Over the last four decades, the crucial impact of Research and Development (R&D) on economic development has become increasingly apparent. Both theoretical contributions and empirical evidence have shown its positive effects on GDP growth, improved well-being and the search of solutions for complex problems.

However, our understanding of the generation process and the determinants of R&D is still limited, despite being analysed from multiple perspectives and disciplines. It is well known, though, that the generation of new knowledge is a complex task, which requires the participation of different types of agents and organizations. Universities, research centres, spin-offs, companies, scientific societies and consultants contribute and coordinate their specific capabilities, at different stages of the knowledge value chain, to promote the advancement of basic science and its practical application to new products and services.

The role of each of these agents is increasingly being analyzed, although in some cases it remains little known. This is the case of Contract Research Organizations (CROs), which have emerged from the need of the biopharmaceutical industry to outsource drug-related research activities.

The study of CROs is very illuminating because they are an essential component of a rather idiosyncratic model not present in other sectors. Let’s look at some aspects in more detail.

R&D in the pharmaceutical sector

The pharmaceutical industry is one of the most R&D-intensive. Designing and developing a new drug is slow, complex and risky; it requires many years of research and a huge amount of resources. The R&D expenditure necessary to design a new drug is more than 1.3 billion dollars, on average. And the investment required to produce new medicines is increasing because the productivity of pharmaceutical R&D has fallen in the last half century. There are several reasons to explain this phenomenon.

First, a substantial component of the cost of the drug, clinical trials, is increasingly expensive due to regulatory requirements. Government drug agencies (FDA in the United States, EMA in the European Union) require the inclusion of a rising number of participants in clinical trials before approving new drugs. In addition, the speed of scientific advances in molecular biology makes it difficult for pharmaceutical and biotechnology companies to possess the updated know-how necessary to innovate successfully.

In parallel with the decline in R&D productivity, the biopharmaceutical sector has experienced a fierce increase in competition. In this scenario, companies have reorganized and devised new ways of developing drugs. One of these innovations consists of outsourcing clinical trials, one of the most complex phases of the drug value chain, to Contract Research Organizations.

Contract Research Organizations or CROs

Contract Research Organizations are companies that offer services related to the development of drugs to pharmaceutical and biotechnology companies on a contract basis. Initially, CROs focused on the coordination and supervision of clinical trials, but they have gradually taken on new stages of the value chain of pharmaceutical products; their services now include interactions with government agencies and ethics committees, advice on country regulations and the design of marketing strategies.

In general, traditional business strategy models advise a company against outsourcing a critical function of its value chain. Normally, companies undertake internally the tasks that constitute the core of the good or service they launch on the market and outsource only auxiliary or complementary tasks, in which the loss of control is less relevant. It is therefore surprising that biopharmaceutical companies delegate a fundamental part of their production process, the performance of clinical trials, to other firms. Is this practice correct?

We do not have enough systematic statistical studies yet to answer this question categorically. However, there are some elements that provide partial and preliminary evidence. Taken together, they suggest that the outsourcing model is working, and that CROs make a positive contribution to the drug value chain.

First, practice over the past few decades has shown that collaboration between biopharmaceutical companies and CROs has significant advantages for the former. It reduces drug manufacturing costs and makes the process more flexible. If outsourcing is an alternative, large fixed cost associated to personnel are no longer necessary.

In addition, outsourcing significantly shortens the time-to-market (the amount of time necessary to bring a new treatment to market). A recent example is the Covid-19 vaccine from Pfizer and BioNTech. The design and production of vaccines normally takes a decade. The coronavirus vaccines, however, were developed in record time: vaccination against Covid-19 began in December 2020, less than a year after the start of the pandemic. The coordinated effort of governments, research centres and companies accelerated the results. There was another crucial factor in shortening the time: the collaboration between Pfizer and BioNTech, on the one hand, and the CRO Icon on the other. Icon set up 153 research centres in the USA, Europe, South Africa and Latin America and recruited more than 44,000 participants in clinical trials in four months. Pfizer might have had the resources to coordinate clinical trials internally, but it is also reasonable to assume that the collaboration with Icon expedited the process of obtaining the coronavirus vaccine.

In addition, outsourcing to CROs allows biopharmaceutical companies to concentrate their resources and energy on their specific activities and competencies. Finally, outsourcing enables the division of the risk associated to a project, typically large in an activity with a very high failure rate; while biopharmaceutical companies assume the ultimate risk of the success or failure of developing a new drug, CROs take on the day-to-day operational risk associated with hiring, training and managing employees who oversee clinical trials or perform other tasks outsourced by the client.

Second, CROs have experienced remarkable growth in recent decades, both in number, size and portfolio of services. The market size for CROs, which has risen to $82 billion in 2024, is estimated to reach $130 billion in 2029, implying an annual growth of close to 10% (more details here). This rapid development suggests that CROs do indeed make a positive contribution to the drug development process. Otherwise their market would be declining instead of expanding.

Ultimately CROs act as hubs that collect, analyze and exchange information and data between the various participants in drug development. They manage and coordinate the interactions between pharmaceutical companies, physicians, hospitals, patients, regulatory agencies and ethics committees. To generate positive economic value, CROs must perform these tasks very efficiently. An indirect test of the viability of their business model, therefore, is the efficiency of these companies in performing these tasks.

Are CROs efficient?

To answer this question, Ricardo Díaz and I analyzed the efficiency of a sample of CROs from around the world using Data Envelopment Analysis (DEA). This tool estimates the technological frontier for a sample of companies, identifies the best practitioners and builds a relative efficiency index for each company based on its distance from the frontier. The analysis is summarized in this article.

The results suggest that the efficiency of CROs is relatively high and growing throughout the period investigated, 2010-2020. This pattern is very different from the poor and decreasing efficiency that we found for pharmaceutical companies in general in a similar period (as we detail here). According to our estimates, a high number of CROs attain the maximum level of efficiency. Very large and very small companies (according to their turnover) are more efficient than the average, while medium-sized companies achieve lower efficiency. One possible explanation is that very large companies benefit from economies of scale linked not only to investment in technology but also to commercial effort, which allow them to establish agreements and alliances with clients in the medium term; this practice, in turn, reduces commercial costs. In addition, very small companies benefit from specialization in a niche of activity. Medium-sized companies cannot exploit any of these advantages.

In a second paper available here we have continued to explore the issue, this time using a super-efficiency model, which allows us to discriminate more thoroughly between companies that lie at the technological frontier. In addition, we have defined and calculated different types of efficiency, distinguishing between commercial, operational and global efficiency. Our finding suggest that a remarkable number of companies in the sample reaches maximum efficiency levels in at least one category, which implies that the degree of rivalry and competition in the industry is high.

In addition, efficiency is associated with structural and fundamental aspects of companies, such as proper management of human and financial resources. These results are reasonable. Since the supervision of clinical trials is labor-intensive, optimizing the human factor is crucial. The most efficient CROs manage to find the balance between adequate staff remuneration, which minimizes employee turnover (sometimes excessive in other competitors) and controlled labor costs, which allow a competitive service provision in an environment of great rivalry. We also detect a positive correlation between proactive short-term liquidity management – which optimizes operational financing needs – and efficiency. We also find that the Covid-19 pandemic has exerted an asymmetric impact on the efficiency of the sector, with positive effects only in the largest CROs.

The risks of the model

The R&D outsourcing model in the pharmaceutical sector is innovative, original and generates economics value; however, it poses some risks. As far as management is concerned, the interaction scheme between client and CRO is becoming increasingly sophisticated and alliances tend to replace contracts; the former involve longer-term relationships, in which the commitments assumed by each party may become blurred (with the associated problems of identifying results, decreased motivation and inertia).

The main threat, however, is more subtle. It consists of a new transformation of the business model that leads some CROs to backward integration. Thus CROs evolve from service providers to competitors, and become pharmaceutical companies themselves capable of patenting new drugs. It is too early to know how far this process will go, and what its impact will be, but it may be not negligible. In any event, it will probably create more competition into the biopharmaceutical sector and endanger the survival of some of its members. If this is the case, the traditional theories of strategy referred to above would end up being right: outsourcing a crucial part of the value chain is very dangerous and even lethal.

It is true that CROs have expertise in the management and coordination of clinical trials and other consulting tasks, and they perform these activities efficiently. But this does not ensure the successful undertaking of the entire value chain of drugs. CROs should carry out a cautious and thorough analysis of the pros and cons of a reorientation towards the initial stages of drug development as an alternative to their traditional tasks.

Concluding remarks

R&D in the biopharmaceutical sector is carried out in a distinctive way: a significant part of the development process of new drugs is outsourced by the pharmaceutical company to another company, the CRO. The experience of these decades suggests that the model is working. CROs are an efficient part of this process and generate positive added value. More and more pharmaceutical and biotechnological companies are recurring to CROs, which in turn are gradually taking on a wider range of functions.

Outsourcing may be advantageous but also risky, especially if the outsourced tasks are essential activities in the value chain and the service provider uses part of the acquired know-how to become a competitor.

So far the current model of R&D management in the biopharmaceutical sector seems efficient and appealing. It will be interesting to see in the future whether it becomes stronger and spills over to other sectors, or whether it is superseded because its downsides outweigh its advantages.