Healthy Skepticism Library item: 2787

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Publication type: news

Mozeson M.
Reinventing Big Pharma
Forbes.com 2005 Dec 1
http://www.forbes.com/2005/12/01/merck-pfizer-in_mm_1201soapbox_inl.html

Keywords:
Merck

Notes:

Ralph Faggotter’s Comments:

Merck has a new CEO who will be making- “fundamental changes in its business model.”

Since he has come to Merck from manufacturing, don’t get your hopes up that this will be a change for the better.

Full text:

Mozeson M. Reinventing Big Pharma. Forbes; December 1, 2005
www.forbes.com/2005/12/01/merck-pfizer-in_mm_1201soapbox_inl.html

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

Merck’s new chief isn’t a former scientist or physician or marketer. He
earned his stripes in manufacturing, and he aims to restructure Merck with
efficiency and return on investment in mind.

In pharma, the signs that big changes were needed have been there for years,
though not much has happened. Revenue growth has been declining steadily as
new products have become more costly to source, develop and bring to market.
Sales and marketing costs have escalated in the face of higher competition
for physician access, the proliferation of consumer channels and the growth
of direct-to-consumer advertising. So why is an industry that prides itself
on innovation struggling to respond to the writing on the wall?

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

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

Is The Blockbuster Model Dead?

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

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

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

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

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

Is The Sales Model In Pharma Broken?

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

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

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

One has to challenge these assumptions. First, does a busy physician react
to quantity or quality? Is there a way to reach a physician on their
schedule and, if so, will that interaction be better? Are there ways to
understand physician needs in advance and address those needs, rather than
recite the same overused sales pitch? We say, of course there are. There are
many ways to do all of this. At some point, with the existing process, the
information becomes noise, and the innovator of the more efficient method of
reaching physicians will realize value. It also doesn’t require a complete
and instant abandonment of the existing model.

Physicians are like all other people: They retain knowledge better when it
relates to solving a problem that exists at the moment. The typical sales
rep provides them with information when they don’t necessarily need or want
it. In fact, they are focused on other problems and not interested in
learning about drug interactions and efficacy advantages.

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

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

Prescriptions For The Future.

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

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

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

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

Mark Mozeson is life sciences practice leader at Archstone Consulting