13 Okt 2016

Project Cancellation Fees are not another tricky revenue strain for CROs

CROs always have to include in their budgets an average cancellation rate of about 3-5% of each quarter’s beginning backlog, Jason Montelone points out in his inspiring article about project cancellations in the clinical outsourcing industry.

So if your CRO is asking in their MSA for an early termination fee: think twice, before you as a sponsor refuse to accept this and brush this aside as just another dirty trick to gain more revenue. Reason:

the business driver of a CRO is to gain more business and not to make money out of lost projects
a small and mid sized CRO can quickly experience serious financial damage in case the average cancellation rate is exceeded

It is clear that a termination fee is an easy way for the CRO to reduce the risk of early project contract terminations. Of course: this is not the only opportunity a CRO has to mitigate project risk. CROs have several opportunities to hide additional sources of profit in their budgets. A sponsor could always argue that any cancellation risk shall already be factored into the rates the budget is based on.

img_20161014_153033207 The key question in contract negotiations is: How can we develop a fair deal that respects the inevitable need of a CRO to mitigate the financial thread by project cancellations and also address the legitimate interest of the sponsor to avoid any additional costs for cancelled projects that are already a wast of money? It is important to understand that this fee shall not be a penalty but an average amount reflecting the real cost of the cancellation.

In good negotiations the parties involved shall always respect the legitimate interests of both sides and shall develop a solution which is acceptable in view of the various sensibilities and interests at stake. We call this „Fair Deal Negotiations“ and this is more than just Harvard’s Win-Win deal approach. One opportunity in this example of early termination fees is to accept the cancellation fees but to open up an opportunity for the sponsor to avoid the fee without any disadvantage for the CRO: in case the sponsor can prove to provide new business to the CRO that is valuable enough to compensate the lost revenue from the cancelled project the cancellation fee shall be waived. Negotiation is over and everybody leaves the table with a smile. Mission accomplished.

However: As cancellation fees need to be evaluated in conjunction with future business it is important to understand that cancellation of a clinical trial does not usually mean the work stops overnight unless you are in very early stages of planning. Therefore CROs usually will have a period of wind-down with revenue generation. This wind down period shall be factored into the evaluation of future business. But does that really help to mitigate the loss for the CRO? Considering the long sales cycles in clinical outsourcing (time from RFP to project award) it is evident that a project wind down period of around 3 months does not compensate the average sales cycle which is needed to win the next project award.

In discussions I had with larger CRO management contacts it turned out that a rapid loss of revenue might cripple a small CRO, but in larger CROs the available staff gets absorbed almost instantly onto other projects unless they are geographically stranded and can’t be placed.

Read more in the inspiring article „What Can a CRO Do to Deal With the Cancellation Bugaboo?“ by Jason Mantelone to understand the financial thread for CROs by project cancellations.

(Foto: Salim Virji - Cancellation Shoes/Flickr – CC BY-SA 2.0)