The Pharmaceutical Market Outlook to 2015.PDF

H E A L T H C A R E

The Pharmaceutical Market Outlook to 2015Implementing innovative, long-term strategies for sustainablefuture growth

By Gayle Hamilton

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Gayle Hamilton

Gayle Hamilton is an analyst within the healthcare function of Business Insights, and

has written previous titles on the Diabetes, Antivirals and Vaccines markets, as well as

Anti-Counterfeiting Strategies.

Gayle also has extensive R&D experience in the pharmaceutical and biotech industries,

holding positions at Celltech (now part of UCB), Genzyme Corporation in the US, and

Procter & Gamble. Previous to this Gayle graduated with a Masters degree in

Biochemical Engineering from University College London.

Copyright © 2005 Business Insights Ltd This Management Report is published by Business Insights Ltd. All rights reserved.Reproduction or redistribution of this Management Report in any form for anypurpose is expressly prohibited without the prior consent of Business Insights Ltd. The views expressed in this Management Report are those of the publisher, not ofBusiness Insights. Business Insights Ltd accepts no liability for the accuracy orcompleteness of the information, advice or comment contained in this ManagementReport nor for any actions taken in reliance thereon. While information, advice or comment is believed to be correct at the time ofpublication, no responsibility can be accepted by Business Insights Ltd for its completeness or accuracy.

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Table of Contents

The Pharmaceutical Market Outlook to 2015

Executive summary 10

Challenges and resistors to growth 10 Failing short-term strategies 11 Future strategies to expand the customer base 12 Future product portfolio strategies 13 Future growth and alliance strategies 14 Competitive company strategy analysis 15

Chapter 1 Challenges and resistors to growth 18

Summary 18 Introduction 19 New challenges faced by the industry in 2004 19 Full clinical trial data disclosure 19 Accusations of industry and FDA collusion 20 Major product recalls 20 Plummeting stock values 21 Continuing challenges 22 Weakening product pipelines 23 Soaring costs of R&D 25 Increasing generic competition and parallel trade 25 Increased cost containment 29 Opportunities in the pharmaceutical marketplace 31

Chapter 2 Failing short-term strategies 34

Summary 34 Introduction 35

iv

Reliance on US revenues 36 Long-term sustainability 38 Increasing sales & marketing spend 39 Long-term sustainability 40 Reliance on blockbusters and me-too drugs 41 Long-term sustainability 42 In-licensing of late-stage products 42 Long-term sustainability 44 Mega-mergers 45 Long-term sustainability 47 Focus on long-term sustainable growth 49 Conclusions 50

Future strategies to expand the customer base 50 Future product portfolio strategies 50 Future growth and alliance strategies 50

Chapter 3 Future strategies to expand the customer base 52

Summary 52 Introduction 53 Expansion into emerging geographical markets 53 Global population demographics 53 Geographical pharmaceutical markets 54 Chinese market entry 55

Case Study: Pfizer expansion in China 56 Targeting growing patient populations 58 Aligning R&D with commercial business functions 58 The ageing population 59

Age demographic trends 59 Healthcare spending by age 60 Age-related diseases 61 The market for age-related diseases 62

The obese population 62 Obesity epidemiology 62 Obesity-related diseases 64 The market for obesity-related diseases 64

Chapter 4 Future product portfolio strategies 66

Summary 66

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Introduction 67 Alternatives to a mega-blockbuster strategy 67 Small molecule drugs versus biological therapies 69 Sector performance 71 Sector growth to 2015 73 The biotech sector 74

Targeted biological therapeutics 75 Case study: Herceptin – a targeted therapeutic for breast cancer 76 Market growth to 2015 77

The generics sector 78 Case study: Sandoz (Novartis) focusing on biogenerics 81 Market growth to 2015 81

Big Pharma involvement in biotech and generics 82 Big Pharma involvement in biotech 82

Successful involvements 83 Investment in the biotech sector 84

Big Pharma involvement in generics 84 Unsuccessful involvements 84 Successful involvements 85 Competitive advantage in the generics sector 86 Investing in the generics sector 86

Chapter 5 Future growth and alliance strategies 90

Summary 90 Introduction 91 Alliances between industry sectors 92 The issue of scale 93 Scale in R&D operations 94 Scale in sales and marketing operations 95 Strategies beyond mega-mergers 96 Re-organization of internal R&D 97 Exploiting external R&D resources 98 Alliance deals 99 Collaborative alliances 100 Technology licensing 100 Buyer-supplier relationships 101 Evaluations 101 Mergers and acquisitions (M&A) 101 Forecast to 2015 102 The move towards networked pharma 104

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Chapter 6 Comparative company strategy analysis 108

Summary 108 Introduction 109 Pfizer 110 Growth and alliance strategy 110 Geographic expansion 111 GlaxoSmithKline 111 Growth and alliance strategy 111 Sanofi-Aventis 114 Geographic expansion 115 Investment in generics 115 Growth and alliance strategy 115 Novartis 116 Investment in generics 117 Growth and alliance strategy 118 Roche 119 Growth and alliance strategy 119 Investment in biotech 121 UCB 122 Investment in biotech 122 Growth and alliance strategy 122 Conclusions 125

Chapter 7 Appendix 128

Primary research methodology 128 Index 130

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List of Figures Figure 1.1: Challenges for pharmaceutical sales and marketing 23 Figure 1.2: Number and time of NME approvals, 1995-2004 24 Figure 1.3: Total value of US drugs going off patent per year, and impact on revenues of generic

copies, 2004-2010 26 Figure 1.4: US patent expiries for top ten selling drugs, 2004 27 Figure 1.5: Pharmaceutical expenditure as a share of total healthcare expenditure in 2002 30 Figure 1.6: Pharmaceutical market drivers, 2004 31 Figure 2.7: Short-term strategies for delivery of revenue growth 35 Figure 2.8: Average branded drug prices in selected countries compared with the US, 2003 36 Figure 2.9: Pharmaceutical sales by region/country, 2004 37 Figure 2.10: Years of marketing exclusivity, 1968-1995 39 Figure 2.11: Breakdown of projects by clinical phase and source of drug, March 2004 44 Figure 2.12: M&A/restructuring activity, 1994-2004 46 Figure 2.13: Change in market shares of mega-merged & non-mega-merged companies, 1995-2002

48 Figure 3.14: Pharmaceutical sales and growth rates by region/country, 2004 55 Figure 3.15: Annual population growth rates by age group and region, 2000-50 59 Figure 3.16: Healthcare spend in the US by age group, 1985 & 2000 60 Figure 3.17: Prevalence of obese and overweight adults in US, 1976-2000 63 Figure 4.18: Product positioning in the healthcare marketplace 68 Figure 4.19: US approvals of small molecule drugs and biological therapies, 1994-2003 70 Figure 4.20: Growth rates in the US by sector, 2003-2004 72 Figure 4.21: Industry prediction of future sector annual growth rates to 2015 73 Figure 4.22: Comparative approval success rates of US biopharmaceutical products and drugs 78 Figure 4.23: US generic drug approvals, 2000-2005 80 Figure 4.24: Biotech sales of leading players, 2003 82 Figure 5.25: The rate of mega-mergers to 2015 91 Figure 5.26: Alliances between industry sectors, 2004-2015 92 Figure 5.27: R&D productivity of the top 39 pharma & biotech companies, 2002 94 Figure 5.28: Sales vs. S,G&A, 2004 96 Figure 5.29: Impact of alliances on future drug development 99 Figure 5.30: Growth and alliance strategies to increase R&D productivity, 2004-2015 103 Figure 5.31: Big Pharma should concentrate on core competencies 104 Figure 5.32: Vision of networked pharma in 2015 105 Figure 6.33: R&D, S,G&A and sales, 2004 109 Figure 6.34: GSK Centres of Excellence in Drug Development (CEDD) 112 Figure 6.35: GSK’s R&D network 114 Figure 6.36: Roche’s R&D network 120 Figure 6.37: Biologic medicine approvals by major indication, 2003 121 Figure 6.38: UCB R&D network 124 Figure 7.39: Survey respondents by type of company 128 Figure 7.40: Survey respondents by job function 129

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List of Tables Table 1.1: Performance of US, Euro, UK and Japanese pharma stocks, 2002-2004 22 Table 1.2: Total pharmaceutical R&D expenditure ($bn), 1980-2004 25 Table 2.1: S,G&A expenditure of top 50 pharmaceutical companies, 1999-2003 40 Table 2.2: Cost savings achieved on past mergers 47 Table 3.3: Most common age-related diseases 61 Table 3.4: Global ageing diseases market, 2003 62 Table 3.5: Obesity-related diseases 64 Table 3.6: Global obesity-related diseases market, 2003 64 Table 4.7: Sales in the global and US markets by sector, 2004 72 Table 4.8: Top global biotech products, 2004 75 Table 6.9: Novartis sales by division, 2003-2004 116

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Executive summary

10

Executive summary

Challenges and resistors to growth

2004 was a particularly difficult year for the pharmaceutical industry. There were

demands for full clinical trial data disclosure, accusations of collusion between the

industry and the FDA to knowingly compromise drug safety, major product recalls

in Vioxx and Celebrex, and plummeting stock values.

As well as facing difficult challenges in 2004, the pharmaceutical industry

continues to experience problems in all aspects of the business. In research and

development companies have weakening product pipelines and soaring costs, while

in sales and marketing companies are facing increasing generic competition and

mounting price pressures.

The total number of new molecular entity (NME) approvals per annum has shown a

general decline since a 1996 peak of 53 NME approvals to just 17 in 2002.

However, 2003 and 2004 witnessed an upturn in NME approvals to 30 in 2004 (not

including the 6 biologic license applications (BLAs) for therapeutic products

transferred from the CBER to CDER), although as yet it is too early to say whether

this is a trend that will continue in the next 5 to 10 years.

An exclusive survey conducted for this report reveals that generic competition

(28% of respondents) and price containment (24% of respondents) are the biggest

challenges currently facing pharmaceutical sales and marketing teams.

Despite the recent problems that the pharmaceutical industry has faced, its

continued growth – although somewhat slower than in the past – is evidence of

underlying demand. This demand is driven by unmet needs for medications,

innovation in biotechnology, the increasing age demographic, and emerging

geographical markets such as China and India.

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Failing short-term strategies

Favoring long-term strategies over short-term solutions designed to meet investor

expectations for near-term growth is one fundamental step that pharmaceutical

companies can take in order to improve R&D productivity.

Since pharmaceutical companies are subject to price constrictions in major markets

outside of the US, then drug prices in the US are maximized in order that high

levels of R&D expenditure can be recouped. This is unlikely to be sustainable in

the long-term with price disparity a key political issue in the US.

Lack of innovation, reduced marketing exclusivity and the resulting increased focus

on lifecycle management has meant sales, general and administrative (S,G&A)

expenditure has rocketed to an average of $140.5m (32.7% of sales) in 2003, with

leading pharmaceutical company, Pfizer, now employing approximately 37,000

sales reps worldwide.

The reliance of pharmaceutical companies on a small number of blockbuster drugs

is increasingly a risky strategy, as shown by the withdrawal of Merck’s Vioxx. In

addition, the reliance on blockbuster drugs causes a focus on a small number of

large disease areas that are overcrowded with too many ‘me-too’ drugs.

Despite the in-licensing of late-stage products having become a key strategy for

pharmaceutical companies in the last decade, this is not sustainable in the long-

term. It is precisely because of the increase in the number of late-stage licensing

deals that there is now a dearth of these products available to in-license.

Additionally, the cost of late-stage licensing has soared, meaning that it is not as

commercially attractive as it has been in the past.

Despite mega-mergers being one of the most frequent strategic moves seen in the

pharmaceutical industry during the past decade, it has not proved to be a valuable

long-term strategy. Indeed, there is little evidence of a positive correlation between

company size and productivity or innovation, despite the theoretical potential for

greater efficiency or more successful product development.

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Future strategies to expand the customer base

The major opportunities that exist for pharmaceutical companies to expand their

customer base are in the emerging geographical markets of China, India and

Eastern Europe, and in growing ageing and obese populations.

The highest growth rates in 2004 occurred in the smaller revenue markets of China,

Latin America, and the Rest of Europe. China recorded the highest growth rate,

expanding by 28% from $7.4bn in 2003 to $9.5bn in 2004.

Although expansion into China represents a significant growth opportunity, it will

take pharmaceutical companies several years, and some investment, to see returns

to match the potential that the market holds. China is therefore a market requiring

long-term investment to achieve long-term profit, rather than a market that is going

to yield short-term gains.

Several companies in recent years have indeed identified China as an important

growth strategy and have begun to invest heavily in the region, for example Pfizer,

Novartis, AstraZeneca and Roche.

Successful companies in 2015 will be those that can accurately identify the disease

areas that will dominate the market in the future. Closer collaboration between

R&D and commercial functions will ensure that resources are used on the products

that have the best chance of success on the market, and return on investment is

maximized.

The global population of seniors and obese patients are rising rapidly and this

presents enormous growth opportunities for pharmaceutical companies as age and

obesity are risk factors for cardiovascular diseases, certain types of cancer, diabetes

and arthritis. The global market for age-related diseases is estimated at $143bn, and

for obesity-related diseases $154bn, however as age and obesity are not the only

risk factors for these diseases then not all of the sales from these diseases can be

attributed to age and obesity.

13

Future product portfolio strategies

The pharmaceutical industry has traditionally pursued the development of small

molecule drugs, and this approach has generated the “mega-blockbusters” that have

dominated the industry. However, in recent years, the decoding of the human

genome and the resulting plethora of targets for new drugs has created new

opportunities for growth for biological therapies.

In 2004 the global pharmaceutical market generated sales of $550bn, 8.1%

($44.3bn) of which comprised biotech products, and 11.3% ($62bn) of generic

products.

Biotech is currently the fastest growing sector in the drug industry. The US biotech

market experienced growth of 17% from 2003 to 2004, which was almost twice the

overall drug market growth rate for the second year running.

Pharma companies that are looking to move into the biotech sector need to take

steps designed to maintain the small-scale and entrepreneurial spirit of biotech

companies, as Roche has with its R&D spin-off companies and equity investments,

and as UCB has with its acquisition of biotech company Celltech, the R&D

function of which remains largely independent of the main UCB research

organization.

The generics industry has experienced significant growth over the last few years.

However 2004 was a difficult year for generics companies due to price erosion and

increased levels of competition.

The defining criterion for successful involvement of pharmaceutical companies in

the generics sector has been keeping distance between the branded pharmaceutical

parent company and the generic subsidiary because the two types of company

operate in such different ways.

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Future growth and alliance strategies

Despite the lack of sustainability of mega-mergers, the majority of industry

respondents (83%) to a Business Insights survey exclusively conducted for this

report indicated that they expected the rate of mega-mergers would stay roughly the

same, or that there would be only a slight increase or decrease in the next 10 years.

The number of alliances formed between pharma and biotech companies are likely

to show the greatest increase to 2015, according to the survey. Respondents also

hinted at increased consolidation within the biotech industry.

In order to address the negative relationship of scale versus R&D productivity, Big

Pharma has two fundamental options: to restructure internal R&D operations to

overcome scale deficiencies; or to exploit external R&D resources through

alliances with companies not burdened with the deficiencies of scale.

In an analysis of 418 deals formed during a 19-month period (2002-3004)

collaborative alliances were the most common deal type for accessing drug

discovery technology and capability, accounting for 62% (259) of all deals.

With Big Pharma companies increasingly looking to external collaborations to

source new products to boost ailing pipelines, the reality of networked or ‘virtual’

pharmaceutical companies is moving closer, at least in terms of the R&D

organization.

Compared to the industry as it stands today, by 2015 the peripheral interests of

individual companies will be substantially reduced. Big Pharma will focus more on

its core competencies of sales and marketing which are enhanced by scale of

operation, and will likely grow these functions organically or through acquisitions.

This central core of key competencies will likely be supported by an R&D

organization consisting of multiple long-term relationships with small external

R&D companies.

15

Competitive company strategy analysis

The sheer size that Pfizer has grown to limits its growth potential, with Pfizer

needing to generate several billion dollars of added sales in 2005, or cut costs by

the same amount, to achieve double-digit growth. The geographic expansion of its

operations into emerging markets, particularly China, has been identified as one of

its major growth drivers.

GSK has sought to counter its poor R&D productivity in recent years by setting up

seven Centres of Excellence in Drug Development (CEDD) in an attempt to foster

the entrepreneurial culture of small biotech players within its R&D operations.

Each of the CEDDs is operated as an autonomous, accountable business with a

specific therapeutic focus.

One of the major strategic shifts for the newly merged Sanofi-Aventis was the

creation of a single generics business called Winthrop Pharmaceuticals in January

2005. Sanofi-Aventis has fairly ambitious plans for Winthrop to extend generics

operations to fifteen or more countries by the end of 2006, and become a major

player in the European generics market.

Like many of its competitors in the generics industry, Novartis’ generics business,

Sandoz, has shown slow growth in 2004 due to declining prices and increased

competition. As a result, Sandoz is aiming to readjust its focus to difficult-to-make

generics and biogenerics.

Roche encompasses many of the strategies cited in this report as being essential to

success in the next decade. The company is forecast to become one of the leaders in

the pharmaceutical industry by 2015.

During 2004 and 2005 UCB transformed from a global pharmaceutical and surface

specialties company to a focused biopharmaceutical company. This transformation

was achieved by the $2.5bn acquisition of leading UK biotechnology leader

Celltech in May 2004, followed in March 2005 by the $1.8bn sale of the surface

specialties business to Cytec Industries.

16

17

CHAPTER 1

Challenges and resistors to growth

18

Chapter 1 Challenges and resistors to growth

Summary

2004 was a particularly difficult year for the pharmaceutical industry. There were demands for full clinical trial data disclosure, accusations of collusion between the industry and the FDA to knowingly compromise drug safety, major product recalls in Vioxx and Celebrex, and plummeting stock values.

As well as facing difficult challenges in 2004, the pharmaceutical industry continues to experience problems in all aspects of the business. In research and development companies have weakening product pipelines and soaring costs, while in sales and marketing companies are facing increasing generic competition and mounting price pressures.

The total number of new molecular entity (NME) approvals per annum has shown a general decline since a 1996 peak of 53 NME approvals to just 17 in 2002. However, 2003 and 2004 witnessed an upturn in NME approvals to 30 in 2004 (not including the 6 biologic license applications (BLAs) for therapeutic products transferred from the CBER to CDER), although as yet it is too early to say whether this is a trend that will continue in the next 5 to 10 years.

An exclusive survey conducted for this report reveals that generic competition (28% of respondents) and price containment (24% of respondents) are the biggest challenges currently facing pharmaceutical sales and marketing teams.

Despite the recent problems that the pharmaceutical industry has faced, its continued growth – although somewhat slower than in the past – is evidence of underlying demand. This demand is driven by unmet needs for medications, innovation in biotechnology, the increasing age demographic, and emerging geographical markets such as China and India.

19

Introduction

Business Insight’s Pharmaceutical Market Outlook to 2015 report outlines, in Chapter

1, the challenging marketing conditions that have caused the slowdown of the double-

digit growth that the pharmaceutical industry experienced during the 1990s. During the

latter half of that decade and the first half of this decade, as R&D productivity levels

have dropped, the pharmaceutical industry has employed a series of short-term fixes in

an attempt to meet shareholders’ expectations of continued double-digit growth, as

outlined in Chapter 2 of the report. However, many of these measures are proving

unsustainable and as a result there are a number of fundamental changes in strategy that

are being undertaken (or still need to be undertaken) by companies to address the slow-

down in growth. These changes can be categorized in terms of the customer base,

product portfolio and growth strategy, which form Chapters 3, 4 and 5 of the report

respectively, as well as a comparative company strategy analysis in Chapter 6.

New challenges faced by the industry in 2004

2004 was a particularly difficult year for the pharmaceutical industry. There were

demands for full clinical trial data disclosure, accusations of collusion between the

industry and the FDA to knowingly compromise drug safety, major product recalls in

Vioxx and Celebrex, and plummeting stock values.

Full clinical trial data disclosure

During 2004 there was rising concern over the lack of transparency of negative clinical

trial data, and as a result the public, government, and other industry stakeholders, have

been demanding that both positive and negative clinical trial data is made public.

In June 2004 New York State Attorney General Eliot Spitzer filed a lawsuit against

GlaxoSmithKline for repeated and persistent fraud in not releasing negative trial data

20

on its antidepressant paroxetine (Seroxat/Paxil), which indicated that the treatment

could be ineffective and unsafe in treating children and adolescents with depression.

This lawsuit was closely followed by the American Medical Association (AMA)

lobbying for a federal database that would be accessible to clinicians and patients, and

which would contain information on all clinical trials.

This concern over negative clinical trial data has caused further damage to the image

and reputation of the pharmaceutical industry, which was already suffering from the

fall-out of negative publicity surrounding the high price of drugs, availability of HIV

medicines, and parallel importation.

Accusations of industry and FDA collusion

The reputation of the industry was further damaged in 2004 following the October

2004 FDA warning of the increased risk of suicide amongst children prescribed

antidepressants. It emerged that the FDA had been made aware of concerns over GSK's

antidepressant Paxil over a year previously, and 10 months previously British

regulators warned physicians not to use the drugs for children. Furthermore, a scientist

within the FDA had warned the public about the drug’s risks eight months before an

official warning was issued.

Major product recalls

On September 30th 2004 Merck & Co. voluntarily withdrew Vioxx (rofecoxib), its

arthritis and acute pain medication initially launched in 1999. The company’s decision

was taken after a three-year trial was halted early because there was shown to be an

increased relative risk for confirmed cardiovascular events, such as heart attack and

stroke, beginning after 18 months of treatment in the patients taking Vioxx compared

to those taking placebo. Not only did this blockbuster withdrawal cause added damage

to the public image of the pharmaceutical industry and Merck & Co. in particular, but

also resulted in $2.5bn of lost revenue for Merck & Co, about 11% of the company’s

sales in 2003, and a loss of 26.2% of shareholder value.

21

Following the withdrawal, criticisms were raised of the FDA and the current regulatory

process as to why this increased risk of heart attacks was not uncovered prior to

approval. The safety of other drugs in the COX-2 inhibitor class, Celebrex and Bextra,

were also questioned, and Public Citizen claimed that safety data from a 1999 Celebrex

study in Alzheimer's patients that showed an increased cardiovascular risk were

“undisclosed”. Despite all the adverse publicity and cardiovascular risks, in February

2005 an FDA advisory panel voted that Celebrex and Bextra should remain on the

market, and that Merck & Co. could reintroduce Vioxx to the market, albeit with black

box warnings. However, in April 2005, after a request from the FDA, Pfizer withdrew

Bextra from the market because of an increased risk of rare but serious skin reactions.

In light of these questions regarding the safety of major drugs, the drug regulatory

process is likely to become even tighter, with drugs requiring more extensive trialing

and thus increased cost.

Plummeting stock values

The events of the 2003/4 have caused pharmaceutical stock values to plummet, as the

industry struggles against continual reports of serious problems with well-known

drugs, in particular antidepressants and COX-2 inhibitors. At the same time R&D

productivity is falling as the industry struggles to find new medicines.

Deutsche Bank reported that during 2004 US Pharma stocks declined 11.2% in absolute

terms, and 18.1% relative terms compared to the S&P 500, as shown in Table 1.1. UK

Pharma stocks showed a similarly poor performance with an absolute performance of -

13.2% and a relative performance versus the FT Index of -19.9%. Europharm stocks

faired better although still experienced a slight decline, while the Japanese Pharma

industry was the only one in the major markets to show growth, and it also performed

better than other industries listed in the Toppix.

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Table 1.1: Performance of US, Euro, UK and Japanese pharma stocks, 2002-2004

Region Relative Performance % Absolute Performance % 2004 2003 2002 2004 2003 2002 US Pharma to S&P 500 -18.1 -15.8 +1.6 -11.2 +6.4 -21.6 EuroPharm vs Eurotop300 -8.1 -6.1 +5.3 -0.5 +5.0 -29.5 UK Pharma to FT All Share -19.9 -3.2 -7.7 -13.2 +12.9 -31.2 Japan Pharma to Toppix +6.5 -18.3 -0.1 +17.3 +1.1 -19.8

Source: Deutsche Bank estimates and company data Business Insights Ltd

Continuing challenges

As well as facing difficult challenges in 2004, the pharmaceutical industry continues to

experience problems in all aspects of the business. In research and development

companies have weakening product pipelines and soaring costs, while in sales and

marketing companies are facing increasing generic competition and mounting price

pressures.

Figure 1.1 shows the results of a Business Insights survey of 300 senior industry

executives and external industry observers, where respondents were asked their opinion

on the factors that were most and least limiting to pharmaceutical sales and marketing

performance. Although there was relatively mixed opinion, the survey respondents

believed that generic competition (28%) and price containment (24%) where the

biggest challenges facing pharmaceutical sales and marketing teams.

The counterfeiting of drugs (3%) and parallel importation (4%) were clearly not

thought to be major issues affecting sales and marketing performance, and in fact 31%

of respondents surveyed believed counterfeiting to be the least restrictive issue

affecting performance, with 18% answering parallel importation. With regard to poor

product differentiation and increased competition from me-too drugs the opinion was

mixed as to the effect of these issues on sales and marketing.

23

Figure 1.1: Challenges for pharmaceutical sales and marketing

Price containment

24%

Parallel importation4%

Generic competition29%

Counterf eiting of drugs

3%

Poor product diff erentiation

24%

Increased competition f rom "me-too" drugs

16%

MostChallenging

factor

Price containment

12%

Parallel importation

18%

Generic competition

7%


31%


18%


14%

Leastchallenging

factor

Price containment

24%




3%


24%


16%

MostChallenging

factor

Price containment

24%




3%


24%


16%

Price containment

24%




3%


24%


16%

MostChallenging

factor

Price containment

12%


18%

Generic competition

7%


31%


18%


14%

Leastchallenging

factor

Price containment

12%


18%

Generic competition

7%


31%


18%


14%

Price containment

12%


18%

Generic competition

7%


31%


18%


14%

Leastchallenging

factor

Source: Business Insights Primary Research Survey Business Insights Ltd

Weakening product pipelines

R&D productivity continues to be a major issue for pharma companies. This is

illustrated in Figure 1.2, which clearly shows a decline in overall drug approvals over

the period 1995-2004. The total number of approvals per annum has shown a general

decline since a 1996 peak of 53 NME approvals to just 17 in 2002. However, 2003 and

2004 witnessed an upturn in NME approvals to 30 in 2004 (not including the 6 BLAs

24

for therapeutic products transferred from the Center for Biologics Evaluation and

Research (CBER) to Center of Drug Evaluation and Research (CDER)), although as

yet it is too early to say whether this is a trend that will continue in the next 5 to 10

years.

The upward trend since 2002 has primarily consisted of more priority approvals, which

take around 5-6 months to approve. However, as more products are given priority

approval, the time taken for standard approval appears to suffer. In 2004 a standard

approval took a median time of almost 25 months.

Figure 1.2: Number and time of NME approvals, 1995-2004

0

10

20

30

40

50

60

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004Year

Num

ber o

f app

rova

ls

0

5

10

15

20

25

30

Med

ian

tota

l app

rova

l tim

e (m

onth

s)

Priority: Number of approvals Standard: Number of approvalsPriority: Median total approval time Standard: Median total approval time

0

10

20

30

40

50

60

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004Year

Num

ber o

f app

rova

ls

0

5

10

15

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25

30

Med

ian

tota

l app

rova

l tim

e (m

onth

s)M

edia

n to

tal a

ppro

val t

ime

(mon

ths)

Priority: Number of approvals Standard: Number of approvalsPriority: Median total approval time Standard: Median total approval time

2004 figures do not include new BLAs for therapeutic biologic products transferred from CBER to CDER

Source: FDA Business Insights Ltd

As product pipelines weaken and there are less products progressing through clinical

trials and onto the market, additional pressure has been put on the sales and marketing

function to generate improved sales from each approved product in order to make up

25

for the short fall in approvals. Thus, in recent years lifecycle management has become

a critical function for pharmaceutical companies.

Soaring costs of R&D

At the same time as R&D productivity levels have slowed, R&D expenditures in the

pharmaceutical industry have continued to increase. The R&D spend per new drug

approval increased from $611m in 1994 to $949m in 2003, equivalent to a compound

annual growth rate (CAGR) of 5.0%. According to the industry group Pharmaceutical

Research and Manufacturers of America (PhRMA), R&D expenditures have increased

significantly year-on-year for the last decade. Total R&D spend has increased from

$1,977m in 1980 to $38,794m in 2004 representing a CAGR of 13.2%. Table 1.2

shows trends in R&D expenditure within the US and abroad by PhRMA members

between 1980 and 2004.

Table 1.2: Total pharmaceutical R&D expenditure ($bn), 1980-2004 1980 1985 1990 1995 2000 2001 2002 2003 2004e US 1.5 3.4 6.8 11.9 21.4 23.5 25.7 27.1 30.6 Non-US 0.4 0.7 1.6 3.3 4.7 6.3 5.3 7.4 8.2 Total 2.0 4.1 8.4 15.2 26.0 29.8 31.0 34.5 38.8 e = estimated

Source: PhRMA Annual Membership Survey 2005 Business Insights Ltd

Increasing generic competition and parallel trade

Generic substitution and parallel imports have become central policies in the drive for

healthcare cost containment. National reimbursement and insurance bodies are

increasingly providing physicians and pharmacists with incentives for prescribing

cheaper generic drugs. Incentives for prescribing and dispensing more expensive drugs,

such as the Japanese yakkasa system have been gradually phased out. Products with an

estimated $100bn worth of revenues will have lost patent protection between 2001 and

2005. This has led to increased competition from generic companies, putting pressure

26

on revenues both pre- and post-patent expiry. As a result, pharmaceutical companies

have focused on maximizing their sales force effectiveness and lifecycle management

in order to maintain market share.

Figure 1.3: Total value of US drugs going off patent per year, and impact on revenues of generic copies, 2004-2010

0

2

4

6

8

10

12

14

16

18

20

2004 2005 2006 2007 2008 2009 2010

Year

Sale

s re

venu

e ba

sed

on 2

003

sale

s ($

bn)

No generic copies 1 generic copy 2+ generic copies

0

2

4

6

8

10

12

14

16

18

20

2004 2005 2006 2007 2008 2009 2010

Year

Sale

s re

venu

e ba

sed

on 2

003

sale

s ($

bn)

No generic copies 1 generic copy 2+ generic copies

Source: Global Generic Drug Stocks, Citigroup –Smith Barney, September 21 2004; Business Insights Business Insights Ltd

Figure 1.3 demonstrates the high value of branded products that will be exposed to

generic competition until 2010. In 2005 approximately $15bn (based on 2003 sales) of

products will lose patent protection. This value is significant since branded

pharmaceuticals lose between 15% and 30% of their market share after the first generic

version reaches the market, and then between 75% and 90% on subsequent generic

launches. Thus, in 2005 if one generic drug is launched for each branded product

coming off patent then the market will lose between $2.1bn and $4.2bn, and if two or

more generic copies are launched then the market will drop between $10.5bn and

$12.6bn.

27

The launch of generic copies forces the price of the branded pharmaceutical products to

be heavily discounted – up to 90% in some cases. With pharma companies increasingly

relying on lifecycle management of existing products to maintain revenues in light of

R&D productivity decline, then this shows the impact of generics to be significant,

having a direct and marked impact on company revenue, profit and value.

Figure 1.4: US patent expiries for top ten selling drugs, 2004

0

10

20

30

40

50

60

2004

Sal

es

2005

2006

2007

2008

2009

2010

2011

2004

glo

bal s

ales

($bn

) EffexorPrevacidProcritSeretide/AdvairNorvascZyprexaNexiumPlavixZocorLipitor

Source: IMS; FDA Orange Book Business Insights Ltd

Figure 1.4 shows the impact of US patent expiries on the top ten selling drugs in 2004.

Procrit lost patent protection in 2004, with Prevacid and Nexium losing patent

protection in 2005. Second highest selling drug in 2004, Zocor, will lose patent

protection in 2006 with Norvasc losing patent protection in 2007. Effexor and

Seretide/Advair both lose patent protection in 2008. Leading selling drug 2004, Lipitor,

loses patent protection in 2010 with Plavix and Zyprexa losing patent protection in

2011. However, it should be noted that the US patent life for Plavix is currently being

challenged by generics companies and patent protection might be lost as early as 2005.

The pharmaceutical industry will experience a significant reduction in the revenues

associated with these blockbuster products as generic competition captures market

28

share. As a result, given that R&D productivity is low and the cost of developing new

drugs at an all time high, the pharmaceutical industry faces considerable hurdles with

respect to maintaining revenue and earnings growth in the future.

In addition to increasing productivity levels while maintaining efficiency of R&D

expenditure, pharmaceutical companies must also ensure that they maximize the return

on investment for those products that reach the market. However, according to PhRMA,

only 3 of every 10 marketed prescription drugs produce revenues that match or exceed

average R&D costs.

Parallel trade is another factor challenging pharmaceutical sales and marketing

performance, although not to the same extent as generics. Legislation promoting open

trade between EU member countries and more tacit regulations directly promoting

parallel trade in pharmaceuticals have resulted in revenue transfers between

pharmaceutical companies and healthcare payers and providers in high price markets.

The size of the parallel import market is increasing and in some countries, such as the

UK, the share of the total market is considerable (in 2002 UK parallel imports

amounted to €518mi). Legislation in Germany requires pharmacists to source at least

5.5% of the medicines they dispense from outside markets. While parallel imports tend

not to affect the unit sales for pharmaceuticals they do have a significant impact on

pricing and revenues. Better-targeted sales efforts and justified pricing promotions are

required to mitigate the effects of parallel trade.

i The Economic Impact of Pharmaceutical Parallel Trade in European Union Member States: A

Stakeholder Analysis. Panos Kanavos, Joan Costa-I-Font, Sherry Merkur, Marin Gemmill. LSE Health

and Social Care, London School of Economics and Political Science (January 2004).

29

Increased cost containment

Rising cost containment measures have resulted from the increased demands on

national healthcare payers and providers brought about by an aging population and the

subsequent increase in those suffering from acute and chronic conditions. At the same

time national budget deficits in countries such as Japan have further enforced the need

to limit healthcare expenditure. A range of cost containment policies are used across

different national markets, including pricing regulations, strict reimbursement

formularies and a growth in both generic substitution and parallel importing. These

measures have resulted in increased pressure on pharmaceutical companies to reduce

their prices and consequently either drive unit sales or cut costs to maintain profit

margins.

At the same time as the pharmaceutical industry faces pressure to maintain revenue and

earnings growth, healthcare providers face cost containment pressures of their own.

Over the past decade, there has been significant growth in global healthcare

expenditure, with healthcare representing a growing share of gross domestic product

(GDP) in developed nations. In June 2004, the Organization for Economic Co-

operation and Development (OECD) published data demonstrating that the annual

increase in per capita spending on healthcare across OECD countries has outstripped

overall economic growth per capita by approximately 70% between 1997 and 2002.

The key levers of cost containment set the current price optimization climate, which

involves a proliferation of reimbursement regulations and the use of reference pricing

systems. Price optimization is also significantly affected by a number of related

disciplines, including the application of pharmacoeconomic evaluations, the impact of

parallel trade and reimportation and the pricing effects of generic substitution.

Alongside the key pricing issues of cost-containment, pharmacoeconomics, parallel

imports and generic substitution, a number of hot topics have also been widely debated

over the last few years. These include US reimportation, Medicare reform, EU

enlargement, price harmonization and pricing and reimbursement hurdles.

30

Advances in medical technologies, population ageing and rising public expectations

have been responsible for significant health spending growth, which was particularly

notable in the area of pharmaceuticals. Between 1992 and 2002, spending on

pharmaceuticals grew by an average of 1.3 times the rate of total health expenditure

growth. Pharmaceutical expenditure accounted for between 9% and 37% of total health

spending in OECD countries in 2002. Figure 1.5 shows the share of healthcare

expenditure generated by pharmaceutical expenditure in 2002 across the main markets.

Figure 1.5: Pharmaceutical expenditure as a share of total healthcare expenditure in 2002

22.3%

21.5%

20.8%

18.8%

14.5%

12.8%

17.2%

Italy

Spain

France

Japan

Germany

US

Average

22.3%

21.5%

20.8%

18.8%

14.5%

12.8%

17.2%

Italy

Spain

France

Japan

Germany

US

Average

Source: OECD Health Data 2004 Business Insights Ltd

The key factors underlining pharmaceutical expenditure growth include:

The ageing population;

The emergence of “life-style” drugs;

A shift to newer and more expensive drugs;

An increase in therapeutic coverage (i.e. new drugs for diseases that previously

could not be treated).

31

Opportunities in the pharmaceutical marketplace

Despite the recent problems that the pharmaceutical industry has faced, its continued

growth – although somewhat slower than in the past – is evidence of underlying

demand. This demand is driven by unmet needs for medications, innovation in

biotechnology, the increasing age demographic, and emerging geographical markets

such as China and India (Figure 1.6).

Figure 1.6: Pharmaceutical market drivers, 2004

GROWTH DRIVERS

Innovation in biotechnology

Rising age demographic

Emerging geographical markets

Unmet needs for medications

GROWTH DRIVERS

Innovation in biotechnology

Rising age demographic

Emerging geographical markets

Unmet needs for medications

Source: Author’s research & analysis Business Insights Ltd

In 2004, there were 82 blockbuster drugs – drugs with sales of $1bn annually – which

was 17 more than in 2003. Increasingly, blockbusters target specialist markets such as

oncology, and are fueled by a surge in new products derived from biotechnology. In

2004, 11 blockbuster drugs originated from biotech companies, and biotech products

accounted for 27% of the active research and development pipeline, and 8.1% of global

sales in 2004. Thus, over the next 5-10 years the growth of the biotech market is

32

expected to continue with products derived from biotechnology representing an

increasing share of the overall market.

33

CHAPTER 2

Failing short-term strategies

34

Chapter 2 Failing short-term strategies

Summary

Favoring long-term strategies over short-term solutions designed to meet investor expectations for near-term growth is one fundamental step that pharmaceutical companies can take in order to improve R&D productivity.

Since pharmaceutical companies are subject to price constrictions in major markets outside of the US, then drug prices in the US are maximized in order that high levels of R&D expenditure can be recouped. This is unlikely to be sustainable in the long-term with price disparity a key political issue in the US.

Lack of innovation, reduced marketing exclusivity and the resulting increased focus on lifecycle management has meant sales, general and administrative (S,G&A) expenditure has rocketed to an average of $140.5m (32.7% of sales) in 2003, with leading pharmaceutical company, Pfizer, now employing approximately 37,000 sales reps worldwide.

The reliance of pharmaceutical companies on a small number of blockbuster drugs is increasingly a risky strategy, as shown by the withdrawal of Merck’s Vioxx. In addition, the reliance on blockbuster drugs causes a focus on a small number of large disease areas that are overcrowded with too many ‘me-too’ drugs.

Despite the in-licensing of late-stage products having become a key strategy for pharmaceutical companies in the last decade, this is not sustainable in the long-term. It is precisely because of the increase in the number of late-stage licensing deals that there is now a dearth of these products available to in-license. Additionally, the cost of late-stage licensing has soared, meaning that it is not as commercially attractive as it has been in the past.

Despite mega-mergers being one of the most frequent strategic moves seen in the pharmaceutical industry during the past decade, it has not proved to be a valuable long-term strategy. Indeed, there is little evidence of a positive correlation between company size and productivity or innovation, despite the theoretical potential for greater efficiency or more successful product development.

35

Introduction

In order to combat the challenges that the pharmaceutical industry has faced in the last

few years, companies have employed a number of strategies in order to maintain

double-digit growth and satisfy investors. These tactics include (but are not restricted

to) a reliance on the US market for revenues, increasing sales and marketing spend, a

focus on blockbuster and “me-too” drugs, in-licensing of late-stage products, and

mega-mergers (Figure 2.7). Although these tactics have been relatively successful for a

short period, their long-term effectiveness has been questioned. Each of these strategies

is discussed in detail below.

Figure 2.7: Short-term strategies for delivery of revenue growth

SHORT-TERM STRATEGIES

Reliance on blockbuster and me-too drugs

Reliance on US revenues

Mega-mergers

Increase in sales and marketing spend

In-licensing of late-stage products

SHORT-TERM STRATEGIESSHORT-TERM STRATEGIES

Reliance on blockbuster and me-too drugsReliance on blockbuster and me-too drugs

Reliance on US revenuesReliance on US revenues

Mega-mergersMega-mergers

Increase in sales and marketing spendIncrease in sales and marketing spend

In-licensing of late-stage productsIn-licensing of late-stage products


36

Reliance on US revenues

Strategic pricing in the pharmaceutical industry is a critical mechanism through which

companies attempt to maximize profitability. However, obtaining high prices is

increasingly difficult as national governments in the major pharmaceutical markets,

with the exception of the US, directly influence the prices of pharmaceuticals by

putting in place legislative and regulatory requirements to restrain healthcare

expenditure. Examples include the UK’s profit control mechanisms, Germany’s

budgetary ceiling for general practitioners and reference price system, and France’s

price cuts and rebates to control the costs of health care.

In contrast, outside of the Medicare and Medicaid programs, the US government does

not fund a national health insurance scheme. As a result, the national government does

not directly influence the prices of pharmaceuticals, but allows drug prices to be

determined by the free market. Drug prices are influenced by competition between rival

products, the market size of the drug, the number of substitute products, and the costs

of R&D of new products.

Figure 2.8: Average branded drug prices in selected countries compared with the US, 2003

58%63%73%75%

87%

108%118%

0%

20%

40%

60%

80%

100%

120%

140%

Italy France Sweden Canada Germany UK Switzerland

US p

rice

s as

a p

erce

ntag

ein

crea

se o

f ave

rgae

pric

es

58%63%73%75%

87%

108%118%

0%

20%

40%

60%

80%

100%

120%

140%

Italy France Sweden Canada Germany UK Switzerland

US p

rice

s as

a p

erce

ntag

ein

crea

se o

f ave

rgae

pric

esUS

pri

ces

as a

per

cent

age

incr

ease

of a

verg

aepr

ices

Source: Boston University’s School of Public Health Business Insights Ltd

37

A study published by Boston University’s School of Public Health in 2004 showed that

branded drug prices paid by Americans were around 81% higher, on average, than in

Canada and seven other western countries in 2003 (Figure 2.8). This price difference

had risen from an average of 60% in 2000. The study examined the prices of 1,000

patented drugs.

As a consequence of having the highest drug prescription prices in the developed

world, the industry is heavily reliant on the US market, which generated almost half of

pharmaceutical industry revenues in 2004, as shown in Figure 2.9. North American

sales (of which 95% were US sales) totaled $248bn in 2004, an increase of 8% from

2003. Sales in the European Union (EU) rose 6%, to $144bn, while sales in Japan grew

2%, to $58bn.

Figure 2.9: Pharmaceutical sales by region/country, 2004

China2%

Rest of Europe 7%

Latin America3%

European Union

26%

North America

45%

Asia (excl. Japan & China), Africa and

Australia

6%Japan

11%

Global sales$550bn

China2%

Rest of Europe 7%

Latin America3%

European Union

26%

North America

45%


Australia

6%Japan

11%

China2%

Rest of Europe 7%

Latin America3%

European Union

26%

North America

45%


Australia


Australia

6%Japan

11%

Global sales$550bn

Includes audited and unaudited markets

Source: IMS Business Insights Ltd

38

While sales in the developed regions of North America, the EU and Japan showed only

modest growth from 2003 to 2004, the emerging markets in the rest of Europe and

China in particular grew at a strong pace. Sales in the rest of Europe increased by 12%

in 2004, to $9bn, and the Chinese market was up 28% to $9.5bn. In the next 5 to 10

years China is likely to continue to be a strong global growth market in the

pharmaceutical industry.

Long-term sustainability

The heavy reliance of the pharmaceutical industry on the high price of US medicines is

unlikely to be sustainable in the long-term. Recently, drug prices have become a key

political issue in the US, as the price differentials within the US and between the US

and different countries have become increasingly highlighted in the public arena.

The disparity in drug prices between the US and Canada in particular, has resulted in

significant ‘unofficial’ parallel importing from Canada by patients without medical

insurance who have to pay for their own drugs. While parallel importation is not legal

in the US, regulations allow for a 90-day supply of pharmaceuticals for personal use to

be imported into the US. The issue of retired people crossing the border to buy drugs

generated considerable interest in the US national press in the run-up to the Presidential

election.

With the future of parallel importation legislation uncertain and the increasing

consumer dissatisfaction with high drug prices, it is unlikely that the pharmaceutical

industry can continue to rely on the US for half of its revenues in ten years time. These

factors will compel pharmaceutical companies to expand into emerging and growing

geographical markets, particularly China, which was the highest pharmaceutical growth

market in 2004.

39

Increasing sales & marketing spend

The decline in R&D productivity over the past decade has increased the pressure on

sales and marketing functions to maximize profits from existing products on the

market. The lack of innovative launches has also caused the competition within

therapeutic classes to become increasingly fierce and thus the length of time of

marketing exclusivity that a new product enjoys before follower medicines enter the

market has reduced, as illustrated in Figure 2.10.

Figure 2.10: Years of marketing exclusivity, 1968-1995

Inderal

Tagamet

Capoten

Seldane

Prozac

AZT &Mevacor

Diflucan

Recombinate Invirase

y = -0.3304x + 659.79R2 = 0.9475

0

2

4

6

8

10

12

1965 1970 1975 1980 1985 1990 1995 2000

Year

Num

ber o

f yea

rs o

f mar

ketin

g ex

clus

ivity

Inderal

Tagamet

Capoten

Seldane

Prozac

AZT &Mevacor

Diflucan

Recombinate Invirase

y = -0.3304x + 659.79R2 = 0.9475

0

2

4

6

8

10

12

1965 1970 1975 1980 1985 1990 1995 2000

Year

Num

ber o

f yea

rs o

f mar

ketin

g ex

clus

ivity

Source: CMR International & IMS Health Business Insights Ltd

In 1968 Inderal enjoyed 10 years of market exclusivity before follow-on medicine

Lepressor was launched in 1978. The 1977 launch of Tagamet was followed by just 6

years of market exclusivity before Zantac entered the market in 1983. However, by the

time Invirase was launched in 1995 it had less than one year of market exclusivity

before rival products Norvir and Crixivan were launched in 1996.

40

Pharmaceutical companies therefore face the pressure of maximizing profit from a

smaller number of new launches in months, rather than years of exclusivity. This is one

reason why lifecycle management has become a key strategic tool for pharmaceutical

companies, where added revenues are extracted from existing products within

competitive and stagnant markets.

Lack of innovation, reduced marketing exclusivity and the resulting increased focus on

lifecycle management has meant sales, general and administrative (S,G&A)

expenditure has rocketed to an average of $140.5m (32.7% of sales) in 2003, with

leading pharmaceutical company, Pfizer, now employing approximately 37,000 sales

reps worldwide. While the total sales recorded by the top 50 pharmaceutical companies

have risen from $352bn in 1999 to $430bn in 2003, a compound annual growth rate of

5.1%, S,G&A expenses have risen at a higher rate (CAGR of 6.6%). Thus, S,G&A

expenditure is taking up an increasing proportion of sales revenues, more than twice

that of R&D expenditure (Table 2.1).

Table 2.1: S,G&A expenditure of top 50 pharmaceutical companies, 1999-2003

1999 2000 2001 2002 2003 CAGR 1999-2003 S,G&A expenditure ($bn) 108.8 117.3 122.8 127.7 140.5 6.6% Total sales ($bn) 351.9 381.9 396.6 419.3 429.9 5.1% S,G&A as % of sales 30.9 30.7 31.0 30.5 32.7

Source: Business Insights; Company Reports Business Insights Ltd


While increased spend on sales and marketing has helped to produce continued growth

in the industry, S,G&A expenditure is rising faster than total sales. S,G&A spend rose

by a CAGR (1999-2003) of 6.6% versus a CAGR of 5.1% for sales. This is because

increasing sales and marketing spend does not tackle the underlying issue causing

S,G&A expenditure to soar – the R&D productivity decline. If more innovative

41

products are launched sales and marketing teams will not be so reliant on extracting

maximum value from existing products through life-cycle management.

Reliance on blockbusters and me-too drugs

The pharmaceutical industry has traditionally been reliant on a small number of

blockbuster drugs that generate annual revenues in excess of $1bn. This means that Big

Pharma is constantly looking for new blockbusters to take the place of drugs that will

be coming off patent or exclusivity protection and become subject to generic

competition.

The withdrawal of Merck’s pain medication, Vioxx, is a good example of the risk of

the pharmaceutical industry’s over reliance on blockbuster drugs. Prior to the recall,

Vioxx had annual sales of more than $2.5bn, corresponding to about 11% of the

company’s sales in 2003. Thus its withdrawal had a major impact on company

revenues and profits, and as a result caused the loss of 26.2% of shareholder value.

Big Pharma companies can be seen as victims of their past successes. As company

revenues have grown, so has the need to satisfy investor and analyst expectations for

ongoing, steady growth. These expectations have put pressure on pharmaceutical

companies to implement short-term strategies to maintain revenue, such as mega-

mergers resulting in one-off cost savings and growth. However, the larger a company

becomes, the greater the dollar amount of new growth must be each year to maintain a

constant rate of growth. In 1989, Pfizer and Merck needed to generate $350m and

$200m, respectively, to grow by 10%. However, by 2003, to achieve the same growth

rate, Pfizer needed to generate almost $3bn and Merck $2bn.

As a result of this quest for ongoing growth Big Pharma has little incentive to produce

$250m drugs for smaller disease areas with inadequate treatment, because these

medicines are much less likely to reach blockbuster status. Instead, Big Pharma has

42

naturally focused its efforts on the biggest possible drug categories for chronic diseases

with high incidence and prevalence rates. However, the number of conditions that

could give rise to a blockbuster drug is limited and congested with competing drugs,

which is one contributory factor to the fall in R&D productivity and market exclusivity

period.

The development of ‘me-too’ blockbuster drugs by the pharmaceutical industry has

been viewed by some as ad hoc imitation and as wasteful. However a study by the

Tufts Center for the Study of Drug Development has shown that the vast majority of the

follow-on drugs for drug classes that were created in the last decade were in clinical

development prior to the approval of the class breakthrough drug. Thus, the increase in

number of follow-on drugs is the result of companies aiming for blockbusters in the

same large disease areas.


The reliance of pharmaceutical companies on a small number of blockbuster drugs is a

risky strategy, as shown by the withdrawal of Merck’s Vioxx. In addition, the reliance

on blockbuster drugs causes a focus on a small number of large disease areas that are

overcrowded with too many ‘me-too’ drugs.

With the continued progress of research in genomics and proteomics, the development

of personalized medicines may yet offer the opportunity for companies to differentiate

their products in terms of disease subgroup, and thus face less competition in smaller

disease markets.

In-licensing of late-stage products

As companies have struggled with internal productivity, pharmaceutical companies

have sought to boost their ailing pipelines by in-licensing products from other

companies. Indeed, licensing has become an integral business development tool that is

43

a critical source of pipeline strength. At the same time, the search for the right licensing

or co-promotion partner has grown increasingly competitive, while deal values have

spiraled upward, particularly for late stage products with blockbuster potential.

Deals for later stage products are more popular as they are post proof of concept and

thus attrition rates are considerably lower than in preclinical and clinical Phase I. Phase

II in-licensing deals are considerably cheaper than Phase III deals, and with similar

attrition rates to Phase III compounds, this makes Phase II compounds a sensible

lower-cost option. However, although the licensing deal itself is less expensive, the

cost of Phase III trials is extremely large and so this must also be taken into

consideration in the cost of the license deal.

Figure 2.11 shows the results of an analysis of 1,377 R&D projects across the pipelines

of more than 200 companies (pharmaceutical companies and 49 biotechnology

companies) in terms of the phase of clinical development and the source of the drug.

In terms of the source of drug, in-house drug development dominates all clinical

phases, accounting for 68.8% of all projects. However, its proportional share within

each phase differs: in-house development dominates the pre-clinical stage, accounting

for 91% of projects; the percentage of in-house sourced drugs falls to 68.5% in Phase I,

63.6% in Phase II and 57.4% in Phase III. Conversely, the proportion of in-licensed

drugs increases as development progresses. In-licensed drugs accounted for:

5.8% of preclinical projects;

16.1% of Phase I projects;

22.4% of Phase II projects;

27.9% of all Phase III projects.

Interestingly, the proportion of co-development drugs is not too dissimilar across the

three clinical stages of development accounting for approximately: 17.4% of Phase III

44

projects, 15.4% of Phase I and 14% of Phase II projects, while only accounting for

3.2% of pre-clinical projects. The lower share of co-development in the pre-clinical

stage indicates that companies mainly focus on early-stage in-house work before

seeking R&D collaborations later in the development process.

Figure 2.11: Breakdown of projects by clinical phase and source of drug, March 2004

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Preclinical Phase I Phase II Phase III Registration

Development phase

Prop

ortio

n of

pro

ject

s by

sou

rce

(%)

In-house Co-development Licensed

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Preclinical Phase I Phase II Phase III Registration

Development phase

Prop

ortio

n of

pro

ject

s by

sou

rce

(%)

In-house Co-development Licensed

Source: Business Insights Company Comparator Tool, March 2004 Business Insights Ltd


Despite the in-licensing of late-stage products having become a key strategy for

pharmaceutical companies in the last decade, this is not sustainable in the long-term. It

is precisely because of the increase in the number of late-stage licensing deals that

there is now a dearth of these products available to in-license. Additionally, the cost of

late-stage licensing has soared meaning that it is less profitable as a growth strategy.

As a result, pharmaceutical companies are now forced to migrate up the pipeline to

Phase I and preclinical compounds, which means increasing risk and uncertainty.

Increasing numbers of larger deals are being made, earlier in development, due to

45

strong demand for licensing opportunities. As the deals have become larger, the risks

have become greater and more visible to the investment community. Consequently,

pharma companies need to nurture long-term relationships with licensor companies and

think more strategically in terms of trying to find partners that go beyond the simple

one-product deal. Examples of companies already engaging in long-term agreements

include AstraZeneca, who have a 5-year relationship with Cambridge Antibody

Technology (CAT) for the development of antibody drugs, and Roche who licensed

Antisoma’s entire oncology portfolio.

Mega-mergers

In recent years pharmaceutical and biotechnology companies have continued to use

mergers and acquisitions (M&A) as a key mechanism for delivering critical mass in

sales and R&D, in order to deliver improved productivity and ROI. While the bottom-

line results of major M&A deals are as yet unproven, the industry’s appetite for

continued M&A does not seem to have abated, with major deals between Pfizer and

Pharmacia, Biogen and Idec and most recently Sanofi-Synthélabo and Aventis.

In 2004 the transaction value of major deals totaled $96bn, dominated by Sanofi-

Synthelabo’s $61bn acquisition of Aventis (Figure 2.12). Although there were 70 other

M&A deals during 2004 these totaled $35bn so were primarily relatively small value

deals, averaging $0.5bn. The number of M&A/restructuring deals has risen

continuously during the past decade from 10 in 1995 to 71 in 2004, illustrating the

industry’s sustained appetite for M&A. Speculation also continues that Novartis will

engage in large scale M&A activity, while the weakness of BMS’ pipeline has

encouraged speculation that it may become a target.

46

Figure 2.12: M&A/restructuring activity, 1994-2004

0

10

20

30

40

50

60

70

80

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004Year

Num

ber o

f M&

A/re

stru

ctur

ing

deal

s

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

200.0

Valu

e of

M&

A/re

stru

ctur

ing

deal

s ($

bn)

Total number of deals Total value of deals

0

10

20

30

40

50

60

70

80

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004Year

Num

ber o

f M&

A/re

stru

ctur

ing

deal

s

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

200.0

Valu

e of

M&

A/re

stru

ctur

ing

deal

s ($

bn)

Total number of deals Total value of deals

Source: SG Cowen Pharmaceutical Industry Pulse 2005 Business Insights Ltd

Though the merger of two companies may lead to strengthened portfolios, improved

market share and a broader geographical coverage, a critical success factor is the ability

of two sales forces to effectively merge as one. In the short term this is both a complex

and costly process. The merger of large pharmaceutical companies is also often

accompanied by the divestment of competing products, which can result in a fall in

market share and increased competition. Additionally, the fact that R&D productivity

continues to decline after a decade of growth in company size and R&D investment

demonstrates the shortcomings of a strategy that seeks size for the sake of size alone.

Table 2.2 details an analysis of the cost savings produced by mega-mergers, conducted

by Deutsche Bank. The table shows the percentage reduction in sales (mostly resulting

from product divestments) and expenses post merger, as well as the savings in $m and

a breakdown of the areas in which the savings occurred. For example, the Pfizer-

Pharmacia merger resulted in a reduction in sales of 9.1%. However the reduction in

47

expenses was greater (12.6%) producing cost savings of $4bn. Similarly, the merger of

GlaxoWellcome and SmithKline Beecham caused a reduction in combined sales of

12%, but cost savings of 17.7% (£1.8bn). The cost savings were mostly achieved in a

reduction in S,G&A expenses (50%), followed by a 35% savings contribution of cost

of goods (COGS), and 15% R&D.

Table 2.2: Cost savings achieved on past mergers Companies Combining Savings Reduction Analysis of Savings $m Sales% Expenses% S,G&A% COGS% R&D% AHP Cyanamid 600 4.6 5.4 70 20 10 Hoechst MMD 750 7.6 9.2 30 40 30 Glaxo Wellcome 1065 10.8 16.3 35 40 25 Roche Syntex 425 5.3 7.1 80 10 10 Pharmacia Upjohn 500 7.2 8.7 60 40 0 Ciba Sandoz 1525 6.6 8.3 50 30 20 Zeneca Astra 1100 8.4 9.1 70 10 20 Hoechst Rhone- € 750 5.4 6.5 55 25 20 Poulenc Sanofi Synthelabo € 250 4.8 5.8 n.a. n.a. n.a. Pharmacia Monsanto 600 5.4 6.4 45 20 35 Pfizer Warner- 1600 7.3 10.7 n.a. n.a. n.a. Lambert Glaxo SmithKline £1800 12.0 17.7 50 35 15 Pfizer Pharmacia 4000 9.1 12.6 n.a. n.a. n.a. Sanofi- Aventis* (1,600) 4.1 (6.5) 5.8 (9.2) n.a. Synthelabo Average n.a. n.a. 7.7 9.9 55 27 19 *() Represents synergies arriving from revenue benefits

Source: Company data, Deutsche Bank estimate Business Insights Ltd


Despite mega-mergers being one of the most frequent strategic moves seen in the

pharmaceutical industry during the past decade, it has not proved to be a valuable long-

term strategy. Indeed, there is little evidence of a positive correlation between company

size and productivity or innovation, despite the theoretical potential for greater

efficiency or more successful product development. M&A activity, after considering

one-off cost savings, in terms of consolidating sales, marketing, R&D and

administrative expenses, has regularly failed to deliver long-term benefits. Indeed

48

much consolidation in the industry has been driven by weakness and the need to meet

shareholder expectation for short-term growth rather than the potential to exploit true

long-term synergies.

Mergers are often accused by executives of contributing to significant operational

disruption leading to loss in R&D momentum and resulting in organizational structures

that are unlikely to be optimized for conducting R&D. This problem is compounded by

the fact that few companies that have undergone mega-mergers during the past decade

have had significant opportunity or committed sufficient time and resources to

overhauling their R&D strategies and operations. While strategies based upon serial

M&A activity may be flawed, the need to rethink R&D strategy is not confined solely

to those companies formed through consolidation. Taking into account the

globalization of the pharmaceutical market over the past decade, the organizational

structure of companies that have achieved strong and sustained organic growth are also

likely to require significant review. Figure 2.13 shows the change in market shares of

mega-merged and non-mega-merged companies from 1995 to 2002.

Figure 2.13: Change in market shares of mega-merged & non-mega-merged companies, 1995-2002

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

"Mega-merged" companies

"Non-mega-merged" companies

Chan

ge in

eth

ical

dru

g m

arke

t sha

re (1

995-

2002

)

Merck & Co.

J&J

Eli Lilly

Roche

Pfizer, GSK,BMS, Aventis

Pharmacia

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

"Mega-merged" companies

"Non-mega-merged" companies

Chan

ge in

eth

ical

dru

g m

arke

t sha

re (1

995-

2002

)

Merck & Co.

J&J

Eli Lilly

Roche

Pfizer, GSK,BMS, Aventis

Pharmacia

Source: Wood Mackenzie Business Insights Ltd

49

During the period 1995 to 2002 those top-ten pharma companies involved in mega-

mergers (Pfizer, Pharmacia, BMS, GSK, Aventis) actually saw their combined market

share decline by 2.8%. In contrast, those top-ten companies who have not undertaken a

mega-merger strategy (Merck & Co, J&J, Eli Lilly, Roche) have shown a 10% rise in

market share.

Focus on long-term sustainable growth

The challenges in the industry and the short-term fixes that Big Pharma has used to

sustain double-digit growth in the last 5 years have been highlighted in Chapters 1 and

2. However, these short-term fixes have hidden the need for the implementation of

long-term sustainable strategies for the industry.

Favoring long-term strategies over short-term solutions designed to meet investor

expectations for near-term growth is a fundamental step that is required to improve

R&D productivity. The M&A activity that has characterized the top-tier segment of the

pharmaceutical market for the past decade is symptomatic of a more fundamental

barrier to productivity. At the root of the productivity deficit lies sustained investor

demand for near-term earnings growth and the industry’s apparent willingness to

deliver on investor expectation by implementing short-term strategies. These,

unfortunately, do little to improve productivity for the long-term. In this respect the

current productivity problems begin to look, at least in part, as though they have been

self-inflicted by the industry through its failure to think long-term.

To address this central issue, a balance should be struck between implementing short-

term strategies – such as in-licensing to fill late-stage pipelines that will deliver short-

term growth – and focusing resources on addressing long-term productivity gains. Due

to the size and structure of Big Pharma R&D, overhauling strategy and operations is a

costly and time-consuming activity. In order provide a foundation for change there

must be a shift to a longer-term perspective both from the sector’s investor base and the

industry. Any strategy that hopes to address the fundamentals underlying productivity

50

deficits requires long-term commitment from executives and shareholder tolerance for

sacrificing short-term gains for long-term growth.

Conclusions

The following three chapters of this report will present in detail a number of innovative

strategies that are available to pharmaceutical companies in order to achieve long-term

sustainable growth. These strategies are categorized in terms of expanding the

customer base, adjusting the product portfolio and alternative strategies for growth.


In the next ten years there is likely to be some fairly major growth opportunities for

pharmaceutical companies as the customer base is expanded by the emerging

geographic markets in China, India and Eastern Europe and by growing patient

populations of ageing and obese individuals.


With the stagnation of traditional blockbuster pharmaceutical markets, the biotech and

generics sectors may offer companies better growth opportunities to 2015. Both of

these industry sectors are currently outpacing overall pharmaceutical industry growth.


Due to the negative relationship between operational size and R&D productivity, there

are a number of innovative ways that pharmaceutical companies can look to either

restructure their internal R&D operations or source R&D expertise and resources

externally.

51

CHAPTER 3


52

Chapter 3 Future strategies to expand the customer base

Summary

The major opportunities that exist for pharmaceutical companies to expand their customer base are in the emerging geographical markets of China, India and Eastern Europe, and in growing ageing and obese populations.

The highest growth rates in 2004 occurred in the smaller revenue markets of China, Latin America, and the Rest of Europe. China recorded the highest growth rate, expanding by 28% from $7.4bn in 2003 to $9.5bn in 2004.

Although expansion into China represents a significant growth opportunity, it will take pharmaceutical companies several years, and some investment, to see returns to match the potential that the market holds. China is therefore a market requiring long-term investment to achieve long-term profit, rather than a market that is going to yield short-term gains.

Several companies in recent years have indeed identified China as an important growth strategy and have begun to invest heavily in the region, for example Pfizer, Novartis, AstraZeneca and Roche.

Successful companies in 2015 will be those that can accurately identify the disease areas that will dominate the market in the future. Closer collaboration between R&D and commercial functions will ensure that resources are used on the products that have the best chance of success on the market, and return on investment is maximized.

The global population of seniors and obese patients are rising rapidly and this presents enormous growth opportunities for pharmaceutical companies as age and obesity are risk factors for cardiovascular diseases, certain types of cancer, diabetes and arthritis. The global market for age-related diseases is estimated at $143bn, and for obesity-related diseases $154bn, however as age and obesity are not the only risk factors for these diseases then not all of the sales from these diseases can be attributed to age and obesity.

53

Introduction

At a time when investors expect double-digit expansion, margins on key operations are

increasingly being squeezed and growth in traditional markets is stagnating, the ability

to forge new and profitable relationships with key customers and to generate strong

sales growth from an increasing patient population is an opportunity that cannot go

unexploited.

The major opportunities that exist for pharmaceutical companies are in the emerging

geographical markets of China, India and Eastern Europe, and in the growing

populations of ageing and obese patients.

Expansion into emerging geographical markets

Expansion into emerging geographical markets represents one of the most significant

growth opportunities for pharmaceutical companies to 2015, as many emerging

markets are growing at rates significantly higher than in traditional markets such as

Japan and Europe. The arguments presented here take note of the higher risk of generic

and copied drugs in emerging markets, and the difference in purchasing power between

patients, governments or healthcare organizations in emerging countries compared to

the US, Europe or Japan.

Global population demographics

According to the United Nations (UN), the global population will increase from

approximately 6.5bn in 2005, to 7.9bn in 2025 and then to 9.1bn by 2050. Greatest

growth will be apparent in newly industrializing countries and developing countries in

Africa and Asia. Within the industrialized world, the rising US population will be

balanced by sharply falling populations in Japan and Europe, most notably in Italy (-

25%), Spain (-22%), Austria (-20%), Greece (-15%) and Germany (-14%).

54

Consequently, the population in industrialized countries will expand by only around

75m (+9%) between 2000 and 2050 compared with 3.2bn (+61%) in newly

industrialized and developing countries. The global population will expand at a faster

rate over the first 50 years of the 21st Century than during the past half-century.

Geographical pharmaceutical markets

Figure 2.9 illustrates pharmaceutical sales and market growth rates on a regional or

country basis in 2004 (reported by IMS). North America recorded the highest sales in

2004, $248bn, which represents 45% of the global market (the US accounts for

approximately 95% of the North American market).

The EU market is the second largest regional market, after North America, with sales

of $144bn in 2004. The EU recorded a relatively slow growth rate in 2004 of 5.7%,

compared to other geographies, primarily as this is a developed healthcare market with

a declining population in major countries – Germany, Italy and Spain. The population

in the other major pharmaceutical market, Japan, is also declining, and by 2050 it is

expected to decline by a further 12.4% from 2005 figures. The Japanese

pharmaceutical market showed the slowest growth rate in 2004 of just $2% and

recorded sales of $58bn. If the Japanese market continues to stagnate then high growth

markets in other parts of Asia, Latin America or Eastern Europe will likely overtake

Japan as the third largest pharmaceutical market.

The highest growth rates in 2004 occurred in the smaller revenue markets of China,

Latin America, and the Rest of Europe. China recorded the highest growth rate of any

single country or region, expanding by 28% from $7.4bn in 2003 to $9.5bn in 2004.

Growth rates in Latin America and the Rest of Europe were also high, at 13.4% and

12.4% respectively. These markets are expanding rapidly and pharmaceutical

companies are beginning to realize the growth potential for expansion of healthcare in

these less-developed regions compared to the US, EU and Japan, where the majority of

sales have traditionally be made. Indeed, successful expansion of operations into

developing regions could provide an incremental increase in sales.

55

Figure 3.14: Pharmaceutical sales and growth rates by region/country, 2004

0

5

10

15

20

25

30

0 50 100 150 200 250 300

Sales in 2004 ($bn)

Grow

th ra

te, 2

003-

2004

(%)

China

North AmericaEuropean Union

Japan

Rest of Europe

Asia (excl. Japan & China),Africa and Australia

Latin America

0

5

10

15

20

25

30

0 50 100 150 200 250 300

Sales in 2004 ($bn)

Grow

th ra

te, 2

003-

2004

(%)

China

North AmericaEuropean Union

Japan

Rest of Europe

Asia (excl. Japan & China),Africa and Australia

Latin America

Includes audited and unaudited markets

Source: IMS Business Insights Ltd

Chinese market entry

Multinational pharmaceutical companies have been operating in China since the 1980s,

but few have yet realized the potential of the market. Frustrated by China’s complex

regulations and distribution networks, its seemingly unenforceable intellectual property

laws, and its comparatively low expenditures on health care, foreign players foresee

minimal near-term success in China. As a result, companies have traditionally invested

cautiously in this market.

Despite the challenges that operating in China poses, it is the fastest growing

pharmaceutical market, rising by 28% in 2004, versus 7% global growth. It is currently

the ninth largest pharmaceutical market but at current growth rates China is likely to

overtake the fourth and fifth largest pharmaceutical economies – Germany and France

– by 2015. One reason for China’s fast growth is the annual rise of 8 percent of the

aging population in North Asia, especially in China. By the end of 2020, the number of

people aged over 65 years old will account for 16 percent of China's population. A

56

second reason is that China's birth rate has continuously declined, currently standing at

1.8 percent, further contributing to rise in median age of the population. With the

increase of China's per capita GDP, the social purchasing power will also expand. In

addition to economic reasons for entering the Chinese market, China's entry into the

World Trade Organization (WTO), in December of 2001, has meant a tightening of

intellectual property laws, regulatory procedures and GMP standards.

Although expansion into China represents a significant growth opportunity, it will take

pharmaceutical companies several years, and some investment, to see returns to match

the potential that the market holds. Thus China is a market that requires long-term

investment for long-term growth, rather than a market that will yield short-term gains.

Several companies in recent years have identified China as an important growth

strategy and have begun to invest heavily in the region, for example Pfizer, Novartis,

AstraZeneca and Roche.

Case Study: Pfizer expansion in China

Pfizer has been present in the Chinese market since the 1980s, and to date its

pharmaceuticals investment has been over $500m. Pfizer has launched more than 40

new products in China in the disease areas of cardiovascular, endocrinology,

neuroscience, infectious disease, arthritis and inflammation, urology, ophthalmology

and oncology. Seven of Pfizer's global blockbusters have been marketed in China,

namely, Lipitor, Norvasc, Celebrex, Viagra, Diflucan, Zithromax and Zoloft, and as an

illustration of Pfizer’s commitment to the Chinese market the company has launched

many of its innovative drugs in China simultaneously to the rest of the world.

Signaling a further acceleration of Pfizer’s China operations, the company announced

in October 2004 that Shanghai would be the location for new regional headquarters,

along with the creation of the Pfizer Investment Holding Company. This new

investment company was established to facilitate the integration of all of Pfizer’s

operations in China, which includes manufacturing plants in Dalian, Suzhou and Wuxi,

a management centre in Beijing and a trade company in Shanghai. Additionally,

57

through this investment company, Pfizer plans to hasten the entry of new products into

China, with Alan Gabor, chairman and general manager of Pfizer Investment Holding

Co. remarking:

“In the next five years, we plan to introduce another 15 innovative drugs into China, three times the number of products launched in the past five years.”

Mr. Alan Taylor, Pfizer Pharmaceuticals Regional President for Asia, recently

commented on the importance of this new investment company and the Chinese market

to Pfizer’s overall development strategy:

“China is an important part of Pfizer's global development strategy. We wanted an increased presence here and an entity to help us to expedite our investment, and that is the core mission of the new Regional Headquarters”

This ongoing investment in China is despite the ongoing patent dispute for Viagra, one

of its best-selling ED (erectile dysfunction) drugs worldwide.

In addition to its manufacturing activities and product launches, Pfizer also plays an

active role in activities such as health education, medical training, disease control,

charitable donations and disaster relief. For example, in Shanghai, Pfizer is involved

with a Teen Healthcare Education Program together with Shanghai Pudong Social

Worker Association. The company also works with the Shanghai Huashan Anti-

infective Institute to guide physicians on the appropriate use of antibiotic medications.

Furthermore, Pfizer has launched an Anti-Cancer Education Program with the

American Cancer Society (ACS), in association with the Shanghai Drug

Administration and the Shanghai Administration of Industry and Commerce. The

global company recently also conducted Anti-Counterfeiting Training to protect

Chinese patients from the hazardous risk of counterfeit drugs.

58

Targeting growing patient populations

Aligning R&D with commercial business functions

Traditionally in many Big Pharma companies there has been relatively weak linkage

between R&D and more commercial business functions such as sales and marketing.

This is one of the fallouts of the large scale of pharma companies and geographical

fragmentation of functions – issues that are less evident in smaller-sized pharma or

biotech companies.

However, it is essential for pharma companies that their R&D and commercial

functions are aligned to ensure that products in research are commercial before

embarking on expensive product development and clinical trials. By aligning R&D and

commercial business functions, then pharma companies can ensure that resources are

used on the products that have the best chance of success on the market, and return on

investment is maximized.

Dr Joachim M. Greuel, a partner and co-founder of Bioscience Valuation, a German-

based management consultancy specializing in the evaluation of pharmaceutical R&D

projects, commented in 2003 that:

“If a company decides to evaluate early-stage projects, R&D and marketing have to discuss possible target profiles. An evaluation would then assume that, in a reasonable time frame, drug candidates can be identified that would correspond to the defined target profile. The positive effect of discussing a target profile should not be underestimated, even if the valuation itself is more uncertain. R&D managers then know exactly in which direction a molecule has to be modified.”

Additionally, closer collaboration between R&D and commercial functions ensures that

the drugs in research fit with the company strategy in terms of therapeutic area.

Successful companies in 2015 will be those that can accurately identify the disease

areas that will dominate the market in the future, monitor their ongoing commerciality,

and accordingly influence strategic decision making in R&D. Two sets of patient

59

populations that are already showing rises in numbers, and that are predicted to

continue to rise at dramatic rates, are the populations of ageing and obese patients.

The ageing population

The ageing population represents another significant growth opportunity for

pharmaceutical companies, as the global population of seniors is set to more that triple

between now and 2050.

Age demographic trends

The UN reports that by 2050 the median age for the world will increase to 37.8 years,

up from 23.9 years in 1950 and 26.8 years in 2000, as the proportion of older persons

(i.e. those aged 60 years and over) rises. At the global level, the number of older

persons will increase from 672m in 2000 to 1.97bn in 2050 and will be most marked in

less developed regions where the older population will more than quadruple. As Figure

3.15 illustrates, greatest growth will be experienced in the ‘older old’ category.

Figure 3.15: Annual population growth rates by age group and region, 2000-50

-1.0

0.5

0.0

0.5

1.0

1.5

2.0

3.0

3.5

4.0

4.5

World Africa Asia Latin America &the Caribbean

Europe North America Oceania

Major area

Aver

age

annu

al g

row

th ra

te (%

) by

age

grou

p

0- 14 15- 59 60+ 80+ Total population

-

2.5

0-

-1.0

0.5

0.0

0.5

1.0

1.5

2.0

3.0

3.5

4.0

4.5

World Africa Asia Latin America &the Caribbean

Europe North America Oceania

Major area

Aver

age

annu

al g

row

th ra

te (%

) by

age

grou

p

0- 14 15- 59 60+ 80+ Total population

-

2.5

0-

Source: United Nations (2003) Business Insights Ltd

60

The UN estimates that the number of octogenarians (aged 80-89) will increase by 5.1

times between 2000 and 2050 to 311m, while the number of nonagenarians (aged 90-

99) will expand by a factor of eight to 63m. However, the number of persons aged over

100 years will rise the most, increasing by 20 times to 3.3m in 2050 compared with

only 167,000 in 2000. Most centenarians will reside in Japan, as today, followed by the

US, China, India, France and Germany.

Healthcare spending by age

As the senior (over 75) population expands, healthcare spending on this group is set to

increase. Figures from the Organization for Economic Co-operation and Development

suggest that healthcare expenditure in the UK is set to rise from 5.6% of total gross

domestic product in 2000 to 6.5% by 2020. Spending in the US shows a similar trend,

where the figure is set to increase from 2.0% to 2.9% over the same period.

Figure 3.16: Healthcare spend in the US by age group, 1985 & 2000

2%

4%

6%

8%

10%

12%

14%

16%

Under 25 25-34 35-44 45-54 55-64 65-74 75+

Heal

thca

re e

xpen

ditu

re a

s %

of a

nnua

l spe

ndin

g

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000 Total healthcare expenditure per year ($)

0%

2%

4%

6%

8%

10%

12%

14%

16%

Under 25 25-34 35-44 45-54 55-64 65-740

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Healthcare spend as % of annual spend 1985 2000

Healthcare expenditure 1985 2000

Agegroup

2%

4%

6%

8%

10%

12%

14%

16%

Under 25 25-34 35-44 45-54 55-64 65-74 75+

Heal

thca

re e

xpen

ditu

re a

s %

of a

nnua

l spe

ndin

g

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000 Total healthcare expenditure per year ($)

0%

2%

4%

6%

8%

10%

12%

14%

16%

Under 25 25-34 35-44 45-54 55-64 65-740

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000





Agegroup

Source: Bureau of Labor (US) Business Insights Ltd

61

In addition, healthcare spend by seniors themselves is higher than in the general

population. In the US, statistics from the Bureau of Labor show that spending on

healthcare by the US population has not only increased substantially between 1985 and

2000, as illustrated in Figure 3.16, but that spending is clearly age related, rising from

just 2.2% of annual spending among the under 25 population to 15% among seniors.

Age-related diseases

Many diseases display a strong relationship between age and prevalence, and can thus

be defined as age-related diseases. For example, within the seven major markets,

prevalence rates for hypertension range from less than 4% in males and females under

40 years of age in the US to 79% in seniors over 75 years of age in Germany.

Hypertension is a risk factor for other life-threatening conditions, including myocardial

infarction and stroke. In the case of stable angina, prevalence rates rise sharply with

age. In Germany, the UK and the US, just over 2% of persons aged 45-54 are affected

by the condition, compared with more than 12% in the 65-74 year old age group.

Angina not only impairs quality of life but it also identifies a population that is at

increased risk of future cardiovascular complications. As with hypertension, disease

management is essential.

Some of the most common illnesses or diseases associated with age are listed in Table

3.3. Since many of these age-related diseases are chronic, following diagnosis, life-long

treatment is invariably necessary, and thus treatments for these diseases will have high-

usage rates.

Table 3.3: Most common age-related diseases Alzheimer’s Acute ischemic stroke Arthritis Hypertension Type II diabetes Angina Male sexual dysfunction Urinary incontinence Osteoporosis COPD Prostate cancer Age-related macular degeneration


62

The market for age-related diseases

The ageing population presents an enormous growth opportunity for pharmaceutical

companies as seniors consume more than double the number of prescriptions per year

and account for more physician visits than any other age segment.

The precise market size for ageing diseases is difficult to quantify as not all instances

of a particular disease can be attributed to ageing, and for related diseases there are

often common treatments. Thus in Table 3.4 the total global market sizes for diseases

and disease categories common to seniors are estimated from company reported data

and IMS Health data.

Table 3.4: Global ageing diseases market, 2003 Age-related disease Total sales 2003 ($bn) Alzheimer’s 1.8 Cardiovascular diseases 78.7 Arthritis 10.8 Diabetes 10.4 Sexual dysfunction 2.8 Cancer 38.5 Total 143.0

Source: Company reports; IMS; Author’s research & analysis Business Insights Ltd

The obese population

In addition to the ageing population, the obese population is the other patient group

expected to present significant opportunities for growth to 2015.

Obesity epidemiology

So high are the levels of obesity in many nations that obesity can now be considered an

epidemic. Figure 3.17 shows that the incidence of overweight and obese individuals in

the US has increased significantly in the last 25 years, such that in 1999-2000 64% of

US adults were either overweight or obese.

63

Figure 3.17: Prevalence of obese and overweight adults in US, 1976-2000

0

10

20

30

40

50

60

70

1976-1980 1988-1994 1999-2000

NHANES surveys

Prev

alen

ce in

adu

lt po

pula

tion

(%)

Overweight or obese Obese

0

10

20

30

40

50

60

70

1976-1980 1988-1994 1999-2000

NHANES surveys

Prev

alen

ce in

adu

lt po

pula

tion

(%)

Overweight or obese Obese

Prevalence is age-adjusted; Adults defined as aged > 20

Source: NHANES II, III and IV Business Insights Ltd

Obesity is a complex condition, one with serious social and psychological dimensions,

that affects virtually all age and socioeconomic groups and threatens to overwhelm

both developed and developing countries. In 1995, there were an estimated 200m obese

adults worldwide and another 18m under-five children classified as overweight. As of

2000, the number of obese adults had increased to over 300m. Contrary to conventional

wisdom, the obesity epidemic is not restricted to industrialized societies; in developing

countries, it is estimated that over 115m people suffer from obesity-related problems.

Generally, although there is a higher proportion of men who are overweight, it is

women have higher rates of obesity.

64

Obesity-related diseases

Obesity poses a major risk for serious diet-related noncommunicable diseases,

including type II diabetes, cardiovascular disease, hypertension and stroke, and certain

forms of cancer. In fact, people with a body mass index (BMI) in the obese category

have a five fold greater risk of developing diabetes than those individuals classed as

neither overweight nor obese. As well as physical forms of disease, obesity is also a

major risk factor for forms of depression and sleep apnea (Table 3.5)

Table 3.5: Obesity-related diseases Type II diabetes Hypertension Stroke Heart attack & heart failure Cancer (prostate, breast, colon) Osteoarthritis Depression Sleep apnea


The market for obesity-related diseases

As with the ageing diseases market, the market for obesity-related diseases is difficult

to quantitate as although obesity is a risk factor for diseases, there are many other risk

factors and causes, including an overlap with ageing diseases markets. Thus Table 3.6

gives total global sales for cancer, cardiovascular diseases, diabetes, arthritis and

depression, although not all instances of these can be attributed to obesity.

Table 3.6: Global obesity-related diseases market, 2003 Obesity-related disease Total sales 2003 ($bn) Cardiovascular diseases 78.7 Diabetes 10.4 Cancer 38.5 Arthritis 10.8 Depression 15.5 Total 153.9

Source: Company reports; IMS; Author’s research & analysis Business Insights Ltd

65

CHAPTER 4


66

Chapter 4 Future product portfolio strategies

Summary

The pharmaceutical industry has traditionally pursued the development of small molecule drugs, and this approach has generated the “mega-blockbusters” that have dominated the industry. However, in recent years, the decoding of the human genome and the resulting plethora of targets for new drugs has created new opportunities for growth for biological therapies.

In 2004 the global pharmaceutical market generated sales of $550bn, 8.1% ($44.3bn) of which comprised biotech products, and 11.3% ($62bn) of generic products.

Biotech is currently the fastest growing sector in the drug industry. The US biotech market experienced growth of 17% from 2003 to 2004, which was almost twice the overall drug market growth rate for the second year running.

Pharma companies that are looking to move into the biotech sector need to take steps designed to maintain the small-scale and entrepreneurial spirit of biotech companies, as Roche has with its R&D spin-off companies and equity investments, and as UCB has with its acquisition of biotech company Celltech, the R&D function of which remains largely independent of the main UCB research organization.

The generics industry has experienced significant growth over the last few years. However 2004 was a difficult year for generics companies due to price erosion and increased levels of competition.

The defining criterion for successful involvement of pharmaceutical companies in the generics sector has been keeping distance between the branded pharmaceutical parent company and the generic subsidiary because the two types of company operate in such different ways.

67

Introduction

This chapter will focus on the strategic options open to pharmaceutical companies in

light of the failings of the Big Pharma strategy of “mega-blockbusters”. The relative

merits of investing in the high value business of targeted therapeutics – in which most

potential lies in biotechnology – and the volume business of generics are discussed in

detail.

Alternatives to a mega-blockbuster strategy

The traditional definition of a blockbuster drug is that which generates sales in excess

of $1bn in a calendar year. However, in today’s pharmaceutical market, Big Pharma is

increasingly reliant on a few “mega-blockbuster” products –drugs with sales of several

billion dollars per year. In 2004, Pfizer’s Lipitor was the first product to reach sales of

over $10bn, and this one product accounted for over 20% of Pfizer’s total revenues for

the year.

“Mega-blockbuster” drugs are aimed at markets that are populated by more than one

million people, targeting chronic, low severity disorders, while several of the 76 drugs

classed at blockbusters in 2004 are actually indicated for the treatment of niche

diseases. For example, Herceptin ($1.3bn) is targeted at a sub-population of breast

cancer patients over-expressing the HER2 protein, while Rituxan ($2.8bn) is targeted at

patients with the B-cell type of Non-Hodgkin’s Lymphoma (NHL).

However, the decline in R&D productivity in Big Pharma in recent years is evidence

that this singular “mega-blockbuster” strategy is unsustainable, because as major

revenue-driving multi-billion dollar drugs come off patent and face generic

competition, companies are launching fewer new “mega-blockbusters” to compensate

68

for declining sales. Therefore, Big Pharma will have to reduce its reliance on “mega-

blockbuster” products, seeking other more sustainable revenue streams to drive growth.

Figure 4.18 illustrates how generics, “mega-blockbuster” drugs (aimed at large chronic

disease markets), and targeted therapies (for niche markets) are positioned in the

healthcare marketplace in terms of four key criteria: medical differentiation; level of

competition; unit sales value of product; and sales volume of product. As drugs for

chronic disease markets sit roughly centrally in terms of each of these criteria, it

follows that in more sustainable revenue streams may lie the high value strategy of

targeted therapeutics, or alternatively in the high volume strategy of generics.

Figure 4.18: Product positioning in the healthcare marketplace

high

low

Leve

l of c

ompe

titio

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Targeted therapeutics(Niche markets)

Generics

highlow Medical differentiation

Unit

sale

s va

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of p

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high

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high lowSales volume of product

Mega-blockbusters(Large chronic markets)

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high lowSales volume of product

Mega-blockbusters(Large chronic markets)


Mega-blockbuster drugs: Traditional blockbuster drugs are aimed at chronic, low

severity disorders, which are prevalent in the general population. As the number of

diseases these criteria encompass is limited, there is a high level of competition for

69

prescriptions in these disease areas, and the time taken for ‘me-too’ or ‘copycat’

products to be launched has reduced dramatically. Following its 1968 launch,

Inderal enjoyed 10 years market exclusivity, while Invirase, launched in 1995, had

less than a year before rival products Norvir and Crixivan appeared on the market;

Targeted therapeutics: The advent of genomics has opened up the possibility of

developing treatments for less prevalent diseases and tailored to an individual’s

unique genetic profile. These targeted products can command high price points and

high margins because genomic diagnostic tests can identify individuals who will

definitely respond to a specific medicine, limiting side-effects and ineffective

treatments. At the same time, the patient potential is low because these products are

not aimed at a large population, and competition is also likely to be low for the

same reason.

Generics: Generic products are at the bottom end of the price scale, but at the top

end of the volume scale: selling in very high numbers but at small margins. In the

generic marketplace the competition is extremely high, as a generic product

competes, not only against branded products, but also against other generic copies

of the same product from different manufacturers.

Small molecule drugs versus biological therapies

The pharmaceutical industry has traditionally pursued the development of small

molecule drugs (synthetic organic chemicals), and this approach has generated the

“mega-blockbusters” (described above) that have dominated the industry. However, in

recent years, the decoding of the human genome and the resulting plethora of targets

for new drugs has created new opportunities for growth.

Many of the new drug targets work on protein-protein interactions, thus presenting

barriers to traditional small molecule approaches. As a consequence, biological

therapies (recombinant proteins and monoclonal antibodies) are growing in prominence

in both the marketplace and the clinic, particularly as biotechnology has high potential

70

in the targeted therapeutics market. Figure 4.19 shows that the gap in small molecule

drug approvals versus biological approvals is reducing year-on-year. In 2004, 11 of the

76 blockbuster products were biologicals, and there are several other products (Humira,

Rebif, Synagis, Avastin and Erbitux) that are forecast to attain blockbuster status by

2005.

Figure 4.19: US approvals of small molecule drugs and biological therapies, 1994-2003

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1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

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Source: Tufts Center for the Study of Drug Development Business Insights Ltd

The small molecule versus biological drug segmentation does not, however, strictly

define the areas in which pharmaceutical and biotech companies operate. The lines

between pharmaceutical and biotech companies have become blurred, with several

biotechnology companies having developed small molecules. Several of the small-

molecule drugs approved in 2003 originated in biotechnology companies, including

Millennium’s Velcade, Gilead’s Emtriva, ICOS/Eli Lilly’s Cialis, Trimeris/Roche’s

Fuzeon, and Vertex/GlaxoSmithKline’s Lexiva. Furthermore, Amgen, the leading

biotechnology company, gained FDA approval for its first small-molecule therapy,

Sensipar (in-licensed from NPS Pharmaceuticals), in March 2004.

71

Similarly, a number of pharmaceutical companies are investing heavily to make

biotechnology a key competence for the future. However, with biotech companies

successfully developing small molecule drugs as well as biologicals, the question arises

as to why biotech companies are able to efficiently develop NCEs while

pharmaceutical companies are struggling with R&D productivity. Two factors

contributing to this productivity disparity between pharmaceutical and biotech

companies are:

Pharmaceutical companies aim for mega-blockbusters that cover the widest

possible patient group, and thus the drugs are more likely to experience adverse

events in such a diverse patient population. Conversely, biotech companies

primarily aim for niche markets or markets where the medical need is unserved by

current therapies. Because the patient population is more targeted, there are likely

to be less adverse reactions to the drug, whether it is a small molecule or a

biological therapy.

There are no proven economies of scale in pharmaceutical R&D, and in fact much

evidence exists that there is actually a negative relationship between the scale of

R&D operations and productivity. Biotech companies, by virtue of operating at a

smaller scale, thus maintain more of an entrepreneurial and innovative culture, and

productivity is higher.

Sector performance

In order to evaluate the most profitable strategy that pharmaceutical companies should

undertake in terms of product portfolio – small molecules, biologicals or generics, or a

combination of the three – it is first necessary to evaluate the industry sectors currently

experiencing highest growth, and those predicted to lead the industry in 2015.

In the 2004 the total pharmaceutical market was worth $550bn, 8.1% ($44.3bn) of

which comprised biotech products, and 11.3% ($62bn) of generic products (Table 4.7).

72

Table 4.7: Sales in the global and US markets by sector, 2004 Market sector Global US Sales % of total Sales % of total Pharmaceutical 443.7 80.6 189.7 80.6 Biotechnology 44.3 8.1 27.5 11.7 Generics 62.0 11.3 18.1 7.7 Total 550.0 100.0 235.4 100

Source: IMS MIDAS, 2/2005 Business Insights Ltd

In the US the total market grew by 8.3% in 2004, increasing from $217bn in 2003 to

$235bn in 2004. However, the growth rates of the pharmaceutical, biotech and generics

sectors of the industry varied considerably. Both the generic and biotechnology sectors

grew at faster rates (10% and 17% respectively) than the pharmaceutical sector (6.9%),

as indicated in Figure 4.20. This was the second year running that the biotech sector

had grown at almost double the industry average.

Figure 4.20: Growth rates in the US by sector, 2003-2004

6.9%

17%

10%

8.3%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Pharmaceutical Biotechnology Generics TotalMarket sector

Grow

th (%

) 200

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04

6.9%

17%

10%

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6%

8%

10%

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16%

18%

Pharmaceutical Biotechnology Generics TotalMarket sector

Grow

th (%

) 200

3-20

04

Source: IMS MIDAS, 2/2005 Business Insights Ltd

73

Sector growth to 2015

In this report’s survey of 300 senior industry executives from pharma, biotech,

speciality and generics companies and external industry observers, respondents were

asked their opinion on the growth potential in the pharma, biotech, speciality and

generic industry sectors.

The graph of survey responses in Figure 4.21 clearly shows that respondents believe

that the biotech and generics sectors are likely to show the highest annual growth rates

in the next 5 to 10 years. 47% believe that biotech will show an annual growth rate of

over 10%, while a further 35% indicated a growth rate of 6-10% to be most accurate.

No respondents believed that the biotech sector was likely to show negative growth,

indicating that the industry sees a very positive future for the biotech sector. Similarly

for generics, 43% of respondent companies believe that this sector will show an annual

growth rate of over 10% in the next 5 to 10 years, with a further 35% answering a 6-

10% growth rate. Again, no surveyed companies thought that this sector would show

decline in the timeframe.

Figure 4.21: Industry prediction of future sector annual growth rates to 2015

0%

10%

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Pharma Biotech Specialitypharma

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Industry sector

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> 10%

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0%

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74

Opinions on the likely annual growth rate of the speciality pharma sector was more

mixed, with 23.5% of surveyed companies responding that a growth rate of greater that

10% was most likely, and a further 35.5% answering 6-10%, and 30.5% of respondents

forecasting 3-5%. It is likely that this mixed response is partly because the speciality

pharma sector encompasses a number of industry subsectors including diagnostics and

small-medium pharma companies focusing on specific technology platforms or

therapeutic areas, and opinions on growth rates likely vary between these different

subsectors.

Responses for the pharma sector were not as positive as for the biotech, generics and

speciality pharma sectors, although single-digit annual growth is still predicted in the

next 5 to 10 years. 49% of respondents thought that the pharma sector would grow 3-

5%, while a further 33% indicated a growth rate of 6-10%.

The biotech sector

Biotech is currently the fastest growing sector in the drug industry. Globally biotech

products generated revenues of $44.3bn in 2004, in a total drug market worth $550bn.

The US is the primary market for biotech products, being the source of approximately

half of sales in 2004 ($27.5bn). The US market experienced growth of 17% from 2003

to 2004, which was almost twice the overall drug market growth rate for the second

year running.

To date 197 biotech products have been approved, with a further 100 under regulatory

review and 800 in advanced stages of clinical trials. Several of these products have

made blockbuster status, a total of eleven brands in 2004. However, since several

companies market erythropoietins, interferons, insulins, granulocyte colony stimulating

factor and human growth hormone under different brand names, these proteins rarely

make bestseller lists in commercial databases, unless taken together.

Erythropoietins had sales totaling $11.8bn in 2004, the second highest selling human

medicine behind Lipitor ($12.0bn). Similarly, interferons and insulins also recorded

75

high revenues in 2004, showing that the biotech market is dominated by its top selling

products (Table 4.8).

Table 4.8: Top global biotech products, 2004 Generic name Brands Indications 2004 sales ($bn) α and β Erythropoietin Epogen, Epogin, Procrit, Anaemia 11.8 Eprex, NeoRecormon, Aranesp α and β Interferon PEG Intron, Pegasys, Avonex, Hepatitis C 6.8 Rebif, Betaseron Multiple Sclerosis Human Insulin Novulin, Humalin, Humalog Diabetes 5.6 Granulocytes – G-CSF Neupogen, Neulasta Granulocytes stimulator 3.0 Rituximab Rituxan Leukemia, Lymphoma 2.8 Etanercept Enbrel Rheumatoid arthritis 2.6 Infliximab Remicade Rheumatoid arthritis 2.1 Human Growth Hormone Serostim, Saizen Dwarfism 1.8 Humatrope, Protopin, Neutropin Trastuzumab Herceptin Breast cancer 1.3 Palivizumab Synagis RSV 0.95 FSH Gonal F, Follistim Infertility 0.95 Glucocerebosidase Cerezyme, Ceradase Gaucher’s disease 0.88 Adalimuzab Humira Rheumatoid arthritis 0.85 Factor VII Novo Seven Haemophilia 0.76 Botulin toxin Botox Wrinkles 0.70 Bevacizumab Avastin Colon cancer 0.55

Source: IMS MIDAS 02/2005 Business Insights Ltd

Targeted biological therapeutics

One of the most promising categories of new biotech products are humanized

monoclonal antibodies, the leading type of targeted medicine. In 2004, three of the

eleven biotech million-dollar brands were monoclonal antibodies – Rituxan, Remicade

and Herceptin – with Humira, Synagis, Avastin, Rebif and Erbitux also expected to

reach the $1bn sales mark in 2005.

The industry expects that research into the human genome will open up a new

dimension in the understanding of the role of genes in the incidence of these diseases.

In clinical practice, however, diagnosis using human DNA is still largely limited to

single-gene inherited diseases. Examples of real use of possible tests for multifactorial

diseases are still limited at present, the most frequently cited being proof of mutations

76

in the bCRA genes causing breast cancer and the association of ApoE with a risk of

Alzheimer’s. At the present time research is focused particularly on diagnosing genetic

disposition to cancer, and thus cancer is likely to be one of the most productive therapy

areas for new targeted therapeutics.

Conventional anti-cancer drugs have tended to be non-selective, attacking both

cancerous and healthy cells. Consequently, cancer chemotherapy is often accompanied

by devastating short- and long-term side effects. Moreover, individual patient

responses to conventional agents are highly variable, even in cases where specific

cancers appear to be histologically identical. Molecularly targeted therapies based on

recent progress in genomics and proteomics, however, hold out the promise of being

more selective, thus drastically reducing the incidence of side effects in patients

undergoing cancer treatment.

Case study: Herceptin – a targeted therapeutic for breast cancer

The most successful example to date of a targeted therapeutic is Roche/Genentech’s

Herceptin (Trastuzumab), which had sales of $1.3bn in 2004. Herceptin was approved

by the FDA in 1998 for the treatment of metastasic breast cancer, or cancer that has

spread beyond the breast and lymph nodes under the arm. Herceptin is a humanized

anti-HER2/Neu antibody, which specifically targets the protein product of the gene

known as HER-2, HER2/neu, or c-erbB2, which is overexpressed in around 30% of all

breast cancer patients.

Herceptin was the second monoclonal antibody approved to treat cancer. The first,

Rituxan (Rituximab) was developed by Genentech and its Partner IDEC

Pharmaceuticals Corp. for patients with one type of non-Hodgkin’s lymphoma, a

cancer of the immune system. Herceptin is a monoclonal antibody bioengineered from

part of a mouse antibody that has been altered to closely resemble a human antibody. It

binds to a protein called HER2, which is found on the surface of some normal cells and

plays a role in regulating cell growth. In laboratory experiments, Herceptin inhibited

tumor cell growth by this binding action.

77

In the case of metastatic breast cancer cells, approximately 30% of tumors produce

excess amounts of HER2. Only patients who have tumors with this characteristic have

been studied and shown to benefit from the new, targeted approach using Herceptin.

The development of an accurate diagnostic test to screen the tumors from women with

metastatic breast cancer for HER2 protein was critical to the success of Herceptin.

Denmark-based Dako developed HercepTest to measure HER2 protein in tumors and

help identify the 30% of patients who may benefit from Herceptin treatment.

It is estimated that 40,000 women each year who face a high risk for recurrence could

benefit from the new test; the first gene-based test for prediction of cancer recurrence

to be approved by the FDA. Using the readily available original breast cancer tissue

sample, the Oncor Inform HER-2/neu test identifies the presence or absence of

increased copies of the HER-2/neu gene. This indicates whether or not breast cancer is

likely to return. In clinical trials, 31% of patients with originally localized breast cancer

that had a positive HER-2/neu test died within five years of surgery, while 97% of

patients with negative test results survived at least five years. Conventional detection

procedures must wait until the disease recurrence is present, allowing the cancer to

advance before treatment begins.

Market growth to 2015

Although the biotech market remains a relatively small proportion of the total drug

market (8.1% globally), it is fast growing and forecast to record sales of $140bn by

2010 and $250bn by 2015 (20.3% of the global market).

As a result of the fast pace of the market, many Big Pharma companies have begun to

invest heavily in biotech, with 27% of the active research and development pipeline of

drug companies now focused on biotech. In addition to the great sales potential of the

biotech market, a study by the Tufts Center for the Study of Drug Development has

shown that biotech products have equivalent or better US approval success rates

compared to new chemical entities (NCE), as illustrated in Figure 4.22.

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Figure 4.22: Comparative approval success rates of US biopharmaceutical products and drugs

0 10 20 30 40 50 60

Chimeric mAb

rDNA

Synthetic peptide

NCE

Approval success rate (%)

AntineoplasticImmunologicalEndocrine

Source: Tufts Center for the Study of Drug Development Business Insights Ltd

The generics sector

Like the biotech sector, the generics sector has also grown significantly faster than the

overall drug market in the last few years. The period 1997 to 2003 saw solid overall

industry growth, a compound annual growth rate (CAGR) of 11%. 2000-2003 was the

fastest growing period with a CAGR of 13% globally. This period was characterized by

high market demand exceeding supply and a favorable regulatory environment.

Globally, the generics sector had sales totaling $62bn in 2004, which accounted for

11.3% of the total pharmaceutical market.

However, in 2004 the generics industry witnessed a downturn. Growth in the US

slipped to 10%, versus US generics growth rates in 2002 and 2003 of 27% and 25%

respectively. A number of factors in 2004 have contributed to this difficult market

environment:

79

Intensified competition and price erosion: In all of the mature generics markets,

the price of generic drugs is falling. As a result, profitability among generic

companies is low, especially when compared with that of the branded

pharmaceutical companies. If reference prices continue to erode slim profit

margins, there is a chance that in countries such as Germany and France,

governments may destroy some of their domestic generics companies, and therefore

risk their supply of low cost generics because generics companies cannot afford to

market them;

Aggressive brand defense strategy: As R&D productivity has fallen for

pharmaceutical companies, more pressure has been put on lifecycle management of

existing blockbusters. Pharmaceutical companies have used increasingly aggressive

brand defense strategies to stave off generic competition, including entering the

generics marketplace themselves, and using various legal tactics to delay generics

entry;

Regulatory changes: The 2003 amendments to the Hatch-Waxman act have

created a more difficult environment for many generics manufacturers. Under the

previous system individual generics companies were allowed to block competition

if, for example, they had either made a deal with the originator not to launch or else

had agreed to take product from the originator. However, the 2003 amendments

include “forfeiture” provisions which can result in the generics company losing its

180-day exclusivity if found to have made such an arrangement. Additionally, the

2003 amendments allowed for “authorized generics”, which are copies made under

license from the respective innovator companies. In return, the originator receives

royalties on sales. Many generics companies feel that authorized generics dilute the

value of market exclusivities in the US;

Supply exceeding demand: Figure 4.23 shows the number of generic approvals in

the US has more than doubled from 137 in 2000 to 320 in 2004. However, at the

same time the volume growth in US prescriptions has been reducing year-on-year,

although there was a slight increase in 2004. Thus, while demand is reducing and

generic prices are falling, supply is at record levels, with capital expenditure

80

increasing for established players, new market entrants and ANDA approvals

increasing.

The generics market is now overcrowded with new entrants having entered the market

to capitalize on this high growth industry, and as a result supply now outstrips demand.

2005 to 2010 is therefore likely to be a period of high consolidation within the industry,

as larger generics players buy out smaller regional generics companies. Beyond 2010

the generics market will approach a more mature state through having fewer

competitors, stable prices and a well-defined regulatory environment.

Figure 4.23: US generic drug approvals, 2000-2005

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Approvals for multiple dosage strengths of the same compound are counted as a single approval

Source: FDA; IMS Business Insights Ltd

Due to the highly competitive nature of the generics market, where prices are falling

and margins are low, a notable trend in recent years has seen number of leading

81

generics players beginning to make inroads further up the value chain into difficult-to-

make generics, biogenerics and some companies have even moved into branded drugs,

seeking the high margins experienced by branded pharmaceutical companies. Generics

companies have also realized that the generics business is heavily tied to the patent

expiry of blockbuster drugs, and thus these generics companies are seeking greater

control of their own future revenues through investing in R&D.

Case study: Sandoz (Novartis) focusing on biogenerics

The market for biogenerics represents one of the most significant growth opportunities

for generics companies, and should help in boosting the growth of the generics sector

as a whole.

Whilst generic biologic medicines, or biogenerics, have enormous potential to redefine

both the generics industry and the biotechnology industry, the future of biogenerics is

uncertain and hinges on legislative, technological and competitive developments. The

creation of a legal framework that can enable the approval, regulation and marketing of

biogeneric drugs is the largest obstacle. However, the legal framework in North

America and Western Europe is forecast to be in place by 2010, paving the way for the

introduction of biogenerics.

Sandoz, the generics wing of Novartis, has stated its intention to focus its generics

business on difficult-to-make generics and biogenerics. This strategic shift is in light of

poor 2004 sales and growth figures for Sandoz, and recognition of the increasingly

competitive nature of the generics market and declining prices for traditional generic

products. Sandoz sees biogenerics as an opportunity to operate in a less competitive

marketplace, with higher value products.

Market growth to 2015

Despite the slower growth of generics in 2004 compared to the previous two years, the

generics market should continue to outpace the growth of the pharmaceutical market

overall due to the high level of branded drugs facing patent expiry in the next decade,

82

increasing efforts to contain healthcare costs and the introduction of biogeneric

products. The global generics market is forecast to grow at a CAGR of 10%, resulting

in 2010 revenues of $100bn and 2015 revenues of $180bn.

Big Pharma involvement in biotech and generics

Having discussed and analyzed the dynamics of the two major growth sectors in the

pharmaceutical industry, this section now examines the current involvement of Big

Pharma in the biotech and generics markets, and if indeed a move into these respective

markets is likely to be a profitable strategic move.

Big Pharma involvement in biotech

Figure 4.24: Biotech sales of leading players, 2003

Amge

n

J&J

Lilly

Novo

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isk

Sero

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2003 sales 2002/03 sales growth

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3,0004,000

5,000

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s ($

m)

-50%

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200%

2002

/03

sale

s gr

owth

(%)

Source: Business Insights, company reports Business Insights Ltd

Based on 2002 and 2003 sales figures, Figure 4.24 shows sales derived from biotech

products of the leading players in the sector. This figure shows that a number of the

leading players producing biological medicines are actually Big Pharma companies,

primarily J&J, Eli Lilly, Novo Nordisk, Roche, Schering-Plough and Abbott.

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Successful involvements

For those Big Pharma companies that have been successful in the biotech market, one

of the main ingredients for success has been the creation or maintenance of the small-

scale and entrepreneurial spirit of biotech R&D.

Roche is perhaps the best example of Big Pharma involvement in the biotech sector,

particularly in the high value sector of targeted molecular therapies. Through its major

shareholding in biotech leader, Genentech, Roche is a major force in biological

therapies, especially in oncology. Roche has also spun-out a number of its R&D units

to create smaller, independent biotechnology companies to focus on R&D in specific

therapeutic areas to promote the entrepreneurial spirit and higher productivity

indicative of biotech companies. Companies resulting from this strategy include

Basilea and Actelion in Switzerland, Novuspharma in Italy and, most recently, BioXell.

AstraZeneca has only recently begun to invest heavily in biotechnology. The director

of discovery alliances at AstraZeneca, Jitendra Patel, has commented:

“Turning a blind eye to biotech is not reasonable. Genomics has opened up a large area of opportunity where biotechnology is the immediate route to benefit. You need to recognize when the time is right to go beyond small molecules, where restricting yourself to small molecules will also restrict your breadth of opportunity.”

AstraZeneca has formed drug discovery partnerships with a number of biotechnology

companies due to its relative inexperience in this field – Cambridge Antibody

Technology (CAT), Abgenix, Lynx, BioVex, and Dyax. Perhaps the most significant

partnership is with CAT, a five-year R&D alliance for the joint discovery of antibody

drugs, one of the fastest growing classes of medicines. Significantly, the deal allows

AstraZeneca to opt-in to existing CAT drugs in development, while the biotech

company has the option of co-marketing drugs with its partner in the US market.

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Investment in the biotech sector

Due to high growth potential of this sector, and the fact that biotechnology is

contributing to an increasing proportion of the total pharmaceutical market, then

investment in biotech is one of the main strategic foci of Big Pharma. The 27% of

active research and development pipelines focused on biotech, compared to the 8.1% of

sales from biotech products, is one indication of pharma’s increasing focus and

investment in this sector.

Since there are no proven economies of scale in pharmaceutical R&D, and indeed

much evidence has suggested that scale actually hinders the R&D process, then this

presents a significant problem for the pharmaceutical industry in trying to compete in

the heavily R&D-focused and innovative biotech industry. Thus, pharma companies

intending to move into the biotech sector should take steps designed to maintain the

small-scale and entrepreneurial spirit of biotech companies, like Roche has with its

R&D spin-off companies and equity investments, and like UCB has with its acquisition

of biotech company Celltech, the R&D function of which remains largely independent

of the main UCB research organization.

Big Pharma involvement in generics

Branded, multinational pharmaceutical companies with R&D specialisms necessarily

operate on a long-term strategy. Generics companies necessarily operate on a short-

term strategy. These key cultural and organizational differences explain the difficulties

inherent in either type of company moving into the other’s market.

Unsuccessful involvements

One example of a branded company that entered the generics market but later withdrew

is Hoechst (now part of Aventis). The company bought Copley in the US in 1994 and

disposed of it in 1999, and sold Cox in the UK to Alpharma in 1998. Similarly, Rhône-

Poulenc Rorer sold its holding in Rugby-Darby to Watson in 1995 and sold UK

company APS-Berk in 1996 to Teva, although it retained an interest in the French

generic market through RPG (which includes French generic pioneer, Biogalénique),

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before selling it to Ranbaxy in 2003. Eli Lilly has also had a commercial interest in the

UK generics market in the late 1990’s under the name of Greenfield but later decided

that generics did not form part of its core business, while Bayer had its own German

subsidiary as well a US joint venture with Schein, which in turn owned Genus in the

UK (now owned by Stada). Bayer later made a strategic decision to leave the generics

market, and it subsequently sold its German generics subsidiary to Ranbaxy and its

French generics business to Teva.

Successful involvements

Nevertheless, some key players in branded pharma have been successful in generics.

The defining criterion has been keeping distance between the branded pharmaceutical

parent company and the generic subsidiary because the two types of company operate

in such different ways. A particular example is Merck Darmstadt, which acquired the

former Generics (UK) network of companies. Merck kept the individual operating

companies as their generic subsidiary in each country and used the existing GUK

model to set up new generic subsidiaries in other countries. This seems to work well

because generics companies, who need to be flexible and responsive, are not subjected

to big company bureaucracy. Pharmacia-Upjohn (now part of Pfizer) also continues to

operate in the UK generic market.

Novartis has also been successful, having bought generics companies such as LEK of

Yugoslavia, Biochemie in Austria, Lagap in the UK in the late 1990’s and others that it

unified under the revived Sandoz name as its generic operation. Sandoz has pursued

further major acquisitions in the last two years, with Sabex of Canada in 2004, and then

Hexal and Eon Labs in 2005 to strengthen its position in the German and US markets.

Novartis has chosen to keep its Sandoz generics subsidiaries at arm’s length and allow

them relative freedom.

Following the merger of Sanofi-Synthélabo and Aventis in 2004, the Sanofi-Aventis

group has maintained the Sanofi-Synthélabo generics division, now trading under the

name Winthrop Pharmaceuticals. The generics division was previously operated

86

independently in several countries through dedicated subsidiaries, namely Laboratoires

IREX s.a in France, Sterwin Medicines Limited in the UK, Lichtenstein Pharmazeutica

GmbH in Germany, IREX Ltda in Portugal, and Laboratoires IREX sro in the Czech

Republic. However, from January 2005 Winthrop Pharmaceuticals has been

headquartered out of a single site in Paris. With Sanofi-Aventis having previously

publicly stated its intention to grow its generics business to become a major player in

the European generics market, this shows that the company is making major strategic

moves in the generics market.

Competitive advantage in the generics sector

The generics companies that have remained part of larger R&D based pharmaceutical

companies have gained from economies of scale in new product development and

purchase of API’s. In addition, being part of a large group has given them access to

larger development facilities and increased buying power when dealing with contract

manufacturers. However, successful generics subsidiaries have also retained a degree

of autonomy leaving them able to respond quickly to changing market circumstances.

Where successful, multinational branded pharmaceutical companies represent a

significant threat to the smaller generics companies. For example, Merck’s French

subsidiary Merck Génériques has been the leading generics company in France for

several years and at the end of 2003 had sales of €232m and a generics market share of

28.3%. In markets where price competition is very high and price erosion is a serious

problem, the ability to contain new product development and production costs by

sharing manufacturing facilities with associated companies makes an important

difference.

Investing in the generics sector

The generics sector has witnessed significant growth in the last decade. However, the

industry is now suffering from competitor saturation and falling prices. Those

companies relying on the periodic boost from major patent expiries could find their

revenue streams shrinking towards the end of the decade.

87

Thus, a move into the generics sector for a major pharmaceutical firm is not likely to be

as successful or profitable as it would have been, for example, say 5 or 10 years ago.

That is not to say that Big Pharma cannot be successful in this sector, see Novartis, but

merely that it is unlikely to generate the level of revenue to compensate for poor

performance in the pharmaceutical sector, and thus a move into the generics sector

could form only one minor strategic move to drive sales growth, rather than a singular,

sustainable growth strategy. Such a move, most likely through the acquisition of one of

the leading generics players, would also be dependent on careful management – to

maintain the separate culture and structure of the generics company, in much the same

way as Novartis operates Sandoz.

88

89

CHAPTER 5


90

Chapter 5 Future growth and alliance strategies

Summary

Despite the lack of sustainability of mega-mergers, the majority of industry respondents (83%) to a Business Insights survey exclusively conducted for this report indicated that they expected the rate of mega-mergers would stay roughly the same, or that there would be only a slight increase or decrease in the next 10 years.

The number of alliances formed between pharma and biotech companies are likely to show the greatest increase to 2015, according to the survey. Respondents also hinted at increased consolidation within the biotech industry.

In order to address the negative relationship of scale versus R&D productivity, Big Pharma has two fundamental options: to restructure internal R&D operations to overcome scale deficiencies; or to exploit external R&D resources through alliances with companies not burdened with the deficiencies of scale.

In an analysis of 418 deals formed during a 19-month period (2002-3004) collaborative alliances were the most common deal type for accessing drug discovery technology and capability, accounting for 62% (259) of all deals.

With Big Pharma companies increasingly looking to external collaborations to source new products to boost ailing pipelines, the reality of networked or ‘virtual’ pharmaceutical companies is moving closer, at least in terms of the R&D organization.

Compared to the industry as it stands today, by 2015 the peripheral interests of individual companies will be substantially reduced. Big Pharma will focus more on its core competencies of sales and marketing which are enhanced by scale of operation, and will likely grow these functions organically or through acquisitions. This central core of key competencies will likely be supported by an R&D organization consisting of multiple long-term relationships with small external R&D companies.

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Introduction

In recent years the pharmaceutical industry has continued to use mega-mergers, and

their promise of improved productivity and ROI, as a key mechanism for delivering

critical mass in sales and R&D. However, mega-mergers have not proved to deliver

these benefits.

Despite the lack of sustainability of mega-mergers, the majority of industry

respondents (83%) to this report’s survey indicated that they expected the rate of mega-

mergers would stay roughly the same, or that there would be only a slight increase or

decrease in the next 10 years (Figure 5.25). The most likely candidate for major merger

or acquisition activity is Novartis, who were in talks with Aventis prior to the Sanofi-

Aventis merger in 2004.

Figure 5.25: The rate of mega-mergers to 2015

0 20 40 60 80 100 120Number of surveyed companies

Decrease significantly

Decrease slightly

Continue at roughly the same rate

Increase slightly

Increase significantly



Decrease slightly


Increase slightly




Decrease slightly


Increase slightly



This chapter of the report will explore alternatives to the mega-merger, including

internal R&D reorganization, selective M&A, collaborative alliances and licensing.

92

Alliances between industry sectors

This section will analyze the sectors most likely to be involved in alliances, before

considering the type of alliance of licensing activity that would be most beneficial to

Big Pharma and the types of alliances that are expected to dominate the industry in

2015. Figure 5.26 shows the results of a Business Insights survey of 300 senior

industry executives and external industry observers, who were asked about the

likelihood of alliances between pharma, biotech and generics companies increasing or

decreasing in the next 10 years.

Figure 5.26: Alliances between industry sectors, 2004-2015

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Pharma-Pharma

Pharma-Biotech

Biotech-Biotech

Pharma-Generics

Biotech-Generics

Alliance partners

Prop

ortio

n of

sur

veye

d co

mpa

nies Increase

significantly

Increaseslightly

Stay roughlythe same

Decreaseslightly

Decreasesignificantly


Pharma-Biotech alliances: Respondents believe that the number of alliances

between pharma and biotech are likely show the most increase, with 49% of

surveyed companies indicating that pharma-biotech alliances will ‘increase

significantly’ and a further 42% answering ‘increase slightly’. This highly positive

response to pharma-biotech alliances is due to the fast pace of growth seen in the

biotech sector in the past few years, and evidence of better productivity and rate of

approvals amongst biotech players;

93

Biotech-Biotech alliances: The survey also shows that industry executives believe

that there will be increased consolidation within the biotech sector, as it moves

towards greater maturity (69% of respondents answered that biotech-biotech

alliances were likely to either ‘increase significantly’ or ‘increase slightly’). Again,

this predicted increase in biotech-biotech alliances has arisen from the recent

growth in the biotech sector;

Pharma-Generic alliances: There was less of a consensus towards increased

pharma-generics partnerships, although 62% of respondents still believed that there

would be an increase in this type of alliance to 2015. This more reserved response

to an increase in pharma-generic alliances compared to pharma-biotech alliances

corresponds to the predicted faster growth of the biotech sector compared to

generics;

Pharma-Pharma alliances: The majority (42%) of surveyed companies believed

that the number of deals between pharma companies was likely to stay roughly the

same in the next 5 to 10 years, in line with the results shown previously that the

number of mega-mergers was likely to remain similar. Again this response

correlates with previous findings of this report, namely that the pharma sector is

stagnating and that the major product growth opportunities lie primarily in the

biotech sector, and secondarily in the generics sector.

The issue of scale

A mega-merger or acquisition is often justified as offering economies of scale in R&D

as well as sales and marketing. For example, for two leading companies which merged

in 1999, the explanatory document produced for shareholders stated that, “Size is an

increasingly important competitive factor in the pharmaceutical industry.”

However, analysis presented below indicates that:

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Size alone does not improve productivity, despite the theoretical potential for

greater efficiency or more successful new product development;

There are no, or negligible, economies of scale in pharmaceutical R&D.

Larger companies are thus no more productive and no more effective at increasing

productivity than smaller companies. This has implications for their ability to grow

shareholder value, since productivity (manifest in return on capital) feeds directly into

economic value added, a proxy for shareholder value.

Scale in R&D operations

In an analysis of the relationship between company operational size and R&D

productivity (Figure 5.27), there has been shown to be no significant economies of

scale in pharmaceutical R&D.

Figure 5.27: R&D productivity of the top 39 pharma & biotech companies, 2002

0

1

2

3

4

5

6

0 5 10 15 20 25 30 35 40

Company rank by 2002 sales (proxy for company operational size)

Universe of 39 companies R2 = 0.187

R&D

prod

uctiv

ity ra

tio

Fore

cast

sal

es o

f cu

rren

t pip

elin

e pr

ojec

ts i

n 20

08 ($

m)

R&

D s

pend

in 2

002

($m

)

Novartis

RocheBMS

LillyPfizer

GSKMerck

AstraZeneca

J&JAventisWyeth

King

Forest

MedImmuneGenentech

Gilead

0

1

2

3

4

5

6

0 5 10 15 20 25 30 35 40

Company rank by 2002 sales (proxy for company operational size)

Universe of 39 companies R2 = 0.187

R&D

prod

uctiv

ity ra

tio

Fore

cast

sal

es o

f cu

rren

t pip

elin

e pr

ojec

ts i

n 20

08 ($

m)

R&

D s

pend

in 2

002

($m

)

Novartis

RocheBMS

LillyPfizer

GSKMerck

AstraZeneca

J&JAventisWyeth

King

Forest

MedImmuneGenentech

Gilead

Source: Business Insights Business Insights Ltd

95

This is despite the theoretical potential for greater efficiency or more successful

product development. Indeed, analysis of the top 39 pharmaceutical and biotech

companies indicates a potential negative relationship between company size and R&D

productivity. In this case, R&D productivity is defined as the ratio between forecast

2008 sales of current pipeline products and R&D spend in 2002, and a company’s total

2002 ethical sales used as a proxy for the company’s operational size. While

rudimentary, this analysis provides no indication of a positive relationship between

operational size and productivity. Importantly, these data highlight the R&D

effectiveness of smaller companies particularly biotechs such as Genentech, Gilead and

MedImmune, which are expected to demonstrate strong productivity relative to their

peers.

Scale in sales and marketing operations

To look at commercial effectiveness of sales and marketing operations across the

pharmaceutical industry, the ROI for commercial activities can be measured by looking

at the relationship between sales revenues and selling, general and administrative

(S,G&A) expenses. Although S,G&A expenses are not strictly limited to commercially

driven costs, they do exclude the expenses relating to R&D, cost of sales and

depreciation.

Figure 5.28 shows the positive relationship between sales and S,G&A expenses for the

top pharmaceutical companies ranked by 2004 ethical revenues. In 2004 each

additional dollar spent on S,G&A resulted in additional sales of $2.98. Across the Big

Pharma sample there appears to be a linear relationship between sales and S,G&A

(97.9% of the variation in sales is explained by S,G&A expenses).

96

Figure 5.28: Sales vs. S,G&A, 2004

y = 2.9829x + 320.73R2= 0.9787

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000

Selling, general and administrative expenses ($m)

Sale

s re

venu

e ($

m)

J&J

Pfizer

GSKSanofi-Aventis

Novartis

AstraZeneca

Roche

Merck & Co

BMSWyeth

Eli Lilly

y = 2.9829x + 320.73R2= 0.9787

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000

Selling, general and administrative expenses ($m)

Sale

s re

venu

e ($

m)

J&J

Pfizer

GSKSanofi-Aventis

Novartis

AstraZeneca

Roche

Merck & Co

BMSWyeth

Eli Lilly

Source: Company reports Business Insights Ltd

Strategies beyond mega-mergers

Some of the major factors underlying poor R&D productivity in Big Pharma are the

deficiencies associated with traditional large-scale R&D operations, which include:

A low degree of flexibility and slow adaptation to change due to bureaucratic

decision-making;

Inefficient R&D expenditure;

Fragmented organizational structure;

Lack of focus;

97

Poor transparency and accountability and a low degree of ownership,

entrepreneurship and value recognition among R&D teams.

In order to address the negative relationship of scale versus R&D productivity, Big

Pharma has two fundamental options:

To restructure internal R&D operations to overcome the scale deficiencies

highlighted above;

To exploit external R&D resources through alliances with companies not burdened

with the deficiencies of scale.

What is more likely than a straight choice between these two options is that Big

Pharma will pursue a dual strategy of internal and external R&D. Internal R&D is more

risky as the average cost of researching and developing a drug in-house is now

estimated to be in excess of $900m. However the rewards of in-house development are

also greater, as the company retains all profits, which is why it is unlikely that

companies will disband internal R&D altogether, at least in the short-term. One of the

merits of pursuing external R&D resources is the lower risk. External R&D requires

less initial outlay but consequently generates less profit due to revenue sharing or

payment of royalties, license or milestone payments to partners.

Re-organization of internal R&D

GlaxoSmithKline (GSK) has put in place one of the most innovative strategies in the

industry to overcome its poor R&D productivity, and the apparent success of its ‘small

but large’ R&D strategy forms the benchmark by which other companies should look

to overhaul their R&D operations.

Although formed through consolidation, GSK has publicly put aside a strategy based

upon M&A in favor of significantly overhauling its R&D operations through its

pioneering ‘small but large’ approach. GSK’s new R&D strategy is based on the view

that certain activities within drug discovery and development benefit from large

98

operational scale while others are impeded. The company has taken the view that scale

is beneficial at the beginning of the R&D process, for example, in activities such as the

high-throughput screening of compounds against target during hit/lead identification,

and during the later stages of development, specifically the benefits that arise from the

capability to conduct large-scale clinical trials on a global basis.

On the other hand, GSK sees scale as a barrier to productivity and innovation with

respect to activities surrounding the middle ‘chunk’ of drug discovery and development

process, specifically the activities that take place from lead optimization to proof-of-

concept. For that middle ‘chunk’, the company has split this part of the organization

into seven smaller Centres of Excellence in Drug Development (CEDDs), in a bid to

foster the entrepreneurial culture of small biotech players within its massive operations.

Each of the CEDDs is operated as an autonomous, accountable business with a specific

therapeutic focus designed to accelerate early stage R&D and reduce attrition rates.

The company’s new strategy attempts to leverage scale at either end of the R&D

process while replicating a model that bears more resemblance to that of a classic

biotech R&D model than that of a large pharmaceutical company in the middle stages

of the R&D process.

From the implementation of the ‘small but large’ strategy in 2001, the company has

shown tangible results with a 76% increase in projects in clinical trials in from 2001 to

2004.

Exploiting external R&D resources

Exploiting a number of relationships across the R&D value chain provides an

alternative strategy to in-house re-organization for boosting productivity. External

R&D offers a number of advantages including distributing risk, lower upfront

investment and adaptability. A number of companies are already taking advantage of

such external R&D relationships, many of which are with biotech companies.

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Alliance deals

Pharmaceutical companies can use a number of types of deal to exploit external R&D

and drug discovery resources and expertise:

Collaborative alliances,

Technology licensing,

Buyer/supply relationships,

Evaluations

M&A activity.

Figure 5.29: Impact of alliances on future drug development

Buyer-supplier relationships15%

Dharmacon designed siRNA reagents for Bayer using its SMARTselections and SMARTpool technologies (Nov. 2003)

Evaluations3%

Initial agreement between ARIUS Research and Protein Design Labs (PDL) to evaluate ARIUS’s anti-cancer antibodies (Oct. 2002)

Mergers & acquisitions2%

Acquisition of 3D-Pharmaceuticals by J&J for drug discovery capabilities, e.g. HTS, combi-chem, cheminformatics (Mar. 2003)

Technology licensing18%

Novo Nordisk licensed the rights to Neose Technologies GlycoPEGylation technologies(Nov. 2003)

Collaborative alliances62%

Collaboration between Roche and deCODE genetics to develop phosphodiesterase (PDE) inhibitors for vascular disease (Nov. 2004)

Mos

t com

mon

type

s of

alli

ance

s (S

ep. 2

002

to M

ar. 2

004)

Alliances with biotechs forming drugs of the future

Buyer-supplier relationships15%

Dharmacon designed siRNA reagents for Bayer using its SMARTselections and SMARTpool technologies (Nov. 2003)

Evaluations3%

Initial agreement between ARIUS Research and Protein Design Labs (PDL) to evaluate ARIUS’s anti-cancer antibodies (Oct. 2002)

Mergers & acquisitions2%

Acquisition of 3D-Pharmaceuticals by J&J for drug discovery capabilities, e.g. HTS, combi-chem, cheminformatics (Mar. 2003)

Technology licensing18%

Novo Nordisk licensed the rights to Neose Technologies GlycoPEGylation technologies(Nov. 2003)

Collaborative alliances62%

Collaboration between Roche and deCODE genetics to develop phosphodiesterase (PDE) inhibitors for vascular disease (Nov. 2004)

Mos

t com

mon

type

s of

alli

ance

s (S

ep. 2

002

to M

ar. 2

004)

Alliances with biotechs forming drugs of the future


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418 drug discovery deals formed in the industry between September 2002 and March

2004 were analyzed by type of deal, as shown in Figure 5.29, to establish the types of

deals favored by pharmaceutical companies. It is these alliances that will be the source

of much of the drug development and drug launches in the future.

Collaborative alliances

Collaborative alliances were by far the most common deal type for accessing drug

discovery technology and capability during the period analyzed, accounting for 62%

(259) of all deals. In collaborative alliances both parties contribute to drug discovery

activities by way of expertise and resources. These deals are particularly attractive as

they benefit both parties. In an alliance between a pharma company and a smaller

player such as a biotech, the biotech will often be rewarded for their contribution by a

combination of up-front fees, milestone and royalty payments. However, this

compensation is linked to the success of the research and program and meeting pre-

defined goals. Thus for the pharma company, there is minimal loss if the project fails,

which mitigates risk.

Technology licensing

Technology licensing deals were the second most common type of deal behind

collaborative alliances. Technology licensing accounted for 18% of total activity

during the 19-month period. These deals, while focused and centered around the

licensing of technology or proprietary data for use in drug discovery, may also involve

the participation of the out-licensing company in drug development activities. In this

respect, the licensing deals span pure technology licensing to hybrid licensing/alliance

deals.

Licensing deals (as defined here) range from high value deals, such as the development

and licensing agreements signed between Novo Nordisk and Neose Technologies in

November 2003 (in which Novo Nordisk gained the right to use Neose’s

GlycoPEGylation technology for the development of next generation therapeutic

proteins in return for milestone and royalty payments of up to $55m) to lower value

101

deals. The latter, for example, simply provide in-licensors with access to proprietary

databases or screening technologies.

Buyer-supplier relationships

15% of the deals recorded between September 2002 and March 2004 were buyer-

supplier relationships. In these deals, companies supplying drug discovery technology

or capability are provided fees for their services in the absence of collaborative activity,

transfer of intellectual property between parties through licensing or complex reward

structures involving milestone and royalty payments. A typical buyer-supplier

relationship would therefore be that formed between Bayer and Dharmacon in

November 2003 in which Dharmacon was tasked with designing small interfering RNA

(siRNA) reagents using its SMARTselection and SMARTpool technologies. These

were to be supplied to Bayer for use in target validation and basic drug development

activities.

Evaluations

3% of the deals analyzed were classed by participating companies as ‘evaluations’.

These deals take the form of exploratory pilot projects designed to test the utility of a

company’s technologies or capabilities which, if successful, are expected to give rise to

more substantial licensing/fee-based or longer-term collaborative deals between

parties. For example, an initial agreement between ARIUS Research and Protein

Design Labs (PDL) in October 2002, which concerned the evaluation of two of

ARIUS’s anti-cancer antibodies by PDL, has since given rise to two new collaborative

deals focused on antibody generation.

Mergers and acquisitions (M&A)

Merger and acquisition activity, while only accounting for 2% of all deals in terms of

numbers, represents some of the highest value deals over the period. The evidence

confirms that M&A activity remains an important mechanism by which to exclusively

secure strategically important technology or rapidly enhance existing R&D capabilities.

For example, the $400m ‘merger’ of Applied Molecular Evolution with Eli Lilly in

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November 2003 followed a series of three collaborative agreements between the two

companies in the area of protein optimization. The decision to acquire this partner has

provided Lilly with ownership of Applied Molecular Evolution’s market leading

Directed Molecular Evolution technology for protein optimization and the ability to

apply this capability horizontally and exclusively across multiple therapy areas in the

development of biotherapeutics. For Lilly this is an important strategic acquisition to

support its long-term position as a leader in biotherapeutics.

While M&A activity, such as the merger between Applied Molecular Evolution and

Lilly can been driven by strategic reasons, other companies have been driven by the

need to simply enhance core R&D expertise and capabilities. For example, the $88m

acquisition of 3D-Pharmaceuticals by Johnson & Johnson, which was completed in

March 2003, provided the company with ‘bolt-on’ drug discovery capability for its

R&D operations Johnson & Johnson Pharmaceutical Research and Development,

L.L.C. The acquisition brought with it a suite of capabilities and expertise in high-

throughput screening, combinatorial chemistry, X-ray crystallography, structure-based

drug design and cheminformatics. Likewise, Merck KGaA’s (EMD Biosciences)

acquisition of ProteoPlex in August 2003, while enhancing the functional genomics,

proteomics and micro-array technology offering of its Life Sciences Products Division,

also provides the company with supporting technology for its own drug discovery

activities.

Forecast to 2015

This section presents the results of this report’s survey question on the strategies likely

to have most impact on R&D productivity to 2015, as shown in Figure 5.30.

Respondents were asked their opinion on which types of deals were likely to increase

and which were likely to decrease in order to improve R&D productivity in the next 5

to 10 years. Respondents believe that the selected acquisition of small R&D-focused

companies by pharma companies will be most likely to increase R&D productivity by

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2015. 45% of respondents indicated that this type of alliance would ‘significantly

increase’ while a further 43% thought it would ‘increase slightly’.

The deals least likely to increase in order to improve R&D productivity were the mega-

mergers. This is not surprising given evidence that such mergers provide no economies

of scale in R&D and that R&D productivity is highest in smaller companies. The

reorganization of in-house R&D also showed a relatively poor response, with licensing

activities, discovery partnerships and selective acquisitions all being regarded as more

likely to shape the industry by 2015. Therefore, the evidence from this survey suggests

that companies are looking towards external R&D resources, more that in-house drug

research, to tackle the productivity crisis and deliver the drugs of the future.

Figure 5.30: Growth and alliance strategies to increase R&D productivity, 2004-2015

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Mega-mergers

Selective M&A

Licensing of late-stageproducts

Early-stage licensing

Discovery partnerships

In-house R&Dreorganization

Type

of a

llian

ce

Proportion of surveyed companies

Decrease significantly Decrease slightly Stay roughly the same

Increase slightly Increase signif icantly


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The move towards networked pharma

With Big Pharma companies increasingly looking to external collaborations to source

new products to boost ailing pipelines, the reality of networked or ‘virtual’

pharmaceutical companies is moving closer, at least in terms of the R&D organization.

Instead of licensing products at a late stage of development, Big Pharma should focus

more on forming collaborations and partnerships which could yield multiple products

and prove far more profitable in the long-term than the $200m deals which have

categorized Phase II, III and registration deals in the last few years.

In Figure 5.31, respondents were asked whether the best way to achieve growth was by

specializing on core functions (i.e. sales and marketing) or operating a diversified

strategy maintaining many competencies and functions. The results show that three-

quarters of respondents believe that the future of the industry lies in concentrating on

the key strengths of Big Pharma – sales and marketing.

Figure 5.31: Big Pharma should concentrate on core competencies

75%

25%

Concentrate on corecompetencies and

divest non-core functions

Maintain a diversearray of competencies

and functions

75%

25%

Concentrate on corecompetencies and

divest non-core functions

Maintain a diversearray of competencies

and functions


Compared to the industry as it stands today, by 2015 the peripheral interests of

individual companies will be substantially reduced. Respondents believe that Big

105

Pharma will focus more on its core competencies of sales and marketing which are

enhanced by scale of operation, and will likely grow these functions organically or

through acquisitions. This central core of key competencies will likely be supported by

an R&D organization consisting of multiple long-term relationships with small external

R&D companies, as illustrated in Figure 5.32.

While many companies have adopted elements of a networked or ‘virtual’ R&D model

within their R&D strategy, few large pharmaceutical companies have integrated a

networked model as fundamentally as Roche. In opting out of M&A activity and

establishing a network of collaborative relationships in core therapeutic areas, the

company has increased flexibility and a wider range of options than are afforded by

more traditional R&D models. This has enabled the company to effectively implement

both long- and short-term strategies for ensuring ongoing productivity.

Figure 5.32: Vision of networked pharma in 2015

Sales & marketing2005 & 2015

R&D network 2015

R&D 2005

Equity investments

Licensing agreements

R&D spin-offs

Joint ventures

Discoverypartnerships

Technologydeals

Sales & marketing2005 & 2015

R&D network 2015

R&D 2005

Equity investments


R&D spin-offs

Joint ventures

Discoverypartnerships

Technologydeals


106

107

CHAPTER 6

Comparative company strategy analysis

108

Chapter 6 Comparative company strategy analysis

Summary

The sheer size that Pfizer has grown to limits its growth potential, with Pfizer needing to generate several billion dollars of added sales in 2005, or cut costs by the same amount, to achieve double-digit growth. The geographic expansion of its operations into emerging markets, particularly China, has been identified as one of its major growth drivers.

GSK has sought to counter its poor R&D productivity in recent years by setting up seven Centres of Excellence in Drug Development (CEDD) in an attempt to foster the entrepreneurial culture of small biotech players within its R&D operations. Each of the CEDDs is operated as an autonomous, accountable business with a specific therapeutic focus.

One of the major strategic shifts for the newly merged Sanofi-Aventis was the creation of a single generics business called Winthrop Pharmaceuticals in January 2005. Sanofi-Aventis has fairly ambitious plans for Winthrop to extend generics operations to fifteen or more countries by the end of 2006, and become a major player in the European generics market.

Like many of its competitors in the generics industry, Novartis’ generics business, Sandoz, has shown slow growth in 2004 due to declining prices and increased competition. As a result, Sandoz is aiming to readjust its focus to difficult-to-make generics and biogenerics.

Roche encompasses many of the strategies cited in this report as being essential to success in the next decade. The company is forecast to become one of the leaders in the pharmaceutical industry by 2015.

During 2004 and 2005 UCB transformed from a global pharmaceutical and surface specialties company to a focused biopharmaceutical company. This transformation was achieved by the $2.5bn acquisition of leading UK biotechnology leader Celltech in May 2004, followed in March 2005 by the $1.8bn sale of the surface specialties business to Cytec Industries.

109

Introduction

This chapter of the report profiles some of the leading companies in the pharmaceutical

industry, and how these companies are positioning themselves for future growth in

terms of geographic expansion and therapeutic focus, investment in biotech or generics,

and the creation of networked pharmaceutical companies. The companies profiled

include Pfizer, GSK, Sanofi-Aventis, Roche and UCB.

Figure 6.33 shows how each of these pharmaceutical companies profiled are placed in

terms of investment in R&D, S,G&A expenses, and sales revenues in 2004.

Figure 6.33: R&D, S,G&A and sales, 2004

0

5,000

10,000

15,000

20,000

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000

R&D expenses ($m)

Selli

ng, g

ener

al a

nd a

dmin

istr

atio

n ex

pens

es ($

m) Pfizer

J&J

GSK

Sanofi-Aventis

Novartis

RocheMerck & Co

AstraZeneca

BMS

Eli Lilly

Wyeth

Amgen

UCB

0

5,000

10,000

15,000

20,000

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000

R&D expenses ($m)

Selli

ng, g

ener

al a

nd a

dmin

istr

atio

n ex

pens

es ($

m) Pfizer

J&J

GSK

Sanofi-Aventis

Novartis

RocheMerck & Co

AstraZeneca

BMS

Eli Lilly

Wyeth

Amgen

UCB

Source: Business Insights, Company reports Business Insights Ltd

110

Pfizer

Pfizer is the world’s leading pharmaceutical company, generating revenues of $52.5bn

in 2004. As well as generating the highest sales, Pfizer also has the highest expenditure

both in R&D and in S,G&A.

However, the sheer size that Pfizer has now grown to limits its growth potential, with

Pfizer needing to generate several billion dollars of added sales in 2005, or cut costs by

the same amount, to achieve double-digit growth, not accounting for losses in sales due

to blockbuster patent expiries. The number of NCEs required to drive growth of a

company Pfizer’s size is likely to be in excess of that which Pfizer can produce, even

with its $7.7bn R&D spend. This is because increasing the amount invested in R&D

does not increase the productivity of this investment, and the R&D productivity of

large companies has shown to be poorer than that of smaller, more focused outfits.

Growth and alliance strategy

Pfizer tends to in-license products at a late stage of development, or after the product

has been approved (as it did with Rebif), and will continue to need to seek late stage

and/or recently launched products over the next few years, in order to fill the gaps in its

cardiovascular, CNS, infectious diseases and oncology pipelines. However, continued

reliance on sourcing individual late-stage products means the company will not gain

full benefit in terms of revenues and profitability from the products it markets and will

not have full control over their development, as recently indicated by the termination of

the deal for CDP-870 with Celltech.

One more profitable strategy available to Pfizer is to establish a stable network of small

R&D companies from which pipeline products are sourced, which Pfizer could help

fund in return for an option on full marketing rights to the resulting products. Such a

strategy could improve Pfizer’s limited in-house R&D productivity and allow the

company to focus on its core strength - not in drug discovery, but in identification of

products with high potential and creation/management of an effective marketing

111

strategy. Pfizer’s recent move to establish Esperion Therapeutics as a wholly owned

subsidiary, rather than attempting to integrate its operations as it did with the

Pharmacia and Warner-Lambert mergers may represent a step in this direction.

Geographic expansion

Pfizer has identified the geographic expansion of its operations into emerging markets,

particularly China, as one of its major growth drivers. Although Pfizer has been present

in the Chinese market since the 1980s, the company signaled a significant acceleration

in its China operations in 2004 with the creation of a new regional headquarters in

Shanghai and the new Pfizer Investment Holding Company. The investment company

was created in order to coordinate the activities of all Pfizer operations in China and

speed-up product entry into this fast-growing market (28% growth in 2004).

GlaxoSmithKline

GSK’s key strength lies in sales and marketing, and in effectively linking its sales and

marketing operations with its lifecycle management programs to ensure maximum life

span of each product. Strong historical examples of this include the success of the

antidepressant Wellbutrin SR, the value of the over the counter (OTC) switch of the

anti-ulcerant Zantac and the added benefits of GSK’s combination HIV therapies

Combivir and Trizivir. The ability of GSK’s sales and marketing team to maximize the

revenue opportunities for the combination asthma drug Seretide/Advair, the

combination oral antidiabetic Avandamet and the controlled-release Paxil CR will be

key to growth.


Despite its success as a sales and marketing company, GSK has suffered from poor

R&D productivity in recent years. However, the company sought to counter its poor

R&D productivity by completely overhauling its R&D operations in 2001 in a

significant long-term strategic move. GSK set up seven Centres of Excellence in Drug

112

Development (CEDD) in an attempt to foster the entrepreneurial culture of small

biotech players within its massive operations. Each of the CEDDs is operated as an

autonomous, accountable business with a specific therapeutic focus designed to

accelerate early stage R&D and reduce the attrition rate (Figure 6.34).

Figure 6.34: GSK Centres of Excellence in Drug Development (CEDD)

Genetics research

Discovery research

Preclinical development

Worldwide development

Biopharmaceuticals

Scale beneficial Scale impedes Scale beneficial

Microbials, muskuloskeletal &proliferative diseases

CEDDs

Metabolic & viral diseases

Cardiovascular & urogenital

Neurology & gastrointestinal

Psychiatry

Respiratory & inflammatory

CEDD 2004

Genetics research

Discovery research

Preclinical developmentPreclinical

development

Worldwide developmentWorldwide

development

Biopharmaceuticals

Scale beneficial Scale impedes Scale beneficial

Microbials, muskuloskeletal &proliferative diseasesproliferative diseases

CEDDs

Metabolic & viral diseases

Cardiovascular & urogenitalCardiovascular & urogenital

Neurology & gastrointestinal

Psychiatry

Respiratory & inflammatory

CEDD 2004


The success of GSK’s R&D reorganization cannot be fully judged until after 2010,

since it takes 10-15 years for projects to advance through the research and development

stages. However, the early signs are positive, with GSK reporting an 88% increase in

clinical NCE projects from 2001 to 2004, although 87.5% of its 88 NCE projects are in

phase I/II trials, with only 11 projects in phase III. Therefore, there remains significant

risk in the pipeline of GSK.

Despite having one of the best early-stage pipelines among leading pharmaceutical

companies, the investment community’s reception to GSK’s reorganization has been

lukewarm, as its investment analysis is focused on late-stage pipeline prospects and

113

earnings growth on a two-to-three year time horizon, which is less positive for GSK

due to the number of products subject to generic threat. Little credit has been given to

the fact that the company, having fundamentally addressed its R&D strategy and

reorganized its operations, provided evidence that it is delivering productivity

improvements that are likely to pay off in the longer-term.

One possible strategy to address the issue of risk within its immature internal pipeline

and boost its late-stage pipeline, is for GSK to build on its already productive alliance

and licensing activities, in addition to internal organic growth. In fact, this alliance

network has provided GSK with some of its most valuable pipeline products, including

the erectile dysfunction therapy Levitra and the cancer drug Bexxar. GSK’s alliance

network falls into a number of different categories:

Early-stage discovery partnerships (e.g. Exelixis, Ranbaxy);

Joint ventures for drug development (e.g. Shionogi, Tanabe);

Licensing deals to bolster pipeline (e.g. Medivir for MIV-210);

Co-marketing/co-promotion deals to bolster pipeline and marketed portfolio (e.g.

Bayer for Levitra, Yamanouchi for Vesicare);

Technology deals to facilitate product differentiation and lifecycle management.

In summary, GSK is operating a twin strategy of developing a networked R&D

organization around its core sales and marketing capability, as well as investing heavily

in internal R&D operations. This twin strategy is an attempt to mitigate the risk of

either strategy, although both center on the principal of smaller R&D units resulting in

higher productivity (Figure 6.34).

114

Figure 6.35: GSK’s R&D network


JointVentures

GSKCore competencies

Tanabe

Shionogi

Medivir

GSK network

RanbaxyExelixis

Drug discovery partnerships

Technology deals

various

GSK Centres of Excellence in Drug DevelopmentBiopharmaceuticals

Neurology &gastrointestinal

Respiratory &inflammatory

PsychiatryCardiovascular& urogenital

Metabolic &viral diseases

Microbials, muskuloskeletal,& proliferative

diseases


JointVentures

GSKCore competencies

Tanabe

Shionogi

Medivir

GSK network

RanbaxyExelixis


Technology deals

various

GSK Centres of Excellence in Drug DevelopmentBiopharmaceuticals

Neurology &gastrointestinal

Respiratory &inflammatory

PsychiatryCardiovascular& urogenital

Metabolic &viral diseases

Microbials, muskuloskeletal,& proliferative

diseases


Sanofi-Aventis

Sanofi-Aventis was formed by the merger of two European Pharmaceutical giants,

Sanofi-Synthélabo and Aventis, in 2004. The merged company has a broad based

strategy for growth, investing in its pharmaceuticals, vaccines and generics businesses.

Within its pharmaceutical business, Sanofi-Aventis also has quite a broad strategy,

with eight primary care blockbusters and also several smaller speciality care products,

and the company continues to invest in research in both these areas.

115

Geographic expansion

Sanofi-Aventis has publicly stated that it believes there are no ‘small markets’ and it

therefore intends to grow its business in emerging as well as traditional markets. The

company is particularly focused on growing its market share in the US market, as well

as the high growth markets in Asia and South America.

Investment in generics

One of the major strategic shifts for the newly merged company was the creation of a

single generics business called Winthrop Pharmaceuticals in January 2005. The basis

of Winthrop Pharmaceuticals was the existing Sanofi-Synthélabo generics division,

operated through independent dedicated subsidiaries in seven countries: France,

Germany, Portugal, UK, Czech Republic, Colombia and a newly-launched business in

South America. However, with the creation of Winthrop the generics business in now

operated globally out of a single site in Paris.

Winthrop will be operated through an arms-length approach due to the fundamental

differences in commercial strategy of operating a generics and a pharmaceutical

business: a generics business operates a short-term, reactive strategy, while the

pharmaceutical business requires long-term vision and direction.

Sanofi-Aventis has fairly ambitious plans for Winthrop to extend generics operations to

fifteen or more countries by the end of 2006, and become a major player in the

European generics market.


Prior to the merger, Sanofi and Aventis had very different attitudes to external

partnerships and alliances. Sanofi traditionally produced the majority of its drugs in-

house and only took partners to aid drug development and expand its geographical

presence. Aventis, on the other hand, traditionally employed licensing to improve its

growth prospects, with 19.3% of its 2003 sales derived from in-licensed products.

116

The merged company’s late-stage pipeline is relatively strong, with 12 drugs forecast

to be launched between 2004 and 2010. However, due to its large size the company is

also looking externally to supplement its R&D resources and pipeline, particularly in

the field of biotechnology. Examples of its partner and collaborations include

Millennium, Immunogen, Cephalon and Regeneron Pharmaceuticals.

Therefore, from the evidence presented Sanofi-Aventis appears to be adopting a

corporate strategy similar to that of Novartis – seeking growth opportunities in a wide

variety of markets.

Novartis

In contrast to many of its peers, Novartis has opted for a highly diversified business

model – being involved in a number of different business areas – rather than one of

depth.

Table 6.9: Novartis sales by division, 2003-2004 2003 sales 2004 sales Growth (%) % of 2004 ($m) ($m) 2003-04 total sales Pharmaceuticals 16,020 18,497 15 65.5 Consumer Health (Total) 8,844 9,750 10 34.5 Sandoz 2,906 3,045 5 10.8 OTC 1,772 1,975 11 7.0 Animal Health 682 756 11 2.7 Medical Nutrition 815 1,121 38 4.0 Infant & Baby 1,361 1,441 6 5.1 CIBA Vision 1,308 1,412 8 5.0 Total 24,864 28,247 14 100.0

Source: Novartis annual report 2004 Business Insights Ltd

As well as its pharmaceutical division, comprising of branded drugs, Novartis also has

a sizeable consumer healthcare division, with over-the-counter (OTC) drugs, generics

117

(Sandoz), the CIBA Vision ophthalmic business, infant and baby, medical nutrition and

an animal health unit. In 2004 the consumer health unit comprised 34.5% of Novartis’

total sales, as shown in Table 6.9.

Investment in generics

Novartis’ generics business, Sandoz, experienced slow growth in 2004 of just 5%

compared to 59.9% growth seen in 2003. This downturn was evident right across the

generics industry with growth slowing from 25% in 2003 to 10% in 2004, due to

increasing levels of competition and decreasing Gx (generic) prices.

Sandoz sales have been particularly weak in the important US and German markets. In

the US, Sandoz has been affected due to pricing pressures, the highly competitive

generics environment, and launch delays. The company has suffered in Germany

because of one-off impairment charges, a decrease in reference prices by the German

authorities, and the rebate war between market leaders.

In order to counter this slowdown in growth and increasingly competitive nature of the

generics market, Sandoz has two main strategies:

Biogenerics: In order to differentiate its products, and operate in a less competitive

and higher value market, Sandoz has identified “difficult-to-make” generics and

biogenerics key growth drivers, utilizing its biopharmaceutical contract

manufacturing expertise;

Acquisitions: Unlike its ethical pharmaceutical division, Novartis’ generics

division (Sandoz) has pursued a strong acquisition strategy in the last few years. In

2002 Sandoz acquired LEK pharmaceuticals for a cash price of $835m. This was

followed in 2004 by the purchase of Canadian generics company, Sebex.

Significantly, despite the difficulties experienced in 2004, Novartis has underlined

its commitment to the generics market with the dual purchase of Hexal and Eon

Labs, which should increase Sandoz’s contribution to overall Novartis sales from

11.7% to 17%. The Hexal purchase should increase Sandoz’s presence in the

118

German market, while Eon Labs will increase its penetration in US – both markets

that proved to be problematic in 2004.


With a number of recent successful launches and its promising pipeline, Novartis is set

to continue to achieve strong organic growth in its pharmaceuticals business over the

next few years, although it has also signaled its intention to expand further through in-

licensing agreements. While the company has continued to make acquisitions to boost

its presence in the generics market, it has not yet undertaken any major M&A activity

in the pharmaceutical market, although it did signal some intention in this area through

the recent talks with Aventis, prior to its agreement with Sanofi-Synthélabo in 2004.

Novartis has increased its level of licensing activity in recent years, in order to boost its

pipeline, and has signaled its intention to increase activity in this area. Novartis has one

partnership at the marketing level. It promotes its women’s health line through the

Novogyne joint venture with Noven Pharmaceuticals, but in general most of the

company’s existing growth drivers were developed in-house, leaving Novartis with

strong operating profit growth. The majority of Novartis’ licensing activity has been to

foster relations with a number of companies to boosts its R&D productivity. Major

products developed in collaboration with partners include the asthma drug Xolair

(Genentech and Tanox) and the cancer therapy PTK787 (Schering AG). Novartis also

has a number of early stage products resulting from new collaborations, including one

with Dr Reddy’s Pharmaceuticals for a novel diabetes drug. As well as direct product

related licensing deals, Novartis has established a number of development

collaborations in the last five years, including discovery alliances with Tanabe, Vertex

and Rigel, and technological agreements with Incyte and Geneva. The licensing of

pitavastatin for European markets from Kowa + Nissan Chemical Industries is a key

example of late stage in-licensing. A presentation at an analyst day in 2003 also

highlighted Novartis’ changing attitude to in-licensing, indicating that in the future it

will be a more central part of Novartis’ overall strategy.

119

However, the company’s marketed portfolio is heavily reliant on in-house discovered

and developed products, with over 95% of its sales in 2003 derived from internally

sourced and developed products.

Roche

In recent years Roche has implemented one of the most innovative and forward-

thinking R&D strategies in the pharmaceutical industry. Indeed Roche has transitioned

into the leading example of a networked pharmaceutical company, utilizing in-

licensing and collaborative R&D partnerships to drive innovation and drug

development. Through its major shareholding in Genentech, Roche has positioned

itself as a leader in biotechnology, especially within the growing oncology field, and

targeted the Japanese market through its equity investment in Chugai.

Since Roche encompasses many of the strategies cited in this report as being essential

to success in the next decade, then Roche is forecast to become one of the leaders in the

pharmaceutical industry by 2015.


Rather than following a singular networking strategy, Roche has used a number of

different strategies in order to drive R&D productivity: equity investments; licensing

agreements; and R&D spin-offs, as shown in Figure 6.36. By operating its R&D

structure through a network of small independent companies or units, Roche is

attempting to promote the entrepreneurial spirit and higher productivity indicative of

biotech companies.

120

Figure 6.36: Roche’s R&D network

Licensing agreement

Equity investments

ROCHEcore competencies

Acetilion

BioXell

Basilea

Chugai

Genentech

Antisoma

ROCHE network

Novuspharma

R&D spin-offs

Licensing agreement

Equity investments

ROCHEcore competencies

Acetilion

BioXell

Basilea

Chugai

Genentech

Antisoma

ROCHE network

Novuspharma

R&D spin-offs


As a leading Networked Pharma company, Roche has utilized its strong collaboration

strategy to drive company growth in a franchise-targeted manner. It formed at least 33

key collaborations between January 2003 and October 2004. These collaborations are

wide-ranging, and have allowed Roche to build up its product pipeline, in addition to

strengthening and diversifying its research programs and technology platforms.

Over the longer term, the wide mix of collaborations that it has formed positions Roche

for strong growth and diversifies the risk associated with the company’s dependence on

a small number of blockbusters. Additionally, Roche has fostered close links with

potential collaboration partners by choosing to partner with companies that it has spun

out, such as BioXell. This forms part of the company’s strategy to retain innovation

and knowledge capital.

121

Investment in biotech

By examining the companies that Roche forms partnerships with, it can be seen that

Roche is investing heavily in the biotech sector. As well as its majority shareholding in

biotech giant Genentech, Roche has licensed the rights to biotech company, Antisoma’s

entire oncology pipeline.

Through its biotech partnerships and spin-offs, Roche is now the front-runner in

molecular targeted medicine, and the world leader in the oncology market, the largest

therapeutic area currently served by biologicals (Figure 6.37).

Figure 6.37: Biologic medicine approvals by major indication, 2003

Oncology30%

Autoimmune

15%

Diabetes

11%

Hormone/Enzyme replacement

11%Cardiovascular

7%

Infectious disease 6%

Reproduction5%

Respiratory

4%

CNS

4%

Others

7%Oncology

30%

Autoimmune

15%

Diabetes

11%



11%Cardiovascular

7%

Infectious disease 6%

Reproduction5%

Respiratory

4%

CNS

4%

Others

7%

Source: PhRMA, FDA, Business Insights Business Insights Ltd

Roche has also positioned itself as the leader in the diagnostics market, recognizing the

importance of diagnostics in the targeted medicines marketplace. For example Roche’s

targeted breast cancer drug, Herceptin, is reliant on the diagnostic test for the HER2

protein for its success.

Since the biotech market is forecast to show the strongest growth in the next 10 years,

and with Big Pharma increasingly looking to external R&D resources for innovation, it

is likely that the Roche model will be replicated by other companies.

122

UCB

Investment in biotech

UCB has undertaken a major transformation of its business strategy since early 2004.

The company has transformed from a global pharmaceutical and surface specialties

company to a focused biopharmaceutical company. This transformation was achieved

by the $2.5bn acquisition of leading UK biotechnology leader Celltech in May 2004,

followed in March 2005 by the $1.8bn sale of the surface specialties business to Cytec

Industries.

This major shift in business strategy underlines UCB’s confidence in the high growth

potential of the biotech sector, which has grown at almost twice the rate of the overall

pharmaceutical industry for the past two years.


As well as shifting its research and product focus towards biotechnology, UCB’s

acquisition of Celltech also signified a change in growth strategy for a company that

had previously relied on internal growth as the primary mechanism to drive growth.

The company has internally discovered and developed a number of compounds that

have gone on to become globally important drugs including Zyrtec and Keppra. The

acquisition also plugs UCB’s pipeline gap between 2007 and 2010 and gives the

company access to a product pipeline that could drive long-term growth in new, high

growth therapeutic areas such as oncology, arthritis and Crohn’s disease.

The successful integration of Celltech’s R&D activities with UCB’s existing operations

represents a significant challenge for UCB, as UCB is a traditional pharmaceutical

company while Celltech is a biotechnology company and both have very different

business models and strategies, and additionally, UCB has limited prior expertise in

oncology, rheumatoid arthritis and Crohn’s disease.

123

Given Celltech’s proprietary knowledge in these therapy areas and in antibody

technology, UCB has decided to manage Celltech’s expert R&D division differently

from its current pharmaceuticals business, allowing Celltech to operate at arms length.

This approach has involved the creation of R&D “centers of excellence”, in as similar

fashion to GSK, with the Celltech R&D site in Slough (UK) now named the Celltech

Antibody Centre of Excellence in Antibody Research, the Celltech R&D site in

Cambridge (UK) now named the Cambridge Centre of Excellence for inflammation,

and the original UCB R&D site in Braine (Belgium) called the Braine-l’Alleud Centre

of Excellence for CNS.

In addition to its major investments and divestments in the past year, UCB is also

involved in several research partnerships, and appears to be using in-licensing to enter

new areas. In June 1999, UCB in-licensed the global rights to Xyzal excluding the US

and Japan, from Sepracor. More recently, UCB in-licensed the European rights to

Watson's oxybutynin transdermal patch for the treatment of urinary urge incontinence.

UCB also has a successful co-promotion agreement with Pfizer in the US for Zyrtec.

In February 2004, UCB formed a research, development and licensing agreement with

Dynavax for its novel treatments for ragweed and grass allergy therapies, and an option

to license Dynavax’s pre-clinical peanut allergy program. This agreement was a shift

for UCB who have previously tended to license single products at a much later stage of

development. Prior to its acquisition of Celltech, UCB was already showing interest in

the biotech market through a variety of alliances, including drug discovery and

technology deals with GeneLogic, Genfit, Galapagos and BioFocus.

UCB’s ‘network’ of R&D activities is illustrated in Figure 6.38, and shows a

resemblance to other pharmaceutical companies such as GSK, although on a much

smaller scale.

124

Figure 6.38: UCB R&D network

Technology deals

UCBCore competencies

Galapogos

Sepracor

UCBnetwork

GenelogicGenfit


Watson

UCB Centres of Excellence in R&D

Inflammation(Celltech)

CNSAntibody Research(Celltech)

Biofocus

DynavaxLi

cens

ing

agre

emen

ts

Technology deals

UCBCore competencies

Galapogos

Sepracor

UCBnetwork

GenelogicGenfit


Watson

UCB Centres of Excellence in R&D

Inflammation(Celltech)

CNSAntibody Research(Celltech)

Biofocus

DynavaxLi

cens

ing

agre

emen

ts


Therefore, with its investment in biotech through the acquisition of Celltech,

divestment of non-core activities, and subsequent R&D re-organization, UCB

encompasses many of the future growth strategies highlighted in this report.

125

Conclusions

Through the analysis of six pharmaceutical companies – Pfizer, GSK, Sanofi-Aventis,

Novartis, Roche and UCB – there is evidence of each of the strategies highlighted in

this report being implemented.

Future strategies to expand the customer base: Pfizer has identified China as a

major market in which to grow its business, and has begun to invest heavily in the

country through the creation of an investment holding company to manage its

operations;

Future product portfolio strategies – investment in biotech: Roche and UCB

have recognized the growing importance of the biotech sector and have adapted

their business models accordingly. Roche has set up a networked R&D model,

while UCB has acquired UK biotech leader Celltech in order to gain a foothold in

the sector;

Future product portfolio strategies – investment in generics: Novartis is

currently the most successful Big Pharma company involved in the generics sector,

through its generics division, Sandoz. Sandoz is run essentially as an independent

generics company, which is the model being also being adopted by Sanofi-Aventis,

through the creation of its Winthrop Pharmaceuticals generics unit in January 2005;

Future growth and alliance strategies: Several companies have recognized the

advantage of small scale in R&D operations. GSK has undertaken a major

reorganization of its internal R&D activities to create a number of small R&D

entities in order to boost productivity, while Roche has established a wide network

of biotech alliance partners.

126

127

CHAPTER 7

Appendix

128

Chapter 7 Appendix

Primary research methodology

The primary research contained within this report includes a detailed survey identifying

key pharma industry trends. The survey data was generated with inputs from 300 senior

industry experts and external industry observers. These respondents were drawn from

multiple company types and job functions in order to get a cross-sectional view of key

trends. Figure 7.39 shows the sample split by company type, and Figure 7.40 by job

function.

Figure 7.39: Survey respondents by type of company

Major pharmaceuticals

48%

Biotech

13%

Generics9%

Speciality products (incl. diagnostics) 10%

Other

20%

300respondents


48%

Biotech

13%

Generics9%


Other

20%



48%

Biotech

13%

Generics9%

Speciality products (incl. diagnostics)


Other

20%

300respondents


129

Figure 7.40: Survey respondents by job function

Corporate

20%

Marketing

28%

Sales

6%Commercial &

Business Development

15%

R&D 11%

Other

20%

300respondents

Corporate

20%

Marketing

28%

Sales

6%Commercial &


15%

R&D 11%

Other

20%

Corporate

20%

Marketing

28%

Sales

6%Commercial &


Commercial &Business

Development

15%

R&D 11%

Other

20%

300respondents


130

Index

Abbott, 82

ageing population, 30, 59, 62

alliances, 14, 83, 91, 92, 93, 97, 99, 100, 115, 118, 123

Amgen, 70

AstraZeneca, 56, 83

Bayer, 85, 101, 113

Biogen IDEC, 45

biotech, ii, 13, 14, 31, 50, 58, 70, 71, 72, 73, 74, 75, 77, 78, 82, 83, 84, 92, 93, 94, 95, 98, 100, 109, 112, 119, 121, 122, 123

blockbusters, 31, 41, 42, 56, 67, 79, 114, 120

BMS, 49

Cambride Antibody Technology, 83

Celltech, ii, 13, 84, 110, 122, 123

China, 10, 31, 38, 50, 53, 54, 55, 56, 57, 60, 111

cost containment, 25, 29

Eli Lilly, 49, 70, 82, 85, 101, 102

EU, 28, 29, 37, 38, 54

France, 36, 55, 60, 79, 86, 115

Genentech, 76, 83, 95, 118, 119, 121

generics, 13, 27, 28, 50, 67, 68, 71, 72, 73, 74, 78, 79, 80, 81, 82, 84, 85, 86, 87, 92, 93, 109, 114, 115, 116, 117, 118

Genzyme, ii

Germany, 28, 36, 54, 55, 60, 61, 79, 86, 115, 117

GlaxoSmithKline, 19, 20, 49, 70, 97, 98, 109, 111, 112, 113, 114, 123

Immunogen, 116

India, 10, 31, 50, 53, 60

in-licensing, 35, 42, 44, 49, 118, 119, 123

Johnson & Johnson, 49, 82, 102

mega-blockbusters, 13, 67, 69, 71

mega-mergers, 14, 35, 46, 47, 48, 49, 91, 93, 96, 103

Merck & Co, 20, 21, 41, 49, 85, 86, 102

me-too drugs, 22, 41

Novartis, 56, 81, 85, 87, 91, 116, 117, 118

obese population, 62

parallel trade, 25, 28, 29

Pfizer, 21, 40, 41, 45, 46, 47, 49, 56, 57, 67, 85, 109, 110, 111, 123

Procter & Gamble, ii

productivity, 14, 19, 21, 23, 25, 27, 28, 39, 40, 42, 45, 46, 47, 49, 50, 67, 71, 79, 83, 91, 92, 94, 96, 97, 98, 102, 103, 105, 110, 111, 113, 118, 119

R&D, 84, 86

Ranbaxy, 85

Roche, 13, 47, 49, 56, 70, 76, 82, 83, 84, 105, 109, 119, 120, 121

Sandoz, 47, 81, 85, 87, 117

Sanofi-Aventis, 45, 47, 49, 84, 85, 91, 109, 114, 115, 118

UCB, ii, 13, 84, 109, 122, 123, 124

131

UK, 21, 22, 28, 36, 60, 61, 84, 85, 86, 115, 122, 123

US, ii, 13, 21, 22, 25, 26, 27, 29, 35, 36, 37, 38, 53, 54, 60, 61, 62, 63, 70, 72, 74, 77, 78, 79, 80, 83, 84, 85, 115, 117, 118, 123

Vioxx, 10, 19, 20, 21, 41, 42

Western Europe, 81

Winthrop, 85, 115

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