The pharmaceutical industry is on the verge of entering into a new era because a series of forces have made pharmaceutical companies current business models obsolete. These forces can be grouped into three categories:
1. Revenues Are Under Pressure
- Patents on numerous high revenue drugs are expiring. The major pharmaceutical companies find themselves in the unenviable position of having to rely on a small number of drugs for much of their revenue and the preponderance of their profitability. However, the patents on many of these treatments will expire over the next five years and 36 treatments that generated nearly $47 billion in U.S. revenues in 2006 will have to compete with low-cost, generic alternatives.
- Pipeline for new drugs looks uncertain. It does not appear that the drugs in the development pipelines of major pharmaceutical companies will generate anywhere near as much in revenue as those with expiring patents.
- More powerful payers. A series of mergers has created a handful of very powerful payers. Today only 10 firms control nearly 56% of the managed care market. While in the past, physicians were the key decision makers as to which drugs were used by patients, these larger payer organizations now influence which treatments their insured will use by manipulating patient copays.
- Lower cost medications such as generics and those treatments sold by pharmaceutical companies at a below market cost so that the payer will include them in its formulary are provided to patients at a very low out-of-pocket cost.
For all other treatments, patients must pay much more, for some drugs nearly 10 times as much as the generic alternative. Consequently, pharmaceutical companies now face the unappealing choice of having to discount even branded medications or effectively be excluded from large segments of the potential patient population.
2. Costs and Risks of Developing New Drugs Are Increasing
At the same time that the pharmaceutical industrys revenues are under pressure, the costs and risks associated with the development of new drugs are increasing for a number of reasons.
First, many of the drugs currently under development are aimed at treating conditions that have more complex and difficult targets, increasing the costs of the research process and reducing the likelihood of ultimate success.
Second, unlike in the past when the R&D process was frequently driven by obvious commercial applications, todays R&D is often driven by new scientific discoveries, a process that is far less predictable from a commercialization perspective.
Third, the regulatory approval process has become significantly more complex and costly. The regulatory agencies are more sophisticated and capable in evaluating drugs than in the past. Consequently, their standards for approvals are significantly higher. This, in turn, is forcing pharmaceutical companies to test their new treatments in larger, more comprehensive and more expensive clinical trials.
Fourth, the current plaintiff-favorable litigation environment continues to be a drag on pharmaceutical company profitability. Since 2000, 65,000 product liability lawsuits have been filed against prescription drug makers, more than in any other industry. This should come as no surprise given certain features of the U.S. tort system: plaintiffs do not need to incur any out-of-pocket costs to hire contingency fee lawyers; prescription drug users represent a convenient group for class action certification; and unsophisticated juries are frequently willing to give exorbitant awards. Further, even if a pharmaceutical company successfully defends a suit without merit, it will incur significant legal costs in the process.
Finally, payers are slowly shifting to an outcomes-based analysis of treatment alternatives. Under outcomes-based analysis, payers focus not on a treatments ability to address any particular symptom but rather its long-term effect on overall health. Consequently, predicting the potential revenue from a new treatment has become much more difficult and it is less certain that companies who spend the hundreds of millions of dollars necessary to develop new treatments will generate a sufficient return on their investments.
The most powerful force sweeping through the industry, however, is the globalization of this industry. What had historically been a U.S.- and EU-focused business, now is shifting to developing countries both for the development of new treatments and as potential markets for products.
The role of these countries in the development of drugs has been aided by several factors. These countries laboratories are becoming more sophisticated as they become populated with U.S.- and EU-trained scientists and their research costs are a small fraction of their developed country counterparts.
These labs also operate under regulatory regimes that encourage development through less adversarial approval processes. And the intellectual property laws of these countries are maturing.
The great economic growth experienced by developing countries has also created a much larger demand for health care and prescription medications than in the past. Although much of their near term demand for drugs will be for generic treatments, the sheer size of the populations in these countries makes them potentially enormous markets for the industry.
Big Changes for the Pharmaceutical Industry
The confluence of these forces is forcing pharmaceutical companies to reengineer their business models, identify their core competencies and focus on that they do best. Consequently, the following trends in the pharmaceutical industry will continue and even accelerate in the future:
1. Corporate Restructuring
- Job reductions. With their revenues under pressure, pharmaceutical companies are reducing costs by shrinking the size of their workforces. In the last three years alone the industry has had nearly 70,000 layoffs. Several of the largest pharmaceutical companies have also announced plans for significant layoffs in 2007 and 2008.