Challenges facing the pharmaceutical industry.
Over the past number of years, the growth of the worldwide pharmaceutical industry has been slower than the increases in Research (R) and Development (D) costs, and this has led to a cost-earnings differential that cannot be sustained indefinitely. Firms have found it increasingly difficult to sustain historical levels of growth principally because of two converging factors. First, the earnings of the pharmaceutical industry are being increasingly squeezed between pricing constraints due to government policies and generic competition; and second, through the rising costs of R and D due to increasing legislative requirements and growing technological sophistication. As a consequence of these pressures on pharmaceutical earnings, combined with that of rising R and D costs, pharmaceutical firms have been forced to adopt a number of cost containment measures in addition to those pertaining to the safety and efficacy of drugs. The need to demonstrate 'value' to the consumer has now become imperative.
Traditionally, the pricing methods adopted in the former producer-driven environment for pharmaceuticals was essentially based on what was considered to be 'fair returns' for the high costs and risks associated with innovation. Today however, much of that has changed. The deregulation of generic products has helped to bring about a much greater acceptance of product substitution, which in turn has led to changes in consumer choice -- an event that has acted as a catalyst for change within the marketplace. Therefore rather than being producer-driven, the market for pharmaceuticals today is essentially customer-led. Price has become the key indicator of how the marketplace truly values the products that are discovered, marketed and sold. Consequently the price that a company charges for a product is the culmination of every decision made along the chain of discovery from discovery through to marketing. Therefore in order to be able to survive this challenging environment, pharmaceutical companies can no longer permit their internal processes to determine price levels, as this has now become the privilege of the customer.
The demand for innovation in an increasingly complex, global business environment has necessitated new approaches to organisation because the requirements for success in the marketplace have changed in a number of profound ways. In addition to demands for efficiency, quality and flexibility, pharmaceutical companies are also required to simultaneously cut costs, improve standards of quality, shorten product development times, and introduce innovative products that customers value. As a result, companies have been forced to re-examine every aspect of how their businesses are implemented and conducted, and this has given rise to a number of important issues that question the long-held and accepted ways of managing pharmaceuticals. It also raises a number of critical questions that are pertinent to five key areas of business.
The discovery, development and marketing of new pharmaceutical products is the essence of the research-based pharmaceutical industry. As a result of the transformation toward a customer-led marketplace, important issues have been raised which present a number of challenges to many pharmaceutical companies. Of greater significance is the issue of cost.
The total cost of bringing a new product to market from discovery through to launch, including the cost of capital with a risk premium and the cost associated with failures, is estimated to be approximately $500 million, over a 10-12 year period. Of this total, around 30 per cent of the costs are concentrated in exploratory research while the remaining 70 per cent are invested in subsequent development phases. At the same time, the percentage of money spent on innovation has been increasing steadily from around 6 per cent in the 1960s to approximately 20 per cent by the late 1990s.
Both the increased cost together with the growing quantity of resources being invested in pharmaceutical innovation are due to a combination of factors other than inflation. Traditionally, the rate of growth of the firm has been linked to new product introductions, as it was believed that increased investment in innovation generally guaranteed more novel products. Furthermore, the shift from acute to chronic therapy has increased the complexity of research as well as the regulatory approval process. Demands for regulatory data have almost doubled since the mid-1980s thus increasing the time it takes to get a product to market. In addition, companies with low levels of new product innovation have spent vast amounts of capital in an effort to secure future sources of revenue.
Owing to the culmination of these factors pharmaceutical companies face the immediate prospect of lower margins and almost no price flexibility for existing products in the world's largest markets. Therefore, the fundamental question that arises is whether pharmaceutical companies can afford to keep spending on innovation at current industry levels?
With regard to the level of research productivity within pharmaceutical firms, two important features have emerged. First, companies have discovered that as research moves up the technology curve it not only becomes more complex and costly, but that the level of output begins to decline as well. Second, as size and complexity increase, so do organisational inefficiencies. This combination of technological complexity, increases in cost, the effect of diminishing returns, as well as greater bureaucracy have consequently led to growing levels of inefficiency within the innovation process.
The implication of this long-term decline in innovative productivity within the pharmaceutical industry suggests that companies are not as successful as they used to be at innovation. Therefore what can pharmaceutical companies do to improve the input/output ratio?
A growing number of new products reaching the market are perceived to be derivatives, or those that offer a low level of therapeutic, safety advantages, or cost savings over already existing products. The adoption of class and therapeutic substitution are customer responses to poor perceived value.
It is universally acknowledged that in customer-led markets the customer's perception of value is paramount. It is for this reason natural that products that do not meet the requirements and satisfaction of the customer base will not be able to recoup the investments made. What therefore can pharmaceutical companies do to customise innovative output to match more closely the needs of its sophisticated, cost-conscious and value-driven customer base?
Historically, the largest pharmaceutical companies have achieved the majority of their sales by developing so-called annuity drugs that treat long-term chronic diseases within the largest number of patients. Because of this, the real strength of all of the pharmaceutical majors is contained in the various therapeutic classes they serve. However, most of these categories are now mature and already have relatively well satisfied patients. With mature products going off patent and with no new major therapies on the immediate horizon, there is the potential for a price ceiling to be placed for large-volume categories experiencing the move to generic status for many of the leading products. Consequently, the move toward organised generic, class and therapeutic substitution is a signal that imitative R and D will be less rewarding in the future.
Will there be a future market for a large number of 'me-too' drugs or is it just a futile economic venture?
One of the most important issues facing most pharmaceutical companies at present is the question of whether they have the capacity to convince their customers to pay premium prices to cover production costs, as well as to provide satisfactory returns for the future development of additional undifferentiated drugs. Many of the as yet fully untreatable diseases such as AIDS, cancer, migraine and multiple sclerosis are those that provide the most lucrative business opportunities. At the same time, healthcare providers and insurers within the industralised nations continue to debate the sensitive issue of whether society can afford the costs of maintaining and extending the quality of life. As a result, an inherent paradox exists.
Therefore will pharmaceutical companies be able to produce rapidly unique products that are truly successful in treating unconquered diseases, while at the same time obtain the high prices that are required to pay for cutting-edge research?
One of the most significant developments in the move toward customer-led change is the accelerated search for mechanisms to establish a sense of 'value-for-money'. This has led to the creation of pharmacoeconomics, which encompasses a set of potentially useful approaches for making more rational decisions for selecting drugs. Such approaches include analyses of cost benefit, cost effectiveness, cost minimisation, cost utility, the quality of adjusted life years, and eventual outcomes. Areas of potential use for customers include price negotiation, reimbursement and co-payment levels, formulary listing, substitution, treatment guidelines and improving prescription decisions. For the pharmaceutical companies involved, the primary use of pharmacoeconomics is to demonstrate value in order to support the marketing of products. It could also be used when selecting projects for R and D purposes.
In most instances however, there are conflicting forces at work. On the one hand, healthcare payers as well as providers demand the lowest-cost solution to their healthcare problems while remaining partial to acquisition costs. Conversely, pharmaceutical companies wish to avoid the downward pressure on prices by focusing on product value rather than on the cost of acquisition. Further escalating the value-cost conflict is the fact that there are no global standards for pharamacoeconomic techniques, coupled with a severe lack of conformity on how customers interpret output. When these factors are combined, the use of a particular set of approaches that are based on single cost structures becomes problematic.
In order for pharmaceutical companies to be able to reverse the decline of their profit margins, it is important that an atmosphere of acceptance be created among customers concerning the value of drugs rather than of their costs. If customers are not convinced that healthcare costs can only be reduced through integrated approaches and not by ingredient cost management, then this effort will surely fall. Conversely, unless research-based firms can discover a mechanism through which future returns for a successful product can be secured, thereby justifying the significant investment required for high risk, cutting-edge research, there will be a general decline in the number of products offering genuine solutions to healthcare problems.
How then can all research-based pharmaceutical companies convince their increasingly cost-conscious customers to look beyond the management of acquisition costs, and to appreciate instead the overall value of a drug in terms of its total savings in overall healthcare costs?
Furthermore, many of the development pipelines are currently saturated with chemical class variations, which will only serve to provide low-grade improvements in efficacy or safety. Such substances only have a limited potential to create meaningful differentiation over existing brands, or cheaper generic or therapeutic substitutes. In addition, the degree of patent protection available no longer provides a safety net over gross profit margins. Thus, the key issue centres on the extent to which a customer perceives how much a product is worth.
Inevitably, many pharmaceutical companies will have to implement an in-depth review regarding the potential marketability of their product pipelines. Therefore, should pharmaceutical companies continue to develop products for which customers are unlikely to pay enough in order that firms may recoup their development costs, or should such projects be abandoned in the first instance?
In the past, it was widely accepted that the more money and effort were put into innovation the greater was the chance of discovering new products. Corresponding to this stream of thought, it was also believed that the greater the number of new products introduced to the market, the greater the prospect of achieving considerable market success and hence competitive advantage. Although somewhat correct, this is no longer the case due to the changes that have occurred in the marketplace. Since much of today's management practice and operating culture in large industrial research laboratories was established prior to 1970, many of the institutions and instincts developed in this early period are now at odds with current realities. A new set of rules has emerged which now governs the market for pharmaceuticals, and as a result, required a re-examination of the assumptions upon which traditional pharmaceutical management is based.
In today's customer-driven market the degree of innovation success is a function of how well a product is perceived to offer new or better solutions to a customer's clinical problems. Companies are forced to make decisions based on resource allocation. They must favour new and better products, select from those considered marginal the few that will establish clinical and cost value from the customer's perspective, and abandon all products deemed mediocre. Success in the pharmaceutical industry is no longer determined by product innovation alone, but through a combination of value generating factors.
For many years the role of the physician was deemed crucial to ensuring product success. This was most common in instances where physicians had complete freedom of choice with regard to prescribing, or where there was relatively little concern for cost containment measures. However, since the end of the 1980s a rapid change has occurred as both public and private payers have come to realise that a policy of cost containment could only become truly effective if industry-focused supply side controls are effectively linked with physician and patient focused demand side controls. This has resulted in the development of a wide array of containment measures ranging from formularies to prescribing guidelines, mandatory substitution of cheaper products, as well as practice protocols. Therefore, while the physician remains an important constituent in the marketplace, the upstream consolidation of buyers together with tighter cost control measures has irreversibly changed the balance of power.
Traditionally, competition in the pharmaceutical industry was based largely on a product's features and its clinical performance. More recently however, this has changed considerably due to three important reasons. (1) The growing capacity of customers to make more informed decisions. Such decisions are based on the customer's perception of the clinical performance and cost implications of competing drugs. (2) The increasing variety and growing availability of generic products. The widespread acceptance of generic substitutability, together with the enhanced therapy provided by more recent introductions, have combined to drive down the price of new products. (3) The slow growth experienced in many of the world's pharmaceutical markets. Pharmaceutical companies have come to realise that the concept of survival is to take away as much market share as possible from rivals. Hence the heightened state of competition within the marketplace. Because of these changes, competition is now firmly based on the firm's abi lity to meet the needs of cost-conscious, powerful and sophisticated customers in the most effective manner. Competition between companies has steadily evolved from simply having the ability to innovate.
In the past, the strong flow of new products at premium prices, together with the ability of producers to raise prices as they wished, made operating costs a relatively unimportant factor. With the advent of a free market for pharmaceuticals, operating costs have now become a major concern for pharmaceutical producers. In an era when the customer dictates what will be paid rather than the company deciding what it will charge, new product pricing based on past practices is virtually impossible. The question of how well a company allocates its resources and structures its costs has become central to the issue of survival in an increasingly cost-conscious marketplace. The sophisticated, value-driven and often cash-strapped consumers who comprise the greater proportion of the industry's consumers are not only able, but are also motivated to make selections based on their individual perceptions of value-for-money. Pharmaceutical manufacturers must therefore be adept at discovering, producing and selling products t hat customers not only want, but are also willing to pay for. Central to this equation, is the need to economise on operating costs.
Pharmaceutical companies recognise the need to reposition themselves in two significant ways. First, they have to become fully integrated contributors to improved healthcare delivery, and second, they also have to become fully accredited partners to other members in the healthcare chain. The concept of becoming directly involved in achieving the optimum outcome for a product has rapidly gained as much importance as getting a product from the initial stage of conception to the finished, marketable product. In the new industry of pharmaceuticals, it is important that pharmaceutical manufacturers satisfy the healthcare needs of customers, rather than just sell pharmaceuticals.
The implications of such changes in the market are both fundamental and wide reaching, involving every aspect of the pharmaceutical business. The traditional marketplace for pharmaceuticals has given way to a more dynamic, customer orientated one -- always evolving and ever changing. In the light of such competitive changes, it is clear that companies have to continue to alter their strategic map and adopt a number of policies that will meet the needs of a modem and far more aggressive market.
Dr. Bianca Piachaud was recently awarded her doctorate by the Aberdeen Business School, the Robert Gordon University, Aberdeen.