Mention the term "outsourcing," and drug development probably doesn't leap to mind. The market is growing at a yearly clip of 15% to 20%. Right now the lion's share of the work has gone to US companies that focus on drug research like Pfizer. But now, India and China are angling to get a piece.

Last year, pharmaceutical companies worldwide spent nearly $2 billion doling out parts of the drug research process, mainly to US specialists. By 2007, spending should reach $6 billion, according to a report by research firm Kalorama Information. The largest outsourcers, which account for 25% of the outsourced drug-discovery spending, are big pharma companies like Pfizer, Merck, Novartis, Bristol-Myers Squibb and Eli Lilly, with Pfizer being the largest single customer.

The US pharmaceutical industry already spends an estimated $14.5 billion annually on outsourcing the manufacturing, formulation and packaging of drugs, according to Desmond Mascarenhas, chief executive of consultant Bioexpertise. Big companies have contracted out management of clinical trials for years, to companies like Covance and Pharmaceutical Product Development.

With pressures on pharmaceutical companies to reduce the time and money it takes to develop a drug--typically seven to ten years at a price of $800 million or more--lower-cost locales like India and China look likely to take a bigger piece of the action.

India already has done some contract manufacturing of generic drugs. Next year, under World Trade Organization guidelines, India will have to adhere to worldwide intellectual-property protection of drugs patented after 1995. (Thus far, India's patent law has recognized processes but not products, so many drug firms have come up with new ways to make drugs that are patented in the US)

Tighter intellectual-property protections are opening the way for a growing number of Indian firms to take on pieces of US companies' drug discovery work. The hotbed for most of the Indian activity is Hyderabad, nicknamed Genome Valley. A smaller Indian firm like Shantha Biotechnics, which has done some of its own drug development, now produces enzymes for US clients like Calbiochem, an affiliate of Merck KGaA of Germany. Ocimum Biosolutions, also based in Hyderabad, develops bioinformatics software in India. It has sold some of its software to Dow AgroSciences, and set up a contract research arm in Indianapolis.

China lags behind India in servicing the US life sciences markets, but it's striving to catch up. Kenneth Epstein, a principal at Los Angeles-based boutique investment banking firm NewCap Partners, has been working to set up contract research deals between US companies and Shanghai Genomics, a 70-person firm in Shanghai, China, led by two Western-trained Chinese Ph.Ds.

The growth in outsourcing parts of the drug discovery process is being fuelled primarily by two factors, according to the Kalorama report. First, most drugs marketed so ferociously today were not actually discovered by the company doing the marketing. Second, the relatively new fields of genomics and proteomics have produced a host of new drug targets--too many to work on all of them in-house at even the largest drug companies. It can also be faster and cheaper to have discovery work done outside of the company.

For now, much of drug discovery outsourcing work will likely go to specialty drug discovery companies or biotech firms in the US The top three providers, per the Kalorama report, are Millennium Pharmaceuticals, Pharmacopoeia Drug Discovery and Albany Molecular Research--the first two of which also develop their own drugs. Each of these three pulled in at least $120 million in 2002 revenue from their outsourced drug discovery activities. With Chinese and Indian firms revving up their operations, the US firms could see their business shanghaied.

-Forbes.com