https://www.materialinsights.org/learn/chemicals/) / [Module 12: The fine and specialty chemicals business: how it really works](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/) Part 4 of 5 ## Business models and how deals are made The same reactors serve very different businesses. Making an exclusive intermediate for one patented drug is a project sold on trust and project management; making an API for generics is a product sold on price. This part explains the models, follows a custom manufacturing project from inquiry to commercial supply, and shows how prices, contracts and patent expiries shape returns. ### 4.1 Custom manufacturing and API-for-generics share plants but are different businesses In custom manufacturing (CM), which Pollak calls the industry's premier discipline, a drug or crop protection company hands process development, pilot production and industrial manufacture of an active ingredient or precursor to one or a few fine chemical companies. The customer owns the product and usually the process; the relationship runs under an exclusive supply agreement. The customer provides a 'technology package', at its simplest a laboratory recipe plus safety notes, and the supplier scales it up about a million-fold, from 10 g to 10 tonnes. Pollak calls such suppliers contract manufacturing organisations (CMOs). Toll manufacturing is a variant: the customer, often an agrochemical company, supplies the starting materials free and a full industrial process, so the toller mainly sells reactor time, with revenue typically under half that of CM for the same product. API-for-generics is a product business. The supplier develops its own process for an off-patent drug substance, files the regulatory dossier and sells to many generic drug makers at market prices, often through agents. Contract research organisations (CROs) sit upstream. 'Product' CROs do process research and make samples, charging per full-time-equivalent scientist-year (FTE); 'patient' CROs run clinical trials. Firms combining research and manufacturing are called CRAMS or one-stop shops. Pollak is sceptical: over 90% of projects stop at the sample stage, and quick lab work and economical large-scale production are different skills. Combining CM with generics can lift utilisation, since generic campaigns can fill gaps between rigid exclusive ones. One rule is absolute: never sell a generic company an API you make for an originator. Data Exclusives versus API-for-generics | Feature | Exclusives (custom manufacturing) | Generics (API-for-generics) | |---|---|---| | Business model | Project driven | Product driven | | Typical products | Advanced intermediates | Finished APIs | | Pricing | Bottom-up from cost | Market price | | Sales channel | Direct | Agents | | Customers | Originator pharma companies | Generic pharma companies | | Main competitors | Customer's own plants; 1-2 suppliers per product | Asian producers | | Competitive advantage | Project management | Price, quality, drug master file | | Who owns the know-how | Customer | Supplier | | Technical contact | Close cooperation | Sporadic | | Legal work | Sporadic | Intensive | | Production planning | Made to order | Minimum and maximum stock | Source: Pollak (2011), pdf p. 163, Table 12.1 Case #### Asia's contract research boom WuXi AppTec in Shanghai, founded in 2001, had $270 million of research sales plus about $30 million of manufacturing by 2009, with 2,700 staff and 30% annual growth. India's largest chemical CRO, Syngene, had over 3,600 employees and $360 million of sales in 2008/09. Pollak puts an FTE at $150,000-250,000 a year in the US and Western Europe and $40,000-60,000 in China and India. - Pollak (2011) · pdf pp. 30, 37-42, 168-172, 177 ### 4.2 From first inquiry to commercial supply takes one to two years of project work A drug offers a fine chemical company four 'windows' over its roughly 20-year patent life. The first, preclinical samples, is CRO territory with slim odds. The second, Phases II and III, is the most attractive: the customer freezes its first-generation route, takes its make-or-buy decision, and launch becomes likely. Drug firms usually give such projects only to approved suppliers, so newcomers must enter at Phase I. The third window opens near peak sales, when a cheaper second-generation process is wanted; the fourth as the patent nears expiry. The customer selects suppliers in four steps: desk assessment, a request for information, audits of a shortlist, and a request for product. Inside the supplier, a new product committee asks Pollak's three questions: can we sell it, can we make it, will we make money? The customer's technology package should give the reaction scheme, product, quantities, dates, specifications, analytical methods, required reports, safety issues, materials it will supply, and packing instructions. Pollak's model schedule follows the flowchart. Technical work usually takes 12-24 months and can cost several million dollars. The pilot plant uses vessels of 100-2,500 litres and includes a hazard and operability (HAZOP) study, a structured review of what could go wrong. For cGMP products the process itself must be validated: designed, qualified and continually verified. Plants are inspected by national authorities and, for the US market, by the FDA, whose findings range from 'no action indicated' to 'official action indicated', which can lead to a warning letter or seizure. For APIs sold to many generic customers, the producer files a drug master file (DMF) with the FDA once; that dossier then supports any generic drug using the API. Process flowchart Custom manufacturing project: from customer inquiry to commercial supply Inputs **Customer inquiry**usually via business development **Confidentiality agreement**signed before technical discussion **Technology package**reaction scheme, specs, quantities, dates, analytics, safety notes **Funding**lab phase on FTE basis with milestones; plant phase per kg Process steps 1 **Desk evaluation and preliminary offer** New product committee asks: can we sell it, make it, make money? Go or no-go 2 **Samples and detailed offer (1-2 months)** R&D programme, production schedule, FTE price for lab, prices for pilot and industrial quantities, plant adaptation costs 3 **Laboratory phase (6-9 months)** Technology transfer from customer; route and sequence selection; analytical methods; critical parameters; safety and ecology data 4 **Pilot plant phase (6-9 months)** Proof of the lab process at 100-2,500 L; HAZOP; validated analytics; final specifications; trial batches for clinical use; regulatory submissions 5 **Supply contract** Firm offer confirmed; typically 3-10 years; quantities, prices, specifications, IP, exit terms 6 **Transfer to industrial plant** Plant adaptation; master batch records; operator instruction; demonstration and validation batches under cGMP 7 **Commercial supply (several years)** Campaign production against forecasts; cycle-time optimisation; second-generation process work; price and schedule updates Outputs **Advanced intermediate or API**from about 100 kg (Phase I) to 10-100 t a year at launch **Regulatory documentation**batch records, process validation, DMF input; FDA inspection **Track record**the main asset for winning the next project Technical work typically takes 12-24 months and several million dollars; most projects end early because the drug fails. Source: Pollak (2011), pdf pp. 94-96, 163-170, 269-270, Fig. 6.1, App. A.3 Case #### How F.I.S. won Roche In 1985 a salesman from Italy's F.I.S. was told by Roche it wanted no new suppliers; the only opening was the veterinary antibiotic Aditoprim, below Roche's own cost. F.I.S.'s R&D said it could not be done. Its founder, Gian-Franco Ferrari, overruled them and took the order. Roche was so impressed that it signed a 10-year frame contract for drug precursors. Track record, not equipment, opens doors. - Pollak (2011) · pdf pp. 86-87, 90-91, 94-96, 127, 164-170, 179-180, 269-270 ### 4.3 Prices are built bottom-up for exclusives and top-down for generics Pollak describes three pricing methods. Research and samples are priced by time, per FTE, often with milestone payments tied to yield or quality targets. Exclusive products at industrial scale are priced 'bottom-up': raw materials (about 35% of price) plus conversion (about 55%) plus a margin. Standard products such as API-for-generics are priced 'top-down': start from the market price and subtract margin, conversion and raw materials; if the answer is negative, costs must fall or there is no business. The buyer sees the molecule differently. For a drug company the API is a raw material worth under 10% of the medicine's price, which Pollak splits into cost of goods about 20%, R&D 15-20%, marketing and administration 35-40% and profit about 25%. Drug prices follow the daily cost of treatment within a class, not the molecule's cost. Low-dose blood-pressure drugs cost about $1-1.40 a day whatever their sales: beta-blockers $1.00, ACE inhibitors $1.05, calcium antagonists $1.28, 'sartans' $1.40. A pharmacy charged the same $419.95 for 100 Lipitor tablets of 20, 40 or 80 mg. Suppliers have no reference price, and for high-dose, complex molecules the gap between buyer and seller can be wide. Margins range from not covering fixed costs to markups of 100% or more. Cheap Asian quotes should be compared on total cost of ownership: freight, audits, registration and supply risk. Pollak's trade-off: a $1 billion drug out of stock for 10 days loses about $30 million of sales, against a few percent saved on the API. Contracts reflect power. CM supply contracts typically run 3-10 years and can involve hundreds of millions of dollars. Around 2000 the market turned from sellers' to buyers'; GlaxoSmithKline told suppliers to commit to cutting every price by 20% over three years. Data From a sellers' to a buyers' market: custom manufacturing contract terms | Term | Before 2000 | After 2000 | |---|---|---| | Contract duration | 5 years | 1 year | | Capital guarantee | Yes | No | | Take-or-pay clause | Yes | Rarely heard of | | Number of suppliers | Sole | Several | | Supplier relationship | Partnership | Auction | | Volume forecasts | Binding | Spot orders | | Price adjustment | Upward, by price index | Downward, by x% a year | | Benefit of process improvements | Supplier | Customer | | Penalties for off-take delays | Paid to supplier | Paid to customer | | Share of plant adaptation costs | Yes, for specific investments | Case by case | Take-or-pay: the buyer pays for agreed volumes even if it does not take them. Source: Pollak (2011), pdf pp. 191-193, Tables 12.8-12.9 Worked example #### Working back from a $4 generic Walmart offered a month's supply of common drugs for $4. For metformin, sixty 500 mg tablets contain 30 g of API: $4 / 30 g = $133/kg for the finished pack. If the API is 25% of that price, its maker must sell at about $33/kg. That is top-down pricing: the market sets the number, and only the lowest-cost producers, mostly in China and India, can meet it. - Pollak (2011) · pdf pp. 178, 184-189, 191-194, 239 ### 4.4 Patent expiry turns a drug into a price war within a year A drug is protected by a product patent and often by process patents on how the API is made. Pollak says product patents typically expire 18-20 years after filing and 8-12 years after launch; Kent describes US patents as giving 20 years of exclusive rights. Then anyone may sell a generic: same API, same strength, bioequivalent, under another name and, if a process patent still runs, by a different route. Prices fall fast. API prices dropped in the first year to 45-75% of their pre-expiry level. For drugs that had sold over $400 million a year they fell to about 30% after five years and 20% after ten; smaller drugs fell less. The money is made in the first months, by whoever is ready on day one: in 2002 Barr shipped 100 million generic Prozac capsules within 48 hours of approval. Pollak lists six requirements: picking the right molecules among more than 2,000 APIs (avoiding both blockbusters and tiny drugs, preferring those needing a niche technology); being first to file; knowing patent law (180-day US exclusivity for the first challenger, the Roche/Bolar provision allowing development before expiry, European certificates adding about five years); being the low-cost producer; a GMP culture able to produce a successful abbreviated new drug application; and financial muscle, since work starts 5-8 years before expiry. National patent history shaped who makes generics. Italy introduced product patents only in 1978 and Spain in 1992, making both strongholds of API-for-generics; China and India joined international patent rules in 2005. Pollak's example in the table shows why chasing a blockbuster's expiry is a poor bet. Data What a generic API is worth to a fine chemical company: number 1 versus number 101 | Step | Lipitor (Pfizer), US no. 1 | Femara (Novartis), US no. 101 | |---|---|---| | Therapeutic class | Cholesterol lowering | Anticancer | | US drug sales, 2008 | $5,900 million | $360 million | | API value (5% of sales) | $300 million | $18 million | | After first-year price drop (55% / 35%) | $135 million | $12 million | | After drug market share loss (50% / 50%) | $70 million | $6 million | | Share won by one supplier (10% / 100%) | $7 million | $6 million | | Earnings on sales (10% / 25%) | $0.7 million | $1.5 million | Pollak's illustration: the obscure drug offers twice the profit at lower risk, because few rivals chase it. Source: Pollak (2011), pdf p. 176, Table 12.5 Case #### Gabapentin: the originator fights back Pfizer's pain drug Neurontin (gabapentin) is a large-volume API, over 1,000 tonnes a year. Soon after patent expiry Pfizer's share fell to 15%. It then outsourced the API to an Indian producer with an innovative, cheaper process, and its share recovered to 75%. A breakthrough in process cost, not marketing, kept the market, and Indian process chemists had become partners in such deals. - Pollak (2011) · pdf pp. 134-135, 171-177, 223, 237-239 - Kent (2012), Ch 11 Chemistry in the Pharmaceutical Industry · pdf p. 405 ### Check your understanding A fine chemical company is asked to quote for an exclusive advanced intermediate for a Phase III drug. Which pricing logic applies? There is no market price for an exclusive product, so the supplier builds the price from its costs; top-down pricing is for standard products such as API-for-generics. Why do pharma buyers and fine chemical suppliers often disagree sharply on the price of an API for a high-dose drug? The drug's price is set by what comparable treatments cost per day; at high doses the API cost the supplier needs can exceed what that price structure allows. In Pollak's example, why is the API for Femara (US no. 101) a better generic target than Lipitor (no. 1)? Many producers attack a blockbuster's expiry, so each wins a small share at collapsing prices. For the small drug a supplier can take the whole market, giving $1.5 million of earnings against $0.7 million. [← Part 3: Inside the multipurpose batch plant](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/p3/)[Mark read · Part 5: Industry structure, cycles and the shift east →](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/p5/) ## Other sections - [Module overview](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/index.md) - [Where fine chemicals sit in the chemical universe](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/p1/index.md) - [Products, customers and the chemist's toolbox](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/p2/index.md) - [Inside the multipurpose batch plant](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/p3/index.md) - [Industry structure, cycles and the shift east](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/p5/index.md) - [Key terms, quiz and sources](https://www.materialinsights.org/learn/chemicals/fine-and-specialty-business/review/index.md)