Biotech Values

[DewDiligence]

Reinventing Big Pharma

[A thoughtful discussion from the Forbes “Advisor Soapbox” column. Please see #msg-8649308 for an amusing bookend to this discussion.]

http://www.forbes.com/2005/12/01/merck-pfizer-in_mm_1201soapbox_inl.html

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By Mark Mozeson
12.01.05

Merck’s new chief executive recently announced that his first major move would involve slashing 7,000 jobs and shuttering manufacturing facilities. He also mentioned that Merck would be making “fundamental changes in its business model.” Other pharmaceutical CEOs and drug-stock investors should take note:

Merck's (nyse: MRK ) new chief isn’t a former scientist or physician or marketer. He earned his stripes in manufacturing, and he aims to restructure Merck with efficiency and return on investment in mind.
In pharma, the signs that big changes were needed have been there for years, though not much has happened. Revenue growth has been declining steadily as new products have become more costly to source, develop and bring to market. Sales and marketing costs have escalated in the face of higher competition for physician access, the proliferation of consumer channels and the growth of direct-to-consumer advertising. So why is an industry that prides itself on innovation struggling to respond to the writing on the wall?

In 1998, large U.S.-based pharmas were trading on average at about 30 time earnings, and in 2000 price-to-earnings ratios grew to an average of about 35. Today, they’re trading at 19 times trailing earnings. Industry leader Pfizer (nyse: PFE ) is trading at just over ten times earnings estimates for 2006. These declines in multiples point to a business model that is not sustainable.

There are two big-business model questions pharma is facing: “Are the days of blockbusters over?” and “Is the physician sales model viable?” Let me address these one at a time.

Is The Blockbuster Model Dead?

The answer is clearly no, but Big Pharma has to manage it better. [Agreed! The death of the blockbuster has been greatly exaggerated.] Blockbusters (or products capable of at least $1 billion in worldwide sales) are certainly harder to come by, and competitive and regulatory pressures on pricing vis-à-vis the new Medicare prescription-drug plan will make these levels of revenue harder to attain for some products. However, it is important to remember why blockbusters exist in the first place: Drugs that provide unique levels of efficacy against common forms of disease will be in high demand and command a price premium. That was true in 1995, it is true in 2005, and it will likely be true in 2015. It is difficult to believe that if a product is discovered that attacks common forms of cancer, or cures Alzheimer’s, it won’t be able to command a high premium.

Why are blockbuster products fewer and farther between? While many medical needs remain unmet, there are many that have been met. As a result, discovery operations are challenged more than ever to discover compounds with blockbuster potential. [Astonishingly, this baby-simple explanation is often overlooked.] With a stronger generic industry, pricing pressure and the proliferation of over-the-counter conversions, it is also tougher to keep a blockbuster going for a long time--even when a company discovers and develops a winner.

The bigger problem for pharma is the assumption that the revenue stream for a blockbuster is an annuity. Traditionally, a pharmaceutical company with a blockbuster begins to build an infrastructure that supports that level of revenue. They add plants and resources in support areas. They bolster research and development budgets and add sales force and marketing support. How much of that added infrastructure is warranted at a level proportionate to the increase in sales? Is it reasonable to treat the revenue increase as permanent? Is it reasonable to assume that the revenue productivity of the R&D will continue to increase in a world where there are fewer unmet medical needs?

Making these assumptions can be dangerous. For example, Pfizer has had a wonderful run with Lipitor. It is the most successful drug in history, with revenue eclipsing $11 billion in 2004 and continuing higher in 2005. Is it reasonable for Pfizer to assume the replacement product for Lipitor will be successful enough to produce revenue that will enable the franchise to grow forever at 10% to 20% a year? Given recent challenges with revenue and earnings growth, Pfizer needs to grow, or at least protect the Lipitor revenue stream. Will it take one, three or five products to replace Lipitor when it loses exclusivity or faces stronger competition from other brands or potent generics? Does anyone really know? This issue goes beyond Pfizer. Many companies in the top 15 face similar pressures and are struggling to address them.

Have many in the industry built infrastructure for a boom that will not last? While investing in a pipeline makes absolute sense, building support organizations sized to support the revenue that currently exists may not. Blockbusters have economies of scale in manufacturing, finance, human resources, information technology, marketing and even sales. In the presence of a blockbuster, margins should go up, R&D should go up and so should planning for that rainy day. With greater difficulty associated with building a blockbuster, it is more likely the rainy day will come.

Is The Sales Model In Pharma Broken?

The answer here is yes, it absolutely is. [Again, I fully agree.] Imagine you’re a physician and have patients in each one of your three examining rooms. As you move from patient to patient, there is a sales rep waiting to tell you the advantages of some product that he or she is prepared to recite from a memorized script for 30 seconds and deliver their message. You stop, you listen, you ask a question, and the sales rep responds “I will have to get back to you on that.” You realize the rep can’t answer the question, you probably couldn’t trust what they told you, and you can’t be sure what you have been told is balanced.

In the primary-care world, this happens a lot. Ninety-three percent of sales representatives’ visits last less than two minutes. Sales representatives only gain access to physicians 43% of the time. Most of the time, calls are focused on dropping off samples and getting a signature. Is that worth 10% of sales? To date, there have been few efforts that are focused on revising this model. E-detailing was an interesting idea and had some success, but it was challenged with the problem of also being an “information push” approach that was still an imposition on the physician’s schedule. What is clear is that while there a lot of these interactions, not many of them produce much value for the physician. In fact, many of these transactions are all about the delivery and receipt of the product samples. At a loaded cost of more than $150,000 per sales rep, that is a high cost for delivery of samples.

This model has proliferated to the point where there are about 100,000 sales reps in the U.S. With reps, promotional advertising and everything else, there is a barrage of attention directed at physicians. The belief is that if you try a different way, you risk losing everything. Further, the accepted practice is to “inundate the physicians with information, and you will be successful.”

One has to challenge these assumptions. First, does a busy physician react to quantity or quality? Is there a way to reach a physician on their schedule and, if so, will that interaction be better? Are there ways to understand physician needs in advance and address those needs, rather than recite the same overused sales pitch? We say, of course there are. There are many ways to do all of this. At some point, with the existing process, the information becomes noise, and the innovator of the more efficient method of reaching physicians will realize value. It also doesn’t require a complete and instant abandonment of the existing model.
Physicians are like all other people: They retain knowledge better when it relates to solving a problem that exists at the moment. The typical sales rep provides them with information when they don’t necessarily need or want it. In fact, they are focused on other problems and not interested in learning about drug interactions and efficacy advantages.

Big Pharma, however, invests heavily in product-information call centers for patients and physicians. They have highly educated, well-trained people to address problems. When they are called, there is a clear demand pull for information and service. It would appear the concept of “demand pull” will lead to higher levels of information retention and possibly a higher degree of customer loyalty to the representative on the phone. This may be a model that can be leveraged to absorb some of the load, reduce overall cost and improve the quality of the results.

The other unfortunate reality of the sales and marketing game in pharma is that for a specific product a multitude of promotional and sales tactics are employed simultaneously--a dozen, two dozen at a time--sometimes more. Understanding which of those programs are most effective at driving prescription volume, however, does not exist. Basically, the only reliable measures of return are at the aggregate level, which doesn’t tell you very much.

Prescriptions For The Future.

While there are some longstanding problems that need to be addressed, and some new ones to consider, the sky is not falling for the pharmaceutical industry. Just think of the percentage of visits to a doctor that result in a prescription as part of the cure for whatever ill a patient has at the time. Also, no firm of significance is in danger of going out of business anytime soon, including Merck, where liability exposure attributable to Vioxx could be significant.

Demographics are the best thing the industry has going for it moving forward. People are living longer, and the number of people over the age of 50 (highest consuming age group for pharmaceuticals) is going up. Data suggest that there are 88 million people today in the U.S. over the age of 50, a number that will grow to 118 million in 2020. Demand for pharmaceuticals should be on the rise over the next 15 years. Margins remain high, balance sheets are strong and growth, while modest, is still positive.

Pharmaceutical executives have to be more balanced in their approach to managing their businesses. What was easy to do five or ten years ago is getting harder to do today. Discovery of innovative compounds and building blockbusters is harder to do. A sales model that is exorbitantly expensive and marginally productive cannot exist ad infinitum. Industry executives must also do better job of managing costs. Decisions made about spending in the name of securing revenue have to be more rigorously scrutinized. The days of extensive and cumbersome supply-chain networks have to come to an end. Why do firms need 30 or more facilities to support a base of business of $15 billion that is concentrated in ten to 15 major products? It doesn’t make sense.

Merck’s recent actions suggests there is urgency, but not necessarily a crisis yet. They are resisting the arguments to wait and are choosing to act now. Who else will follow that lead?

[Mark Mozeson is life sciences practice leader at Archstone Consulting.]
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