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Outsourced Chemistry Shop, BioBlocks, Sees Growth in San Diego and Hungary

Xconomy San Diego — 

Peter Pallai has an unusual take on outsourcing. In his view, it might be the way to bring some stability to the volatile world of biotechnology.

Pallai, a Hungarian-born medicinal chemist, is carrying out this vision through a contract-chemistry shop in San Diego called BioBlocks. Pallai started this outfit in 2002 after spending more than 20 years at drug companies, including Woburn, MA-based ArQule (NASDAQ: ARQL). In those jobs, he saw firsthand that after a biological discovery is made, say, of a promising new target for cancer, then the long, hard slog begins. Chemists need to work to “optimize” a drug that hits the target precisely, and tightly, without causing harmful side effects—a process that can take years and millions of dollars.

Approximately one out of 5,000 compounds pass an initial screen, hit the designated biological target, and end up making it to clinical trials. So Pallai’s pitch is simple. He and his team are good at one thing-chemical synthesis of new drug candidates to hit those targets. By outsourcing this piece of the puzzle to his team of chemists, about 25 of whom work in Budapest, Hungary, biotech companies can get the work done fast and well, he says. It makes sense professionally for his chemists as well, because they can get steady work, rather than hitch their wagons to one of hundreds of biotechs that dream of becoming the next Genentech, but are more likely to end up flaming out in a few years.

“This is a treacherous path to travel,” Pallai said when I visited his office a few weeks ago. “Companies have to ask themselves if these are things they really know well how to do. We can make them more efficient, and spend their intellectual effort on other things.”

BioBlocks claims it can shorten the process from a biological “hit” to the identification of a “lead” drug candidate to inhibit it. Running through the databases, the patent literature, finding the right reagents and ingredients is the chemists’ forte, he says. It’s a critical skill that biotech companies often lack.

So why do this work in Hungary? First, Pallai has connections there and speaks the language. But second, he says Hungary has an ample supply of talented chemists with experience at companies like Sanofi-Aventis. And, of course, the wages are about 30 to 40 percent lower there than in San Diego, although it’s still more expensive than in China or India, Pallai says.

The way he counteracts the lower-price competitors is through personally serving as a liaison between customers he meets in Southern California, and the chemistry group he oversees in Hungary. One example where he plays that ambassador role is with Valencia, CA-based Mannkind (NASDAQ: MNKD) which is working on an inhaled form of insulin for diabetes.

BioBlocks doesn’t identify all its customers, but Pallai has had some modest success in making this pitch. BioBlocks grew to about $2 million in revenue in 2007, and expects 30 to 50 percent annual growth in 2008, he says.

BioBlocks thinks this market will continue to expand, as venture capitalists put more pressure on their biotech investments to remain “virtual.” That means hiring a small group of managers to oversee product development at a company, but essentially finding contract shops like BioBlocks to perform most of the work for a finite period of time. As long as BioBlocks can maintain several contracts at once, Pallai says his business can survive downturns much better than the average biotech that is betting the farm on one or two products. “I work with six companies. If I lose one leg from the stool, I still have a fairly stable situation,” Pallai says.

The work may be steady, but getting the contracts in the first place isn’t easy. Pallai says he’s always feeling the heat from low-cost chemistry shops in China. But interestingly, the Chinese competitors have become two to three times as expensive for U.S. customers as they were four years ago, because competition for talent there is driving up wages, Pallai says.

Ultimately, Pallai sees stable work for his team of chemists in Hungary, and a reliable way for San Diego biotechs to get vital work done without having to hire (and likely fire) new chemists every few years. “Outsourcing has a bad name, and certain segments of it make more sense than others,” Pallai says. “I can see us helping to change the drug development model in San Diego.”

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    Pallai’s business model is based upon cost arbitrage as is most outsourcing models. This will work until wage rates flatten out across the globe which will over a period of time. First work shifts to low cost execution locations. Then workers would shift to such countries thus flattening the wage curve.

    I feel the second stage in evolution of outsourcing would be when skills and expertise become the cause for outsourcing. Companies which merely play on cost advantage will fold up and only those with competency advantage will survive and thrive.

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