Transforming Big Pharma

Assessing the Strategic Alternatives

John Ansell

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317007715
• Edition: 1
• Topic: Business
• Subtopic: Pharmaceutical, Biotechnology & Healthcare Industry
• Index: Business

In Transforming Big Pharma John Ansell addresses critically how strategy works in the pharmaceutical industry. The long-standing dearth of new products has led to a growing shortfall in revenues. Ansell assesses the wide range of alternative strategies big pharma companies have been pursuing in recent years in attempting to overcome this. He shows that there is sound evidence to expect the recent upturn in the number of new products reaching the market to go on to greater heights. Chapters assess the complex trends in attrition rates, show how rife spectacular sales underestimation in the industry remains, and explain how conventional wisdom on the chances of product profitability also seriously undersells the industry. The surest route to transforming the prospects for big pharma, Ansell contends, is to step up activity in acquiring and developing new products. This is now realistic because, as he shows, the amount of intellectual property available is much greater than it was a decade ago. Ansell believes that no other strategies have sufficient transformative powers, though they may be useful as a stopgap whilst the sales of forthcoming new products mature. He argues for a reversal of big pharma's recent cutbacks in R&D and licensing, and re-focussing on new product development. Transforming Big Pharma is intended for those in senior and middle management in the pharmaceutical industry. It will also be valuable to students, as well as to all those dealing with the industry, including biotech companies and those providing services and products to the pharmaceutical industry.

PART I
How Pharma Differs and Why This Is Important

1
How Pharma Differs

What is long life for a corporation – 100 years? Two hundred years? Defined legally as a person, modern public corporations don’t live very long. Most expire within 25 to 50 years. A few of the best ones survive for more than a century.

Daniel Pascheles and Christopher Bogan, Merck & Co/
Best Practices, LLC, 2012

Countless numbers of new management concepts are offered to industry each year. The majority are never adopted or are soon proven to be inadequate. Sometimes this applies regardless of industry type but this is not necessarily the case. Occasionally there are concepts which seem to apply particularly well to some industries, and there are examples which I shall mention in this book for pharmaceuticals. Far more commonly, management concepts sold across the board turn out to be particularly unworkable in some industries. Again, there are plenty of examples in pharmaceuticals which I shall also go into. But new concepts more often fall down for a particular industry because of its inherent characteristics.

Only some eight years ago, when I was first putting together courses providing a general introduction to the pharmaceutical industry, did I hit upon the importance of defining its distinctive characteristics at the outset. There was no ready reference which I could use – and so I set out to develop the material myself. As I gained more experience in giving these courses, I began to realize how many misconceptions about the industry – from insiders as well as outsiders – could be prevented if these basic characteristics of the pharmaceutical industry were explained at the outset.

Since I was to give my first course to a group of accountants at a company in Switzerland, I decided to start with a cost breakdown of the pharmaceutical industry. That proved to be a sound basis for steering the participants in the right direction and avoiding misapprehensions about the pharmaceutical industry. It has become a feature of the opening sections of this course ever since. And so I also make it my starting point in this book.

The Pharmaceutical Company Cost Structure

Dr Barrie James (2003) produced the following typical breakdown of costs for the pharmaceutical industry expressed as a percentage of sales revenue:

R&D	16.5%
Cost of goods	13.2%
Sales & marketing	35.0%
General & administrative	8.0%
Total	l72.7%
Hence margin:	27.3%

Let’s look at these areas of cost one by one:

R&D COSTS

In major pharmaceutical companies, R&D accounts on average for the equivalent of around 16 per cent of sales revenue. This is the highest percentage for any industry by far. It reflects two associated factors: the long duration of the pharma R&D process, which I shall address later in this chapter, (see pp. 17–19) and the complex and demanding nature of regulatory requirements.

Critics of the pharmaceutical industry sometimes urge it to spend much more of its resources on R&D (see also p. 12). Yet it spends far more as a percentage of sales than any other industry. The 2012 EU Industrial Scoreboard measures R&D expenditure across industries for the Top 1,000 companies globally. (The 2012 EU Industrial R&D Scoreboard.)

This R&D Scoreboard showed that the Pharmaceuticals and biotechnology industry spent the equivalent of 15.1 per cent of sales on R&D. This was more than half as much again as the second-ranked industry, Software & computer services, which spent 9.5 per cent. Only one other industry, Technology hardware & equipment, spent anywhere near as much, with 7.9 per cent. All of the 35 other industries covered spent less than 7 per cent and 30 of them spent less than 4 per cent.

Another indicator of the importance of pharmaceutical R&D is its share of total R&D expenditure conducted by all industries. The R&D Scoreboard showed that no less than 17.7 per cent of all global R&D was accounted for by the pharmaceutical industry. This was just ahead of Technology hardware & equipment (16.8 per cent) and Automobiles & parts (15.8 per cent). Also, the R&D Scoreboard report gave rankings of the Top 1,000 global companies by absolute R&D expenditure. In 2012 no less than seven pharmaceutical and biotech companies appeared in the Top 20 highest spending companies. Automobiles and parts accounted for another six, these two industries therefore dominating these rankings. In the upper reaches of the rankings four pharmaceutical companies, Novartis, Pfizer, Roche and Merck & Co all appeared in the Top 10 companies, more than any other industry.

MANUFACTURING COSTS

Pharmaceutical manufacturing is not labour intensive like many other industries. In pharmaceuticals manufacturing costs are typically equivalent to only 10–15 per cent of sales. For new products, which are usually relatively highly priced, the figure is often well under 10 per cent and sometimes as low as 5 per cent. This means that manufacturing is much less at the forefront of company management priorities than it is in many other manufacturing industries. It is uncommon, for example, that the director of manufacturing has a seat on the main board, or if that is the case, it is normally in combination with other responsibilities.

Traditionally, pharmaceutical companies had a rather cavalier attitude to pharmaceutical costs. This was because costs were not considered the main priority. In developing a new production process for a forthcoming product, it is far more pressing that perfection of the process be on time to avoid delaying launch. Every month’s delay can cost millions of dollars in lost revenue. Before pharmaceutical companies began to become cost conscious across the board some 10–15 years ago, manufacturing cost considerations were therefore not an important issue. Concepts such as ‘quality by design’ and continuous manufacturing are now gradually being introduced to benefit quality as well as ultimately reducing costs.

SALES AND MARKETING COSTS

The pharmaceutical industry and in particular some industry associations have often tended to be coy in their representation of sales and marketing costs. They have presumably feared criticism if they fully stated these costs. Sometimes figures as low as 20 per cent of sales have been suggested for this cost area.

In reality the figure is much higher than this. Look at a handful of big pharma company accounts and you will find that the equivalent of about 35 per cent of sales turnover is commonly accounted for by marketing and sales costs. Some companies with a preponderance of specialist products who therefore do not have to employ mass GP sales forces may spend a smaller percentage than this.

As mentioned above, critics of the pharmaceutical industry often complain at the high percentage of sales spent on marketing, and propose that the industry should spend less on marketing and sales and more on R&D. Yet across all industries, marketing costs typically amount to 35–40 per cent of a product’s selling price according to a PricewaterhouseCoopers Global Best Practices report for 2005.1 Thus pharmaceuticals is very much in line with other industries.

GENERAL AND ADMINISTRATIVE COSTS

Dr Barrie James cited a figure of 8 per cent for general and administrative costs. Often in US company accounts, sales and general and administrative costs are combined. James gives a figure of 43 per cent for this (James 2003).

NET MARGIN

What remains is the net margin. In the pharmaceutical industry the figure is typically 25–30 per cent. This is higher than for most other industries – and far higher than for many. At one time – though not so commonly in the past 20 years – this impressive net margin level attracted companies from outside the pharmaceutical industry to enter it. But, as most of these companies found, pharmaceuticals is also a relatively high-risk industry. And the high level of risk has often proved too uncomfortable for new entrants to persist for very long (see p. 57). Established pharma companies are more used to though not necessarily comfortable with the high risk – high gain environment.

I deal in more detail later with barriers to entry for potential newcomers to the pharmaceutical industry (see pp. 53–9).

COST CONSEQUENCES OF THE TREND TO BIOLOGICALS

The cost percentages discussed above are for traditional, small molecule products. Over the past decade there has been a trend towards biologicals, that is, large molecule products. The figures that apply to large molecules are different in several important respects.

Taking R&D costs first, there is no good evidence that large molecule products are any more or less expensive to develop than small molecules. Thus the standard percentage of around 16 per cent still applies.

However, the cost of goods is often considerably greater than the 10–15.2 per cent for small molecules. Large molecule biologicals are more difficult and hence more expensive to manufacture.

On the other hand, sales and marketing costs can be very much lower with large molecule biological products. This is because in the main biologicals are not mass-market pharmaceuticals prescribed by general practitioners (GPs); they are purely specialist or, at least, specialist-oriented products. As the numbers of each type of specialist doctor are far less than of general practitioners – for example in the United States often a few thousand rather than tens of thousands – the cost of promoting a large molecule product to a few or sometimes just one specialist target group is very much less than is the case for a mass GP product. Thus, rather than the 35 per cent of sales which is the norm for small-molecule, GP-oriented products, the figure for a large molecule specialist product can be 10 per cent or less. Another factor depressing the percentage here is that the price of specialist-oriented products tends to be far higher than for mass GP products.

Regarding the remaining cost area, general and administrative, there is no difference between small and large molecule.

But the costs aggregate to a much lower total percentage for large than for small molecule products. Rather than a margin of 25–30 per cent for small molecules, a figure of around 50 per cent is the norm for large molecules. Companies such as Roche were trend setters in switching their emphasis in the early years of this century from small to large molecules. With only a limited number of small products worthy of promotion, Roche was one of the first to disband its large GP sales forces and concentrate instead on promoting its growing range of hospital- and specialist-oriented products.

To focus more on large molecules products is now an aim of the majority of big pharma companies. Though still representing a minority of all products, the number of biologicals is increasing, and this is becoming possible for more companies. However, as I show later there has recently been some reversal of this trend (see pp. 42–3).

CONCLUSIONS ON COST

When an outsider without a pharmaceutical background is appointed as company doctor to sort out a pharma company in distress, the first thought is usually to cut costs. For most industries this is a not unreasonable first move. However, unfortunately the scope for reducing costs in pharmaceuticals is much less than it is in most other industries. When Jeffrey Kindler, with a background in General Electric and McDonalds, became chairman of Pfizer in 2006 this was one of his prime aims. But as was already evident, it was R&D productivity rather than costs that were the fundamental problem of Pfizer, and Kindler left the company four years later.

In the light of vastly increasing absolute levels of R&D costs over the past 15 years, various attempts by big pharma over that time to carry out ‘smarter’ R&D more efficiently and so reduce costs have so far been unconvincing. To cut R&D risks hampering the longer-term future of the company – although it is an option that many companies have in the past couple of years begun to take to protect their shorter-term profits. There is likely to be a longer-term penalty, as I explain later (see pp. 236–7).

With manufacturing there is often scope to reduce costs through disposal of surplus manufacturing capacity (often resulting after mergers and acquisitions) but as manufacturing is not a major cost area, it is unlikely that there will be scope to turn the company around on that basis.

How about marketing costs? It is often tempting to reduce the size of sales forces. But unless there are other factors in play, like the trends mentioned above from small to large molecule products and from GP to specialist products, then this can lead to inadequate support of products.

The sales of Lipitor began to decline several years before patents expired on atorvastatin. Whilst the availability of older, cheap, off-patent statins played its part here, Pfizer’s reduction in effort on Lipitor undermined the sales of the product and also allowed a product which was then widely viewed as an unimpressive latecomer, AstraZeneca’s Crestor (rosuvastatin), to make steady inroads into its sales. By the time major atorvastatin patents were expiring in 2012, Crestor sales had reached $6.622 billion dollars, it was ranked the seventh best-selling product globally and was still growing strongly, by 17 per cent in that year (see also pp. 76–7, 114).

Unfortunately sales forces remain the most effective medium for promoting products – and still account for over 60 per cent of total promotional expenditure – not much less than in their heyday several years ago. A variety of ploys to replace sales forces have over many years been ineffective. Sooner or later sales forces bounce back. In the US, where detailing by sales representatives had been declining in recent years, IMS data showed an upturn in expenditure on sales forces in 2011 to a level higher than any since 2007 (IMS 2012b). This may well reflect the increased number of new products approved in the US in 2011 (see p. 194). On another front, it is noteworthy that in China, local pharmaceutical companies are busy currently in setting up huge sales forces.

Maximizing Revenue

In pharmaceuticals the best way of pulling out of a crisis is quite different from the conventional company doctor’s medicine for other industries: it is to find ways of increasing revenues rather than prioritizing cost reduction. Of course it is easier said than done to identify opportunities within or outside a company which can achieve this.

Schering-Plough was in a parlous position when Fred Hassan joined it as chairman and CEO in 2003. The team he brought in quickly identified opportunities in the late R&D pipeline which could be developed within a few years into major new products. The additional revenues from these new products completely turned the company around.

And so, crudely speaking, success in pharmaceuticals has much more to do with maximizing revenues than it does with reducing costs, though that does not rule out the merits of also doing the latter. In pharmaceuticals new products are truly the lifeblood of the industry. Putting a new product on the market is the best way of increasing revenues. This explains why pharmaceutical companies generally make sure that they strive to market products proficiently and adequately. And it also explains why they go to such lengths to gain commercial rights to potential new products. This means that deals – with other companies or with other types of organization party – are much more important in the pharmaceutical industry than they are in most other industries.

Now let’s turn to several other features of the pharmaceutical industry which have a big impact on its distinctiveness.

Who Is the Customer?

Although the patient consumes medicines, it is the doctor who prescribes them. Thus there is a disconnect between the (physical) consumer and the prescriber/immediat...

Table of contents

• Cover
• Half Title
• Dedication
• Title Page
• Copyright Page
• Table of Contents
• List of Figures
• List of Tables
• List of Abbreviations
• Acknowledgements
• About the Author
• Introduction
• Part I How Pharma Differs and Why This is Important
• Part II Assessing Management Concepts for the Pharmaceutical Industry
• Part III Big Pharma’s Strategic Options
• Part IV Where Will New Products Come From?
• Part V Prospects for New Products
• Part VI Getting a True Fix on Prospects
• Part VII Conclusions and Summary
• Appendix: Measuring Global Longevity
• References
• Index