Has the Pharmaceutical Blockbuster Model Gone Bust?

FOR IMMEDIATE RELEASE

   Contact: Cheryl Krauss
   Bain & Company
  Phone: 646-562-7863
  Mobile: 917-783-0013
  cheryl.krauss@bain.com

HAS THE PHARMACEUTICAL BLOCKBUSTER MODEL GONE BUST?
A New Bain & Company Study Reveals New Drug Commercialization Costs Have Now Reached $1.7 Billion While ROI Has Plummeted To Just 5%

New York, NY - December 8, 2003 - The pharmaceutical industry's blockbuster approach to developing new drugs that created a trillion dollars for shareholders may now be broken. And the demise is being fueled by a heftier-than-thought commercialization price tag - this according to a new study from Bain & Company, the global management consultancy. When the costs of failed prospective drugs are factored in, the actual cost for discovering, developing and launching a single new drug has risen to nearly $1.7 billion. That's a 55% increase over the average commercialization cost for the five years from 1995 to 2000.

These rising costs of commercializing a new drug are also expected to substantially drive down investment returns. Based on recent investment levels, success rates and forecasts of commercial performance, Bain expects the current blockbuster drug model to deliver just 5% return on investment - significantly lower than the industry's risk-adjusted cost of capital. This suggests that only one out of six new drug prospects will likely deliver returns above their cost of capital, an unattractive prospect for investors.

What's needed now, the study concludes, is a new, integrated model that effectively brings together planned experimentation, aggressive use of partnerships, and eventually, a far-reaching transformation in the way most pharmaceutical companies organize to compete.   

So what happened to the blockbuster model that proved so successful in the past?

Several factors can be held accountable for driving down returns from the blockbuster model to 5%, including:

  • Declining R&D productivity - only one compound now reaches the market for every 13 discovered and placed in pre-clinical trials, compared to one for every eight between 1995 and 2000.
  • Rising costs of commercialization - as detailed above, new data reveals a significantly higher cost than previously thought for discovering, developing and launching a new drug.
  • Increasing payor influence - mounting payor price pressures and aggressive patent challenges limit the total revenue potential of the average drug.
  • Shorter exclusivity periods - increasing competition from 'me-toos' (i.e., they are easier to create, receiving FDA approval and MCO coverage) and patent protection increasingly under attack (i.e., increasing country and EU pressures, state and federal backlash against perceived pharmaceutical company exploitation, and related societal pressures

"The choice is stark," said Ashish Singh, director of Bain's Global Healthcare Practice and co-author of the study.  "With fewer resources to drive primary care products and to invest in the 'arms race' in R&D, sales and marketing, most pharmaceutical companies must take steps to proactively replace their blockbuster strategies."

However, even with stagnating blockbuster strategies and market values already shifting to smaller pharmaceutical industry players - the likes of Novo Nordisk AS, Genentech, Inc, and Forest Laboratories Inc. - the Bain study suggests few pharmaceutical 'majors' are abandoning the blockbuster model.   

"The pharmaceutical industry is a prisoner of past successes," adds Singh, "most executives are still in a state of denial."

So what should 'Big Pharma' do?

Despite its current inertia, the laws of risk and return still apply to the pharmaceutical industry.  Companies will need to experiment in order to create a new model, managing the inherent risks through a sound strategy and a thoughtful approach to execution.

No one-size-fits-all solution is likely to emerge. Instead, companies should craft a tailored model constructed from four inter-related building blocks, all of which, according to the Bain study, are being used today by niche companies to compete successfully among the giants of the industry.

1. Shift From Opportunism To Focus

Every company has had its own 'Viagra experience' - creating one blockbuster from an R&D program focused on an altogether different therapeutic area. Breakthroughs like these have led pharmaceutical companies to gear their sales and marketing investments for "the big one," and to see an opportunity cost in scaling back. Today, these approaches have simply become too expensive.
In fact, history has overemphasized these lucky breaks.  Seventy percent of all "blockbusters" have been created by companies with significant prior experience in the relevant drug category. Prior experience helps companies design better trials and launch products more effectively, which in turn delivers more compelling economic results - increased probability for launch success and dramatically lower costs of developing and commercializing a drug.

2. Use Partnerships To Manage Risk And Return

Today, 'Big Pharma' is largely based on a 'FIPCO' model, with each company running its own discovery, development, manufacturing, marketing and sales for the majority of its product pipeline and portfolio. External relationships tend to be opportunistic, but trying to do everything carries a high risk and investment.
On the other hand, partnerships can lower risk and volatility. 'Big Pharma' can learn a lesson here from the oil and movie industries, where players use partnerships aggressively, picking those elements of the business model that can build competitive advantage and entering collaborations to combine skills and diversify risk. The majority of "blockbuster" movies are brought to market by a partnership of multiple studios, and with large number of independent contractors providing support in key capabilities required (screen writers, directors, actors, special effects and so on). While the studio shares the rewards of blockbusters, it also shares the cost of failures, and shares in more profitable movies per year.
"Going it alone may no longer be practical," said Singh. "Coopetition among 'Big Pharma' could pave the way for a new industry model and continued value creation."

3. Develop A Customer-Driven Approach

Historically, the pharmaceutical industry has focused on selling pills that address the patient's disease, but don't necessarily cure their disease or meet the patient's full needs in managing their disease. The high profitability of pills suggested that incremental investment should always focus on maintaining existing brand franchises or on discovering the next blockbuster.  But the declining fortunes of the blockbuster model argue that this strategy may no longer be valid.

And pressure for better solutions is growing with increased payor and consumer influence over treatment. For the next several years, the pill itself will likely retain the most profit. But over time the industry can expect to see some shift in profits, just as profits in the computer industry shifted into ancillary products and services from the traditional boxes.

4. Develop An Integrated Business Model

Traditionally, 'Big Pharma' has organized itself along functional lines, with separate functional units for each stage of the drug development and marketing process. In such an organization, each function aims to operate efficiently, making the best use of scale, building competence and coordinating with other related functions. 

This functional structure maps well to the blockbuster model. R&D operates with a distinct focus on creating blockbusters, which are then handed off to a flexible, commercial operation for launch. Other functions work to support R&D and commercial functions effectively and efficiently, with marketing serving as the bridge.

However, as 'Big Pharma' grows to an unwieldy scale the industry would do well to look at companies such as Dell, GE and Johnson & Johnson to assess the advantages of more decentralized organization models based on discrete business units. These units are held accountable for making integrated, cross-functional, customer-focused decisions rapidly. They also push down P&L accountability, and put in place new metrics which shift the focus from mainly product revenue to business area profitability, return on investment and functional productivity.

So what's the outlook?

While each building block can create value by itself, their full value is likely to emerge when companies integrate them coherently. Experience from other industries suggests that companies should experiment in a controlled fashion before committing fully. Inevitably, there will be failures along the way. The study suggests that the key is to contain the risks within the experimental phase and to learn quickly for the next round. 

But once the experimental phase is complete and capabilities are in place, organizations must commit fully to their new direction. Executives who act now to build a new strategy constructed from tested building blocks and making best use of their companies' capabilities, stand the best chance of emerging from the coming period of change as winners. For as we've seen, smaller players, out of necessity, have moved ahead of the majors in finding successful new business models that make use of these four building blocks, and the results are beginning to show.

For more information or an interview with authors Ashish Singh or Preston Henske, please contact:  Cheryl Krauss, e-mail:  cheryl.krauss@bain.com or ph.:  646-562-7863

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