Drug prices have gone up significantly in the last several years. According to an analysis conducted for Bloomberg, since October 2007 the cost of brand-name medicines has soared, with prices doubling for dozens of established drugs that target everything from multiple sclerosis to cancer, blood pressure, and even erectile dysfunction while the consumer price index rose just 12 percent during the period. There was an article on BBC late last year mentioning the high profitability of the pharmaceutical industry (http://www.bbc.com/news/business-28212223). Per the article, the pharmaceutical industry made spectacular margins well ahead of banks, autos, oil & gas and media industries. The society expects the industry to save lives and alleviate suffering and not profiteering from the old and weak.
However, this profit trend may not last long. There are fundamental challenges faced by the industry that may be why it’s trying to shore up its short term profitability.
What are these changes?
- Pharma innovation model is at risk: The business model for pharmaceutical companies is based on developing and launching new drug products every few years. In the interim years, they extend the life of their existing patented products through product extensions. This approach to product development is no longer sustainable. Look at any of the pharmaceutical and biotech company’s product pipeline, you would find that the revenue and profit potential is significantly lower than what used to be 10 to 15 years ago. Why is this happening?
- Drugs for peripheral diseases: Drugs for most of the common diseases have already been discovered. R&D investments are currently focused on peripheral diseases. Take for example Ebola, it is a scary disease but only infected a small population. Drug development and testing for such small disease incidence are expensive due to difficulty in getting sufficient patients for clinical trials. Also, these drugs have lower lifetime revenue potential as only a small population will pay for it. A recent study found that new drugs are twice as expensive to develop and are likely to generate half the revenue of earlier blockbusters.
- Getting approvals for product extensions becoming difficult: A large number of drug patents have active ingredients (main ingredient) that are out of patent. Pharmaceutical companies try to improve the efficacy of these by mixing and changing other ingredients in drugs. Though regulatory bodies were happy to provide patent extensions on these in the past, there is now greater push back from both consumer groups and regulatory bodies on these practices.
- Declining demand for expensive / patented drugs: Though pharmaceutical companies seem to increase their prices at will, governments, insurance providers and patients are moving away from expensive drugs.
- Move towards generics: Generics are growing rapidly with the expiry of patents for major drug products. With competition from generics, the revenue of patented products drops by 90% plus after the patent expiry. There is a concern about generic producers increasing their prices as the industry consolidates. This is probably a short-term problem. Since the product know how is available, there is nothing stopping other generic companies from entering the market if they find the pricing attractive.
- Drop in government reimbursements globally: Government reimbursements are a key source of revenue for pharmaceutical companies. It not only determines how much Governments are willing to pay for different drugs but also sets benchmarks for insurance companies. Governments across the globe are looking to manage their budgets and clamping down on reimbursements.
- Difficulties in penetrating developing markets: With most countries signing WTO agreements, pharmaceutical companies were expecting increased revenue from developing markets. Developing countries are worried about the impact of patented products on their budgets and the ability of their population to afford such expensive drugs. To address these concerns, several countries have created restricted drug list that essentially keeps the patented drugs out. Pharmaceutical companies have been able to become part of the private insurance market, but these are not having a significant impact on their revenue and bottom line results.
How is the industry reacting?
The industry is trying to address these issues through traditional ways. There is a general focus on cost cutting. Headcount reduction is usually the first and has been going on for some time. Many pharmaceutical companies have started to move their R&D, manufacturing and back offices to lower cost countries. Also, there is a great appetite in the market for merger and acquisitions. Companies are looking to bolster their product pipeline through the acquisition of start-ups along with a desire to remove duplicate headcount and infrastructure to improve short term profitability.
Though these measures can help to bolster short term profitability, they are not sufficient to address the core challenges facing the industry.
How to bring back glory days for the pharmaceutical industry?
- Rethink business model: There is a need for pharmaceutical companies to think out of the box, perhaps starting with listening to customers and stakeholders. Increasing short term pricing and lowering structural cost through consolidation or move to lower cost countries is not going to give the desired competitive advantage against generics. It will end up alienating the goodwill they will need in the market. Perhaps, they could think through their business model and come up with a new way of doing business. Key areas to focus are:
- Innovation: The market is not asking for newer drugs for newer diseases. The days of thousands of people dying from the plague, cholera, or other epidemics are long gone. People are living longer, and they are more health conscious than before. What is needed now is a general focus on affordability. Pharmaceutical companies will gain by focusing on how to reduce the overall cost of medication (total treatment cost instead of just the drug cost). It would require them to partner with medical service providers to identify ways of reducing the cost to patients and governments.
- Sales & Marketing: Traditional heavy sales force and branding focus are not working. Some of the practices have reduced the credibility of the industry bringing in restrictions from regulatory bodies. There is a need to rethink the value generated from the money spent on selling expenses versus a focus on targeted education to doctors and patients.
- Manufacturing and Distribution: Pharmaceutical products are manufactured through large batch processes. The focus is on control, tracking, and ability to explain it to regulatory bodies. There is a great reluctance to introduce the latest practices in manufacturing and supply chain. The reluctance comes from the fear that change will introduce new variables that can lead to bad regulatory reviews if something goes wrong. This, in turn, has created an industry that can’t respond to market changes efficiently and creates huge waste (expired drugs and raw materials) throughout the system. The industry would benefit by considering small / distributed manufacturing and demand driven planning (instead of primarily relying on forecasts) that would allow better response to market demand.
- Sourcing: Pharmaceutical companies spend significantly more on services than raw materials and capital. These services include wholesale agreements, contract manufacturing, and professional services, etc. Due to the sensitivity of these relationships, sourcing teams are typically kept out of this buy. Pharmaceutical companies will benefit if they open their services buy to the latest sourcing practices. Total Cost of Ownership (TCO) is a good way to structure and drive value from these relationships instead of a traditional negotiation approach.
Our team has helped many leading companies to make significant advances in the above areas and regain their momentum.
Short-term profitability is probably the pharmaceutical way of building a war chest to survive upcoming merger and acquisitions. The current business model seems to have reached its end of life, and there is a need to rethink with a focus on innovation to improve overall treatment affordability, targeted selling/education, and latest supply chain and sourcing practices. Everyone including companies themselves, governments and regulators have a role to play in ensuring financially viable healthcare and pharmaceutical industries for generations to come.
About Author: Suman is a Partner with Three S Consulting. The firm drives value for clients through Strategy, Supply Chain, and Sourcing.