SIC 2833

This classification covers establishments primarily engaged in manufacturing bulk organic and inorganic medicinal chemicals and their derivatives, as well as processing—grading, grinding, milling—bulk botanical drugs and herbs. Included in this industry are establishments primarily engaged in manufacturing agar and similar products of natural origin, endocrine products, manufacturing or isolating basic vitamins, and isolating active medicinal principals from botanical drugs and herbs.

NAICS Code(s)

325411 (Medicinal and Botanical Manufacturing)

Industry Snapshot

Companies in this industry segment furnish the active ingredients used by pharmaceutical firms to manufacture finished products, called pharmaceutical preparations (see SIC 2834: Pharmaceutical Preparations ). Active ingredients constitute the portion of a finished drug that creates the desired effect—therapeutic or preventive—for humans and animals. Extracts of crude drugs (not yet processed) derived from plant or animal sources are important examples of the components produced by this industry sector. By the 1960s synthesized chemicals—either a manufactured copy of an organic or inorganic substance or a new chemical entity (NCE)—had become common active ingredients in pharmaceuticals from vitamin pills to hormones. Meanwhile, the biotechnology revolution, beginning in earnest in the 1980s, resulted in ways of inserting genetic material into small microorganisms. This made them miniature factories for the production of active drug ingredients like insulin and, in the process, created new molecular entities (NMEs) that could be patented.

By the late 1990s, the primary market for this industry—the pharmaceutical industry—risked high research and development costs for the prized billions of dollars it could generate with new products. Although many drug companies have vertically integrated production lines, a trend grew to favor outsourcing chemical intermediates and active ingredients to smaller fine chemicals companies.

By 2001, medicinal and botanical manufacturing reached an estimated $11.4 billion in shipments, according to the U.S. Census Bureau's Annual Survey of Manufactures. As consolidation continued among fine chemicals giants in the early 2000s, the desire to streamline their huge operations benefited small-and medium-sized companies, which continued to receive outsourcing business. The economic climate during 2001 and 2002 proved challenging for the industry, which suffered from overcapa-city, ebbing demand, and increased competition from Asia.

Organization and Structure

A large number of the medicinal and botanical establishments are divisions or subsidiaries of other firms, including pharmaceutical industry giants such as Merck and Hoffman-La Roche. Parent firms that have developed in-house active ingredient suppliers are said to be "back-integrated," and their chemical products are referred to as "captive," dedicated to the parent firm. Chemicals produced by firms independent of the final purchaser are called "merchant."

Many "fine" chemical companies producing for the merchant market are contracted to large pharmaceutical companies to supply custom, or specialty chemicals, and others produce and sell them on the open market. The latter often manufacture well-known bulk pharmaceutical compounds, like those used in the production of aspirin. Custom and specialty chemicals are produced in smaller quantities than bulk chemicals and frequently combine several different chemical compounds called intermediates, which are more expensive. Traditionally, fine chemicals were those with fewer impurities than the industrial chemicals not intended for human consumption.

Both the back-integrated firms and the independent fine chemical companies are involved in the complex processes of producing extracts of natural substances, synthetic inorganic and organic chemicals, or combinations of any or all of these, that go into most modern medicines. The specific formulas for these substances can be found in academic monographs or in the official U.S. Pharmacopeia (USP) and the National Formulary (NF). If they have not yet been manufactured on an industrial scale or are entirely new compounds (NCEs or NMEs), the pharmaceutical firm creates a document as a reference for its own in-house producers or as a guide to firms contracted to supply active ingredients. These references provide manufacturers with the acceptable legal standards of purity and potency for products. A new manufacturing process, as well as an NCE or NME, can be patented in the United States.

Active ingredients from natural sources start as crude drugs. According to the standard text on drug extraction from natural sources, Pharmacognosy, crude drugs from vegetative or animal origins are "natural substances that have undergone only the processes of collection and drying." Natural substances are those "found in nature… that have not had changes made in their molecular structure." The sources of these substances, medicinal plants or the animals from which glands and organs are needed, can either be raised commercially or collected in the wild. But environmental concerns tended to support the former in the 1980s and 1990s. Especially with plants, it is of vital importance that the correct species be identified before collection. Once a crude drug has been collected and the needed portions separated and cleaned, it must be safely stored or immediately processed according to how quickly the active ingredient might spoil or lose its potency. Plants are often stored over long periods to help decompose unwanted plant components while leaving the desired portions intact. Animal glands and organs, however, are generally processed quickly to avoid deterioration.

If the crude drug is a plant, the active constituent—the ingredient desired for the final drug product—must be extracted. The first step in this procedure is grinding and mincing the appropriate plant parts, such as the leaves or the seeds. Production facilities in this industry house hammer mills, knife mills, and teeth mills designed to reduce leaves, stems, seeds, or roots to a manageable powder composed of evenly sized granules. Some plant products, such as herbal remedies, can be packaged at this point for sale or combined into other preparations. For most plant-derived drugs, the powdered plant must be submitted to a series of solvent baths (a process called maceration) in alcohol or ether, or the plant goes through a series of distillation procedures (in the case of volatile oils) that separate the desired ingredient from the crude material. Animal glands or organs are also minced, then mixed with a solvent that aids extraction and often preserves the substance. After centrifugation, the animal extract is filtered to separate remaining impurities. Antibiotic molds, on the other hand, are actually grown in large fermentation tanks. The molds release their medicinal yield into a fermenting medium or solution. These fluid mixtures of either mold, plant, or animal materials are submitted to "precipitation," which involves the application of either heat or freezing cold or the addition of salts or some other compound that separates or isolates the target active ingredient from the fluid. Isolates are then sent to the customer in either powdered or fluid form to be assembled into a marketable drug.

Manufacturers of active ingredients ship finished products in "batches" to the preparation firm awaiting them. The chemical composition of these shipments must match a parent batch to ensure purity and strength and must meet with the approval of the U.S. Food and Drug Administration (FDA) as well as the client company. Firms that desire a regular supply of high-quality materials will often inspect manufacturing plants before assigning a production contract for active ingredients. Besides comparing active ingredients to the standard, the FDA is responsible for ensuring that every step in the process of pharmaceutical raw material production meets specific production standards.

Background and Development

Raw material suppliers for pharmaceutical companies, in the form of fine chemical producers, actually predated the pharmaceutical industry. Until well into the nineteenth century, doctors and apothecaries (i.e., pharmacists) collected and processed their own botanical remedies and compounded their own medicinal chemicals. Drugs in the limited and nonstandardized pharmacopeia were herbal remedies whose provenance dated back centuries and could be prepared simply. Pharmacists could produce what chemical treatments there were in drugstores using comparatively unsophisticated equipment. Because of the similarity of pharmaceutical chemicals to the processes for making industrial chemicals, small-scale producers often engaged in the manufacture of both. In fact, many modern medicinal chemical suppliers, like Dow and Hoechst, produce industrial chemicals as well.

An increase in the scientific study of chemistry and botanical extracts in the nineteenth century yielded a whole range of new chemicals and isolates with pharmaceutical potential. Included among these were the anesthetics ether and morphine. These new drugs required a greater degree of standardization and production expertise than earlier treatments. Their efficacy also increased public demand. Pharmacists, like H. E. Merck in Germany, as well as doctors and fine chemical producers, started developing and building the manufacturing capacity to meet these needs. The new pharmaceutical firms called themselves "ethical" manufacturers to differentiate themselves from the "patent" medicine producers, who bottled popular concoctions with broad therapeutic claims but dubious medicinal value. The makers of ethicals clearly labeled the contents of products and promoted the therapeutic strength and purity of their medicines.

Many early active ingredient suppliers for both the American ethical and patent producers were European fine chemical companies. But such events as the War of 1812, the Civil War, and World War I tended to disrupt European supplies and spur American companies to increase capacity for domestic chemical manufacture. American companies like Squibb, which subsequently became Bristol Myers-Squibb Company, established themselves by supplying medicines for the Union armies.

By the first decades of the twentieth century, breakthroughs in understanding the bacteriological basis of many diseases by Louis Pasteur and the effect of chemicals on certain parts of the body by Paul Ehrlich led to a new era in pharmaceutical science in which specific compounds could be screened for effectiveness against known disease organisms. The discovery of such "wonder drugs," like the anti-infective sulfanilimides and various vaccines, increased the demand for reliable new drug treatments. Most drugs, however, with the exception of injectables, still did not reach the physician or pharmacist in finished form. Pharmaceutical firms still purchased fine chemicals from companies like Pfizer Inc. or Merck and Co., Inc. and compounded them into pharmaceutical mixtures for distribution to hospitals and pharmacists. Pharmacists mixed these bulk ingredients into finished form in the drugstore. However, it is important to note that these treatments did not displace botanical products as the dominant form of drug treatment until after World War II.

With its emergency demand for the new anti-infectives like the antibiotic penicillin (as well as sulfa drugs), World War II changed the structure of the pharmaceutical industry. Bulk suppliers like Pfizer and Merck found themselves producing drugs on a massive scale in both finished and bulk form. After the war, these companies stayed in the profitable ethicals business, making prescription-only pharmaceutical preparations. With a high public demand for new life-saving or extending medications, companies began to finance enlarged research and development departments to discover and develop important—and profitable—new therapies. A vast array of new drugs resulted in the 1940s, 1950s, and 1960s, including tranquilizers, steroids, vaccines, and more anti-biotics. Many of these drugs were derived from the laboratory screening of botanicals and animal products, like steroids from yams used to make a cortisonal treatment for arthritis and insulin from animal pancreas extracts used to control diabetes. The limits of natural supply, however, prompted many pharmaceutical companies to synthesize the active ingredients in these medicines.

Meanwhile, new federal regulatory requirements slapped tight new restrictions on the production of drugs after 1962, when a popular European sleeping pill, Thalidomide, was found to cause severe birth defects in some newborns. In response, Congress passed the 1962 Kefauver-Harris Amendments to the 1938 Food, Drug, and Cosmetic Act. The legislation required FDA licensing and oversight of all pharmaceutical manufacturing facilities and processes, including those of bulk pharmaceutical suppliers. Similar production controls had already been instituted after 1949 for "batches" of bulk penicillin.

Kefauver-Harris reinforced trends in the industry toward in-house production of active ingredient supplies for pharmaceuticals. Because the pharmaceutical company was ultimately responsible for the purity of its product, even if an outside supplier provided ineffective or dangerous compounds, companies thought it safer to have internal oversight and production control. Perhaps as important to major firms was a desire to maintain command of active ingredient supply even after patents had run out on new medications. In his history of the pharmaceutical industry titled The Structure of American Industry, Walter S. Measday cited a situation in which "upwards of 150 companies" offered Vitamin C in dosage form whereas "the entire output of the vitamin itself is produced by Merck, Pfizer, and Hoffman-La Roche, Inc." If ethical pharmaceutical companies could control bulk supplies for more advanced medications than Vitamin C even after product patents ran out, they would effectively extend their patent period—and associated high profits—indefinitely.

In the late 1980s and early 1990s, pharmaceutical firms began to reverse the trend toward the in-house production of active ingredients in favor of a more complex combination of captive production and long-term contracts with outside custom suppliers. Among the factors fueling this trend were the 1992 economic recession and excess world chemical capacity, the increasing costs in both time and money to negotiate regulatory hazards, the complexity of new drug compounds, and the desire to avoid tying up too much capital in supply factories.

Meanwhile, the highly politicized drive for health-care reform in the late 1980s and early 1990s created downward pressure on the prices the big pharmaceutical firms could charge for their prescription drugs, even for new "breakthrough" treatment therapies costing considerable amounts of money to develop. The immediate winners in this contest over drug prices seemed to be the smaller independent generics companies. Generics, markedly cheaper therapeutic and chemical equivalents of prescription patented medicines, went into production once the patent protection on a prescription drug expired. Generics companies could manage cheap prices because they only had to copy—not research and develop—the drugs they produced.

Because of this, however, the active ingredients in generics accounted for almost one-half of the sale price—a ratio three to four times greater than prescription versions of the same drug. This made the generic companies susceptible to changes in the supply of active ingredients worldwide. When, as Drug Topics reported in 1994, the European Economic Community temporarily "outlawed the exportation of bulk/fine chemicals," generics companies were faced with a 85 percent cutoff of supply. At the same time, the prescription pharmaceutical firms controlled the current capacity on the active ingredients in their drugs coming off-patent. Combined with a wave of takeovers or start-ups of generics firms by large pharmaceutical producers, the cutoff in supplies threatened to squeeze independent generic producers out and effectively extend prescription patents and higher drug prices much longer than healthcare reform advocates desired.

By 1999, the fine chemicals sector of the industry was very fragmented, with the top 25 companies accounting for less than 25 percent of the $60 billion market, according to Jan Zuidam of DSM Fine Chemicals. Of the $21 billion U.S. market, 44 percent of sales were generated by the pharmaceuticals industry and 54 percent were Agro chemicals, according to reports by Frost and Sullivan and Kline and Co. Inc.'s president Andrew A. Boccone.

As life sciences industries underwent a growth boom, companies in this industry likewise looked forward to strong growth as pharmaceutical companies focused more on research and development and increasingly outsourced active-ingredient production. Outsourcing reduced the burden of drug development while accelerating the process for pharmaceutical companies. Additionally, pharmaceutical companies were no longer responsible for costs associated with maintaining manufacturing facilities.

The botanicals segment of this industry also offered tremendous growth potential as consumer awareness and demand grew in the global nutritional industry. According to International Research Institute, U.S. sales of botanical medicines in 1998 totaled $4 billion. Companies were able to add value to natural ingredients by developing and patenting methods of standardized extraction of active plant constituents. One such company, Inter-Cal, a subsidiary of Zila, Inc., patented Ester-C brand products and a standardized extract of Saw Palmetto for treatment of benign prostate hyperplasia, affecting 50 percent of the male population by age 60. Additionally, Congress called for funding for university research grants to increase scientific information available for botanical dietary supplements. In 1999 the National Institute of Health granted $7.5 million to UCLA's new Center for Dietary Supplements Research, Botanicals.

Whereas the botanicals segment was taking steps to gain public trust, seven leading vitamin manufacturers pled guilty in the largest criminal settlement in U.S. history and agreed to pay combined fines of $1.8 million in 1999. Five of the companies pleaded guilty to charges of conspiracy to fix and inflate vitamin prices. Fined most heavily were Swiss pharmaceutical giant Hoffman-LaRoche, Inc., which agreed to pay $500 million, and German BASF AG, which agreed to pay $225 million. The scheme lasted nearly a decade, according to Assistant Attorney General Joel I. Klein, affecting more than $5 billion in U.S. commerce in common household products. Dr. Kuno Sommer, former director of worldwide marketing for Hoffman-LaRoche Vitamins and Fine Chemicals Division, agreed to plead guilty, resulting in a four-month prison term and a $100,000 fine.

Current Conditions

Medicinal and botanical manufacturing reached an estimated $11.4 billion in shipments, according to the U.S. Census Bureau's Annual Survey of Manufactures. Faced with overcapacity, ebbing demand, and increased competition from Asia in 2001 and 2002, analysts nonetheless predicted growth within the fine chemicals segment of 5 to 6 percent over the next few years.

Challenges faced by the fine chemicals sector included the decline of new drug approvals, on a downward trend since 1999. Just 35 new products were approved for marketing that year, which dropped to 27 in 2000 and 24 in 2001. The trend was expected to continue in 2002, with only 15 new molecular entities approved by December of that year. Product withdrawals—14 in all from 1997 to 2000—also contributed to the negative atmosphere in the fine chemicals industry. These factors all related to the stricter control being exercised by the FDA in the early 2000s, which was toughening safety measures on all fronts, from drug interactions to manufacturing practices.

With major pharmaceutical manufacturers consolidating, some fine chemical operations were being brought in-house, increasing competition among small-and medium-sized companies in an already overcrowded landscape. With outsourcing experiencing double-digit growth in the late 1990s, in the early 2000s more fine chemicals were being produced in-house with a significant portion still being outsourced.

The popularity of herbals and botanicals, which reached highs in the 1990s, sagged in the early 2000s. Sales were estimated at $4.34 billion in 2001, up slightly from 2000 sales of $4.12 billion according to HBP Consulting, who also predicted growth rates of 2 to 4 percent from 2001 through 2004. The most popular herbals/botanicals included St. John's Wort, ginkgo biloba, echinacea, ginseng, garlic and saw palmetto, which all saw a decrease or only slight increases in sales from 1996 to 2000. Among the fastest growing herbals were valerian, soy, green tea, yohimbe, milk thistle, and black cohosh.

Some attributed the decline in the popularity of herbals to negative media attention, particularly in the area of drug interactions, safety and effectiveness. With herbals sometimes requiring long-term use for results, some say consumers have moved on to specialty dietary supplements aimed at gaining immediate relief from a specific condition. Industry analysts also argue that consumers have begun to question the effectiveness of herbals overall.

Industry Leaders

Merck & Co. Inc. continues to dominate the market by delivering, developing, manufacturing, and marketing a broad range of human and animal health products. Overall sales in 2002 totaled nearly $51.7 billion, with an 8.5 percent sales growth from the previous year. The company employed 62,000 people worldwide in 2002. Although the company continued to form partnerships with biotech companies and academic scientists for research, the company was not among the "aggressive outsourcers," for botanicals and fine chemicals. In contrast, in 1998 as global demand for Merck products grew, the company sought to expand its bulk chemicals capacity and broke ground for a new chemical manufacturing facility in Singapore.

Roche Group, of Switzerland, generated 2001 sales of approximately $15.6 billion, a 12.1 decrease over the previous year. The company's pharmaceutical products comprise 60 percent of its sales. Roche manufactures pharmaceutical products, diagnostics, fragrances, and flavors. In 2001 Roche employed approximately 63,717 people worldwide (28 percent in North America). The company's Vitamins Division manufactured 13 vitamins, several carotenoids, medicinal feed additives, amino acids, citric acid, polyunsaturated fatty acids, UV filters, emulsifiers, and antitussives (cough-reflex inhibitors). In 1999 the division employed approximately 7,000 people. In 1998 the division's sales reached 3.63 billion Swiss Francs (approximately $2.4 billion), undergoing a slight decline due to heavy price pressures. That year the company invested in four new vitamin production facilities in Scotland, Poland, Germany, and China. In 1999 the company expected a favorable net profit despite the $500 million penalty in the vitamin price-fixing suit agreed to by its subsidiary Hoffman-LaRoche, Inc.

Dowpharma, the pharmaceutical and biopharmaceutical custom manufacturing arm of Dow Chemical Company, was moving to become a leader in the fine chemicals market in 2003. Drawing on the strength of its parent company, which posted 2002 sales of $27.6 billion, and via acquisitions and investments in technology, Dowpharma had growth rates in the double digits in 2002 and was expected to continue that momentum into 2003.

America and the World

Despite the twentieth century revolution in chemical pharmaceuticals, it was reported in The Medicinal Plant Industry that "50 percent to 80 percent of the developing world depends on traditional therapies for their health care," namely plant-derived remedies. In China and Southeast Asia, indigenous industries process and package plant-based remedies based on ancient recipes. Some processors utilize the same machinery and manufacturing expertise as American companies, and others are extremely small and use traditional methods. This system of traditional active ingredient production for drugs, except to the extent that Western-style medicines were adopted or locally produced for export to the West, remained relatively untouched by American corporate influences.

Suppliers of fine chemicals for American pharmaceuticals, however, have never been limited to the country's borders. European chemical companies, except for temporary alterations during various wars, have always had—and continued to have in the late twentieth century—a large presence in the American market. Chemical Processing on the Web reported in 1999 that of the top 25 fine chemicals firms in the world, 15 were European, 7 were from the United States, and 3 were Japanese. Of the $60 billion world market, U.S. companies had sales of only $25 billion. American producers, however, more than held their own in domestic markets. In the 1990s industry leadership remained in European and American hands, which, with the addition of Japan, were estimated to control almost 90 percent of the market. A growing threat to this Western fine chemical hegemony were Asian and Indian producers, who do not have the strict Western environmental codes applied to U.S. producers. Asian producers showed themselves particularly competitive in the bulk pharmaceutical and intermediates classes.

Further Reading

"About Roche." F. Hoffmann-LaRoche Ltd., 1999. Available from .

"A Bear Market for Supplements; As Consumers Contemplate Herbal Products' Negatives, Sales Have Dropped." The Washington Post, 15 May 2001.

"Chairman of Pharmanex, Inc. Medical Advisory Board Awarded Unprecedented $7.5 Million Grant By National institutes of Health (NIH) to Research Botanical Dietary Supplements; Dr. David Heber to Head New 'UCLA Center for Dietary Supplements Research: Botanicals (CSRB)' to Investigate Red Yeast, Green Tea Extract, Soy, St. John's Wort and Others." PR Newswire, 12 October 1999.

Challener, Cynthia. "Changing Fortunes for Dietary Supplements." Chemical Market Reporter, 17 June 2002.

——. "Smaller Fine Chemicals Players Find Their Niche." Chemical Market Reporter, 30 September 2002.

"Dowpharma is Positioned For Significant Growth." Chemical Market Reporter, 24 March 2003.

"Fine Chemicals Forge Ahead." Chemical Week, 2 January 2002.

"Hoover's Company Capsules." Hoover's, Inc., 1999. Available from .

Howlett, Elizabeth. "Outsourcing by the Pharmaceutical Industry Provides Opportunities for Fine Chemical Producers Worldwide." Industry, Trade, and Technology Review, October 1999.

"Leading Chemical Industry Management Consulting Firm Shares Views of Industry Outlook." PR Newswire, 27 September 1999.

Lichtblau, Eric. "Seven Vitamin Makers Settle Antitrust Suit for $1.8 Billion." Los Angeles Times, 4 November 1999.

"Medium-Sized Producers Benefit From Size and Flexibility." Chemical & Engineering News, 22 July 2002. Available from .

Merck 1998 Annual Report. Whitehouse Station, NJ: Merck and Co., Inc., 1999. Available from .

McKinley, Ed. "Growth and Consolidation for Fine Chemicals." Chemical Processing on the Web, July 1999. Available from .

Mullin, Rick and Natasha Alperowicz. "Pharma: Repositioning Fine Chemicals." Chemical Week, 18 September 2002.

"Pressure On for Fine Chemicals as Pipeline Slows to a Trickle." Chemical Market Reporter, 9 December 2002.

"Roche Sees 'Good' FY Despite Special Charges in Vitamin Case." AFX Europe, 14 October 1999.

Rouhi, Maureen A. "Fine Chemicals: Mid-Way through 2002, Producers Are Cautiously Optimistic About Business, Adopting Different Strategies to Achieve Growth." Chemical & Engineering News, 22 July 2002. Available from .

Sniffen, Michael. "Vitamin Giants Sued Millions." San Francisco Examiner, 6 November 1999.

Storck, William. "Industry's Bright Outlook." Chemical and Engineering News, 12 January 1998.

Tyler, Varro, et al. Pharmacognosy. 8th ed. Philadelphia, PA: Lea and Febiger, 1981.

U.S. Census Bureau. Annual Survey of Manufactures. Washington, DC: 20 December 2002. Available from .

Wijesekera, R. O. B. The Medicinal Plant Industry. Boca Raton: CRC Press, 1991.

"Zila's Inter-Cal Launches Palmexx Saw Palmetto Extract, Based on New Purextrax Technology." PR Newswire, 11 November 1999.

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