[Ip-health] The Economist - Why Big Pharma Needs a New Business Model

[Mike Palmedo]

http://www.economist.com/business/displayStory.cfm?story_id=3D2269456


Why Big Pharma urgently needs a new business model

Economist
December 4

would be =93the kings of science.=94 This week GSK unveiled its crown
jewels: a full pipeline of compounds in research and development, the
result of a =A32.6 billion ($4.5 billion), 16,000-researcher-strong
effort. 82 new drugs and 20 vaccines are in development, 44 of them
moving into later-stage trials.

Yet if Mr Garnier hoped that these numbers would impress his
shareholders, he had to think again: GSK's share price actually fell on
the news. Like investors in many other big drug firms, GSK's
shareholders have little confidence that many of its new compounds will
earn them a cent anytime soon. Of the 20 drugs that GSK plans to put
into final-phase human testing in the next three years, the chances are,
on current industry averages, that less than half of them will make it
to market.

Next, consider Merck. On November 20th, news that the firm was stopping
development of a diabetes drug after finding tumours in lab mice was met
with dismay=97and a wave of selling that knocked 11% off the firm's
already-battered share price. With another vaunted project=97an
experimental anti-depressant=97also failing last month, Merck's near-term
pipeline now looks horribly empty. Even an upbeat profit forecast for
next year, on December 3rd, did not cheer investors much.

Merck and GSK are not alone. In 1998-2002, according to Lehman Brothers,
Big Pharma firms launched on average 59 drugs per year. In 2002-06,
reckons Lehman, they will launch just 50 per year. Moreover, as many
patents for the industry's existing products expire in the next five
years, competition from generic-drug makers will threaten $30 billion
(one-fifth) of annual sales in America alone, says AT Kearney, a
consultancy.

When the drugs don't work

Big Pharma now faces two big challenges. First, control costs better.
Stuart Walker, head of the Centre for Medicines Research International,
reckons that total industry spending on R&D will reach $50 billion this
year, over 25% up on 1998. Sales and marketing overheads have soared,
too. In the past four years, says Dean Hart, head of North American
sales at Takeda, a Japanese drug firm, the number of sales
representatives employed by drug firms in America has risen by 54%, to
90,000. Each rep costs on average $200,000 a year.

Sales, general and administrative expenses account for 17% of a typical
big American firm's revenues, says Christopher White of AT Kearney. In
the drug industry, such overheads (even excluding the big American sales
forces) account for 33% of revenues. Standard management practices such
as consolidating procurement, outsourcing personnel and finance
functions and automating transaction processing all compare poorly with
other industries, says Mr White. Many firms still make pills in-house, a
job perhaps better done by a contract manufacturer.

But the tougher challenge is to improve the productivity of R&D. As Mr
Walker points out, it is not just the number of new products that has
fallen in recent years, but also their originality. Less than 30% of
drugs launched last year were first or second in their class. The
proportion was far higher in the late 1990s. Roughly 40% of R&D spending
by Big Pharma is now on =93line extensions=94=97improving existing drugs, n=
ot
creating entirely new ones.

Many big drug firms have begun to license more of their technology and
products from outside companies, especially biotechnology start-ups:
having slumped in recent years, the value of biotech firms is now rising
again. Novartis has set up a big R&D centre in Cambridge, Massachusetts,
in part to better position itself to collaborate with outside academics.
Eli Lilly's InnoCentive subsidiary runs a website where problems
confronting drugmakers, such as how to generate a particular compound in
chemical synthesis, are posted to be tackled by more than 25,000
registered problem-solvers as far afield as Russia and China. For a
reward of $10,000-100,000, the firm gets a solution that would have cost
more time and money to solve itself.

Others hope to improve the way they manage in-house R&D. Wyeth is
encouraging its researchers to perform their tasks better by changing
how it pays them. Unusually for the industry, its scientists get to
share a bonus pool which depends, in part, on how many new drugs they
launch each year. There used to be a temptation for Wyeth's early-stage
researchers to throw their work =93over the wall=94 before it was ready to
the scientists who run clinical trials, says Robert Ruffolo, the firm's
head of research. Because early-stage researchers now share incentives
with later-stage scientists, the later-stage researchers have begun to
=93pull=94 the development of the most promising compounds forward. A
corresponding =93push=94 from early-stage workers hastens the process. GSK
fundamentally reorganised its R&D in 2001, splitting its more creative
arm into smaller =93centres of excellence=94, and enlarging the arm that
enjoys economies of scale. Mr Garnier claims that his =93best of both
worlds=94 strategy is now paying off.

The industry's bloated overheads appear to be driving its decisions on
the sort of drugs it seeks to develop. Like a supermodel who will not
get out of bed for less than $10,000 a day, Big Pharma has decided that
it is simply not worth investing in anything but a blockbuster. This
means that lesser, albeit interesting, compounds fall by the wayside. An
oft-quoted figure from the Tufts Centre for the Study of Drug
Development puts the average cost of bringing a new drug to market at
$897m. But as F.M. Scherer, an economist, points out, this is an average
cost for big firms producing drugs for chronic diseases. Other firms can
bring drugs for other complaints=97infectious diseases or rare conditions,
say=97to the market for around $100m-200m.

Big Pharma also needs to do something about its poorly trained,
generalised sales force, which is simply not equipped to chase smaller,
more specialised markets. Most sales calls end, at best, with just a few
seconds of a doctor's time, laments Mr Hart of Takeda. Some reps do not
even make it past the reception desk before dropping off their free
samples. Drug firms lag behind other industries in the way they use
information technology to discriminate between profitable and
unprofitable customers. Only one in five drug companies invests in any
salesforce training beyond initial courses offered to recruits. Who,
after all, needed to bother with trifles such as training and IT when,
without much effort, a drug such as Lipitor, Pfizer's
cholesterol-lowering medicine, was making sales of $8.6 billion last
year alone?

Can Big Pharma achieve transformation without changes at the top? The
bosses of big drugs firms have been horribly slow to grasp the enormity
of their problems. Until recently, Merck's boss, Raymond Gilmartin, has
been reluctant to license much technology from outside, instead putting
his faith in the firm's own scientists. With Merck's in-house R&D now
struggling, it will be no surprise if Mr Gilmartin's head is the first
to roll.