The deconstruction of “Big Pharma”

12 Feb The deconstruction of “Big Pharma”

A few years ago, a VC friend of mine (that had worked previously at a “Big Pharma” company) talked repeatedly about a concept that was gathering force – the deconstruction of Big Pharma: deconstruction, in this case, meaning the casting away of parts and downsizing.
At that time, while I listened to him and agreed, I didn’t recognize this movement as the transformational one it is now becoming. The problem, as recognized by a recent article in The Economist, is that Big Pharma has morphed into Enormous Pharma!
The first stage of Big Pharma deconstruction, the reduction of physical assets as a result of continued mergers and acquisitions, had as its prime objective the acquisition of product pipelines, presence, and market share in key markets and countries around the world. As Big Pharma’s excess plants, offices, and R&D sites went up for sale, this stimulated the emergence and development of the CRO (contract research organization), CMO (contract manufacturing organization), and CSO (contract sales and marketing organizations) industries.
In this stage, although physical assets were cast away, sales forces were mostly kept intact, as were, for the most part, R&D scientists. But manufacturing personnel were lopped off, as was senior management, R&D management, and marketing management of the acquired company.
In the second stage of Big Pharma deconstruction, marginal products were pruned. Any product below $100 to $150 million in annual sales – the first to go were the $5 and $10 million sales/year products, which then escalated to $25 to $50 million sales/year products, and so forth – was no longer deemed as having sufficient sales to warrant promotional time from these vast armies of sales forces. This activity stimulated the growth of the specialty pharma industry, which was built by these able ex-Big Pharma execs who knew actually which products were on the chopping block, and who to talk to about picking them up.
High-margin focus
The third stage of Big Pharma deconstruction has been a sell-off of non-strategic divisions to focus only on the higher margin ethical (prescription-based) products. These are products that yield gross margins of 90 to 95 percent (meaning the cost of goods is only 5 to 10 percent). Only Johnson & Johnson and Abbott Labs, never really strong Big Pharma players, have bucked this trend by going for the healthcare conglomerate strategy. This involves having drugs, medical devices, diagnostic products, and other product lines at the same time.
But even Abbott Labs has recently sold off its lower-margin hospital products division (now Hospira) and diagnostics business (to GE Healthcare).
The fourth stage of Big Pharma deconstruction, stimulated by generic competition and the loss of high-profit, patented drugs, represents a second wave of intense chopping at cost structure and redundant physical assets. This further cost and size reduction was critical to keep pace with the overall profit erosion as formerly patented drugs lost their patents around the world. This stage further fuels the development of all of the above industries, and also of the generic industry itself, particularly Indian Pharma and Teva, as they have acquired facilities around the world.
The fifth stage of Big Pharma deconstruction, the reduction of pharmaceutical sales forces, is just beginning and is being stimulated by physicians reacting to the incredible increase in pharmaceutical sales forces over the last 10 to 15 years. Physicians are tired of seeing four or five different reps from the same company promoting the same products to them. While physicians still view sales reps as a primary source of new product information, the effectiveness of these calls and the amount of time doctors will spend with these reps has decreased significantly as a physician backlash begins to develop.
Although use of the Internet has increased as a sales and marketing tool to get information to doctors, the personal relationship model continues to be the primary mode of convincing physicians to prescribe products. Nevertheless, a drastic reduction in overall selling and marketing expenses is about to take place in the industry, due in part to physicians’ negative reaction and to the need to pare costs as a result of generic encroachment.
A typical Big Pharma sales rep can cost up to $170,000 per year, including salary, car, computer, travel, and benefits, according to a February 28, 2005 article in Business Week. This reduction in Big Pharma sales forces will further increase both the growth of specialty pharma and the CSO industry.
The last stage of Big Pharma deconstruction, the reduction of R&D organizations, also is just beginning and is focused on increasing R&D productivity and reducing R&D expense and time-to-market. Major drugs are now taking up to $1 billion to develop and 12 or more years to get on the market. Most Big Pharma companies have supplemented their R&D pipelines by as much as 40 to 50 percent with in-licensed drugs. The reality is that bigger R&D budgets and teams do not necessarily translate into an increase in blockbuster drugs.
Money talks, innovation walks
The reality is that Big Pharma does not do a good job in drug innovation these days. Big Pharma has the money to acquire not only new products but also discovery tools to aid its internal R&D productivity, and even once stodgy Merck has aggressively acquired discovery toolkit companies and revamped the way they practice R&D. Big Pharma will need to do this even faster and better, however, as the Food and Drug Administration takes a harder look at drug safety.
Lastly, the free ride on drug pricing in the U.S. is coming to an end, and much like Europe and Japan, the U.S. (and the FDA) will most likely move to some kind of price capping on new therapies as drug reimbursement takes hold (it already plays a significant role in medical devices and diagnostics). In this stage, there will be radical reformation of Big Pharma’s R&D groups and the realization that a company can no longer excel in 10 or more therapeutic areas. The result will be a drastic reduction of internal R&D personnel, but probably not overall R&D dollars as much more R&D will be outsourced to smaller companies.
I mentioned in numerous other articles the growing impact of generic drugs. According to the November 2006 edition of MedAd News, the generics business reached $60 billion in annual sales in 2005 and grew about 21 percent over the prior year, or almost three times the growth rate of the entire pharmaceutical industry. Furthermore, there are $80 billion in current drug sales that are expected to come off patent by 2008. By 2015, this number is expected to reach $160 billion in annual sales.
Generic trends
Some trends which will further enhance the growth of the generic drug business are as follows:
• Globalization of generic Pharma companies (once again Teva, the Indian companies, and the Canadian company Apotex are good examples of this).
• Approval of a biogeneric regulatory pathway in the U.S. and Europe.
• Increased cost to patients of new drug therapy.
Even Big Pharma has begun to rethink its way of combating generics by creation of “authorized” generic competition in advance of patent expiration, creating its own new generic divisions, and accelerating an “ethical-to-OTC- switch.”
They will have to as Teva, the world’s largest generic company, surpassed Pfizer in the first six months of 2006, for the first time, in total prescriptions. In an article in the Economist, it is estimated that by 2010, six to eight Indian Pharma companies will be in the top 50 Big Pharma companies around the world.
One of them, Ranbaxy, acquired six competitors last year. On the other hand, a failed strategy to manage the generic impact on a company’s sales can be seen with Bristol-Myers Squibb and its debacle with Apotex. As a result, Bristol-Myers is now considered to be an acquisition target.
So how is this really playing out? Well, let’s take a look at Pfizer, the world’s largest pharmaceutical company, and see what is happening. Under the helm of a new CEO, who did not grow up in the pharmaceutical industry, Pfizer has just announced a series of gut-wrenching moves to reshape itself. The question is, will this painful and expensive move be enough?
What were these moves?
• First, a significant cut back in its huge sales force in the U.S, called “detail men” (and “detail women”), although it was not clear by how much. In an article from Business Week (Feb. 28, 2005), Pfizer had 38,000 sales reps out of a total of 115,000 total employees, or one third of all employees. As Business Week points out, this is the size of three army divisions.
• Second, the sale of Pfizer’s OTC business to Johnson & Johnson for over $8 billion at the end of last year.
• Third, and more recently, a reduction of 10,000 employees around the globe, almost 10 percent of Pfizer’s global workforce. A recent article in the Economist indicated about 20 percent of Pfizer’s sales force in the U.S. and Europe, or close to 6,000 sales reps, will be cut. Additionally, Pfizer is cutting five research centers (including a major one in Ann Arbor, Mich.), and several manufacturing sites around the world.
Pfizer currently has more than 15,000 scientists in seven major research labs around the world; a number of these employees will also be cut.
Beyond Pfizer
So is this just about Pfizer? Not really! Right after Pfizer made its announcement, AstraZeneca also announced a major reduction in its worldwide sales force, and other companies are likely to follow suit. The Swiss Big Pharma Novartis has already identified correctly this growing generic trend and has been a leader in this business segment, as well as in-licensing new innovative drugs from small companies.
The other Swiss giant, Roche, has also placed its innovation bets on Genentech, of which it owns a healthy chunk, and markets this company’s products outside of the U.S.
Merck, under a new CEO, has also revamped its traditional business model, streamlining its R&D and drug development process. Even the largest biotech company in the world, Amgen, now a Big Pharma member in its own right, faces strong generic competition as well as other growth issues.
It will be interesting to see the composition of Big Pharma 10 years from now and how these companies will have weathered the storm. The reality is that the pharmaceutical business will continue to be a big and growing industry due to the world demographics: populations in North America, Europe, and Asia are aging quickly and will require greater medical expense. Drug therapy offers a cost effective alternative to hospitalization.
Finally, there are still a number of disease that need conquering (cancer, Alzheimer’s, etc.), the re-emergence of “old” diseases (tuberculosis, malaria, antibiotic-resistance, etc.) as well as new the emergence of new diseases (SARS, West Niles Virus, obesity, etc.).
See you soon!
Previous articles by Michael Rosen
• Michael Rosen: The 10 biggest events shaping biotech in 2006
• Michael Rosen: A Midwest small-cap, life-science surprise package
• Michael Rosen: 2006: A mixed blessing for Midwest life science companies
• Michael Rosen: 2006: A great biotech financing year, unless you were going public!
• Michael Rosen: Financing life science: The ongoing saga