Beyond the Blockbuster

For decades, blockbuster product development has driven the pharmaceutical industry. Under that model, a handful of products-and, in some cases, a single product-produce the lion's share of revenue and dictate a company's strategic direction. As companies get larger, they rely more and more on blockbusters to sustain their growth. The high cost of developing major, successful drugs only reinforces the need to focus on blockbusters. It's a vicious cycle that remains firmly in place for most Big Pharma.

In 2000, for instance, Claritin (loratadine) accounted for 45 percent of Schering-Plough's total revenue. Similarly, Prilosec (omeprazole) represented 44 percent of AstraZeneca's 2000 pharmaceutical revenues. At Aventis, two blockbuster therapies-Allegra (fexofenadine) and Lovenox (enoxaparin)- accounted for 22 percent and 20 percent of reven-ues, respectively. (See "Big Pharma's Product Pie,")

Big pharma's product pie

Although the blockbuster approach has served well for many years, it is now under pressure on several fronts:

Uncertainty over pipeline sufficiency. There may not be enough blockbusters in the pipeline to sustain the industry's double-digit growth .

Genomics and the promise of personalized medicine. These powerful trends raise the possibility of fragmented, smaller markets, unsuited to the blockbuster model.

Increased speed of "fast follower." The time between product innovation and second-generation has dropped from years to months, limiting pharma's ability to maintain a premium price for innovative therapies.

Reimbursement and cost pressures. Payers are trying to reign in healthcare costs, and pharmaceuticals are a prime target. Some states have refused to pay the high price of innovative drugs and threatened such actions as limiting reimbursement levels.

Tightening of regulatory pressures. FDA and other regulatory agencies are raising the bar for both getting new drugs approved and keeping existing ones on the market.

As those pressure points converge on Big Pharma, it becomes clear that the existing blockbuster model will not survive unchanged in this decade. This article offers lessons from medium-size pharma companies that have pursued alternative approaches with comparable success and from other industries that have had to reinvent their blockbuster strategy in the face of changing economic and competitive imperatives.

Research from the Tufts Center for the Study of Drug Development and PRTM Consulting demonstrates that the product development experiences of medium-size pharma companies carry important implications for their larger counterparts. The study defined big pharmaceutical companies as those spending more than $1 billion annually on research and development and medium-size companies as those spending between $500 million and $1 billion on R&D.

Message from the Middle

Researchers conducted a comparative analysis of big and medium pharmas by looking at the financial performance of the two sectors during the last few years. That involved comparing the two populations statistically across such key measures as gross margin; net margin; cost of goods sold (CoGS) over revenues; selling, general, and administrative expenses (SG&A) over revenues; and capital expenditures over revenues.

The analysis revealed little statistical difference in performance between the big and medium players. (See "The Size/Performance Issue,") In fact, the medium-size pharmas slightly outperformed their larger counterparts on several metrics. That finding leads to a central question: How did mid-size companies perform on a par with the biggest organizations without the inherent advantages of global scale and huge R&D expenditures? Extensive research reveals that they have developed certain strengths outside of the blockbuster model that positively affect performance.

The Size/Performance Issue

One prominent strength is their ability to act with flexibility, nimbleness, and speed. With less bureaucracy in their organizations, they can make decisions quickly. Moreover, they can more easily and effectively shift direction and re-deploy resources as needed. A timely no-go development decision, for instance, is more likely to result in the rapid and complete re-deployment of resources off a project.

Medium-size companies don't often have the luxury of hedging their bets. Consequently, they are more likely than Big Pharma to focus their resources on the best bets. Furthermore, the big companies tend to approach the product development process sequentially, while their mid-sized counterparts show a willingness to run development activities in parallel. And, although the approach entails some risk, it can significantly reduce time to market.

Another strength of successful medium-size pharmas is their willingness to engage in collaborative relationships. They are more likely to outsource key parts of the product development process. They also display a greater openness to ideas originating from outside of their own organizations and are more likely to incorporate approaches and processes that they did not create. In some sectors, they have established a better track record of adopting new R&D technologies than their larger counterparts, especially in the areas of drug delivery and, in biotech, product discovery.

Collectively, those strengths have had a positive impact on the business performance of medium-size players, who close a higher number of business deals relative to their size than do big companies. Furthermore, they have lower overall developments costs. By going after targeted markets with narrowly defined drug characteristics, they hold development costs in check while obtaining comparable results overall.

As they reassess the blockbuster model, Big Pharma may want to consider those strengths. By managing certain processes concurrently, by aggressively incorporating new technologies, and by leveraging more collaborative opportunities, the big companies may be able to more efficiently manage their R&D investments. The approach may also help them identify and kill failure-prone products earlier in the development process-a capability that can translate to huge cost savings.

Big pharma also can learn from other business sectors that have been forced to modify their original blockbuster orientation. The successful efforts of the automotive and movie industries as well as the unsuccessful attempts of the personal computer sector offer several important lessons. In each case, the dominant companies had to change their blockbuster mentality in response to a changing business environment. The transition required companies to

• generate a higher degree of cooperation with the competition

• share risk across multiple elements of the development and supply chains

• grow their business through next-generation products that complemented, rather than fragmented, the core market.

The US automotive industry of the 1950s and 1960s displayed many similarities to Big Pharma today. A handful of car models drove the revenues for the Big Three automakers. Consumer options were limited because manufacturers emphasized production runs of at least 200,000 units. Outsourcing was almost unheard of. The manufacturers controlled all aspects of design and production in-house, and suppliers were viewed as subservient entities that had to adhere to the dictates of the automakers.

Automotive Allegory

Everything started to change in the 1970s when competition from foreign companies came into play, and new technologies, such as integrated circuits, emerged. At the same time, consumers began asserting themselves. They sought a wider range of models and options to suit their particular tastes, effectively launching the journey toward "mass customization." In the wake of the oil crisis of the early 1970s, consumers also began demanding greater fuel economy and more cost-efficient cars.

Faced with such realities, US automakers realized they had to change. They embarked on a de-proliferation strategy that created both greater flexibility and economies of production scale. Today, that strategy can be seen in the common platforms shared by multiple models-for example, the Lexus ES300/Toyota Camry and the Infiniti I30/Nissan Maxima.

But perhaps the biggest change in the auto industry has been the landmark shift in supplier relationships. The industry no longer looks down on suppliers as necessary evils but rather views them as valued partners and often credits them as the source of breakthrough innovations. Automakers rely on their key suppliers to help them quickly develop new technology and respond to fast-changing consumer desires. Key suppliers typically share in new product development costs and risks as well as in the benefits.

At the major automotive companies only core competencies such as engine and drive train remain in house; non-core activities are outsourced to partners. Thus, the automakers have transitioned from manufacturers to assemblers and marketers. In fact, close to 70 percent of every automobile is outsourced today.

Better supplier relationships would likely benefit big pharma companies, too, as they redefine their product-development model. A co-development approach for new drugs, for example, could lower development costs and increase risk sharing.

Product development in the movie industry has undergone a metamorphosis similar to that of the automotive sector. In Hollywood's Golden Era, the studios owned their own sets and film crews. They also "owned" the actors, who were under contract. All development work was done in-house. Writing, pre-production, production, marketing, and distribution were under the firm hand of the studio. In a very real sense, the major studios operated a factory for making movies.

In the Movies

Over the years, an onslaught of external pressures forced the studios to change their approach to product development. Some of the forces that helped change the industry's old vertical business model were the emergence of a highly fragmented workforce, the increasing power of individual directors, and the rapid and widespread growth of alternative media such as television, cable, pay per view, and the internet.

Making a movie today essentially requires the creation of an entire company dedicated to the creation of a single product. When completed, the company disbands and individual components reform into new groups to make other movies. Movie production typically involves a one-time contractual agreement between a major distributor, a production company (or two), and a collection of freelance talent. Editing and special effects generally are outsourced to film labs and animation studios. Most of the people who work on a film today are not studio employees but independent contractors represented by various unions. Directors typically like to keep using the same freelance production and creative talent, forming a network of small ad-hoc teams they bring in when needed and disbanded once the movie is finished. Collaborations often occur with little reference to organizational boundaries.

One beneficial result of that fragmentation is a sharing of the risk among multiple parties. It is particularly important in an industry in which only 5 percent of all purchased scripts are ultimately made into movies. Fragmentation also has led to another important benefit-greater cooperation. Competing producers now often share their capital assets, such as sound stages and production facilities. Smaller production studios increasingly rely upon the larger studios to distribute their movies.

The revenue stream has changed significantly, too. In the old days, movie making began and ended with the movie and the theater operators. Today, a single movie generates multiple revenue streams through sequels, videos, cable and TV reruns, music and video games, action figures, and more. In fact, the biggest margins come through the market channels, not production.

Big Pharma needs to carefully heed that message of risk fragmentation and collaboration. By sharing capital assets across the product development process, they may be similarly able to reduce risk-and realize the attendant bottom-line benefits. When developing and marketing new products, the big companies need to consider additional revenue streams to augment therapy sales. They also need to think about moving drug development from cross-functional teams to a network of independent teams. The ability to effectively integrate and manage such a networked structure might prove to be a sustainable competitive advantage for the industry.

Not all industries have successfully moved away from the blockbuster model. The personal computer industry offers one such example. IBM effectively created the PC business in the early 1980s, rolling out blockbuster products that dominated the market. The company abandoned the traditional, vertically integrated product design model in favor of an open-source, modular-product architecture. It outsourced the microprocessor to Intel and the operating system to Microsoft. With that strategic decision, IBM set the de facto standard for personal computers and laid the groundwork for the undoing of its blockbuster model.

The PC Problem

The market grew rapidly, and initially, profit margins were tremendous, accelerating the PC to a blockbuster status that it maintained throughout most of the eighties. Yet, just as the growth curve was approaching its apex, the model began to fall apart. The high margins attracted fierce competition from both the United States and abroad. IBM's early decision to create a modular product and outsource the building blocks only opened the door wider to competitors. With the standard interfaces in place, other PC makers could easily copy IBM's product and compete aggressively on price.

Then the blockbuster model changed. Value migrated from the sub-system assembler (IBM) to the sub-system providers (Microsoft and Intel). The dominant product became IBM compatible rather that just IBM.

The experience holds several important lessons for blockbuster-driven Big Pharmas. First, there's no guarantee that the products and technologies that are successful today will remain so in the future. Second, industry stagnation often occurs in the transition to a post-blockbuster environment-evidenced by the fact that a PC costs less today in actual dollars than it did in 1990. Third, outsourcing decisions need to be made with careful consideration of long-term implications-beware of "Intel Inside." Finally, companies need to develop new strategies for addressing the competition when product performance is not a key differentiator.

The lessons of other industries-coupled with the experiences of mid-sized companies in their own industry-can help Big Pharma successfully redefine their blockbuster business model. Other business sectors have prospered during the evolution; Big Pharma can do the same.

Adapt and Survive

The need for flexibility and speed, the business value of collaborating with suppliers, the bottom-line benefits of fragmenting risk, the importance of understanding the long-range implications of outsourcing decisions-those are all issues that large pharma companies need to consider as they rethink their approach to new product development. The blockbuster model may not be dead, but it will never look the same again.