RISK-SHARING CONTRACTS: Creating a Win-Win

By Michael Rosenberg, MD, MPH; President and CEO, Health Decisions

Vol. 1, Issue 101, March, 2002 -While great strides are being made in understanding how the elements of project man­agement, product development expertise and technology fit together in bringing promis­ing new drugs to the market, one aspect of the successful CRO-sponsor partnership still lags behind: the commercial contract, in particular an understanding of the concept of risk sharing.

Contracts in the pharmaceutical industry have traditionally been based on careful speci­fication of the work to be provided and bids based on time and effort. In contrast, many other industries have moved towards creating arrangements that focus on strategic goals that reward suppliers for achieving better financial returns for the industries’ prod­ucts. A common problem today is the sponsor’s assumption that outsourcing providers will understand their cost constraints, but contracts are often structured in a manner that precludes the provider from deriving future financial benefit, thus short-sightedly pitting the interests of one party against those of the other.

The goal of risk sharing is creating a win-win: the sponsor achieves important strategic goals more quickly and effectively, and the service provider can make long-term commit­ments to the quality and timeliness of their product.

Pharmaceutical companies have largely grown by managing processes, and risk sharing allows them to focus on core competencies and achieve synergy through partnerships with service providers. Such risk sharing partnerships have shown to have real bottom-line benefits. In one documented case, a five-year project timeline was cut by 1.6 years and the sponsor saved $32 million in direct costs.

What is a performance-based contract?
This type of contract allows the sponsor to specify strategic objectives and measures the CRO’s performance against those objectives. Key objectives and specifics are agreed to in advance, and the CRO is only compensated for measurable achievements. These broader contracts encourage the CRO to invest additional resources and leverage its internal knowledge and expertise in achieving value-added strategic outcomes with the hope of reaping additional reward (income) and can free the sponsor from having to micromanage the CRO. This approach can be applied against deliverables that may be very specific (eg initiation of first patient) but needs to be at a level such that the sponsor can track study progress and be comfortable knowing study project status. A part of such a contract should also be a fail-safe clause that allows the sponsor to, in effect, fire the CRO for poor performance.

Typical performance-based contracts set payments against achievement of milestones such as patient recruitment, last patient visit, database lock, and report production. Bonus/penalty contracts imply that a portion of each payment is “at risk,” in the sense that delivery outside a designated window of time results in lower payments, while early delivery produces a bonus. It may also describe at cost and cost sharing, where the spon­sor agrees to reimburse CRO costs and CRO profits are deferred until project completion.

Elements of successful contracts
A successful contract is gained or lost at the point of its negotiation. Perhaps the most important single element is specifying an end goal and establishing careful milestones by which progress can be measured. The difficult aspect is realizing that research is not an assembly line, and the performance in one project may not be replicated in another, iden­tical project. Assumptions (historical data) for contract benchmarks must be clearly speci­fied, along with contingencies if those benchmarks are not confirmed.

One of the most important elements of bonus/penalty contracts is the availability of time­ly progress reports. Despite the wealth of information generated during drug development, project tracking is often poor. Up-to-the-minute progress reports on quantitative informa­tion such as enrollment status and outstanding queries may take days or weeks, by which time the ability to respond to, and manage, many issues has passed. Additional informa­tion such as meeting minutes, memoranda, or other management issues may be more challenging. In the end, it is this transformation of data to information and subsequently to knowledge that allows earlier, better strategic decisions and the achievement of the goals that both parties seek to achieve.