Pharma 2012: Hard Times Before the Harvest

2012 is a transition year for pharma, one of the most important in the industry's history of product cycles that spin from plenty to penury. On the positive side, the fires of drug discovery are finally being stoked by a growing understanding of how genomics shape the biology of disease. This is leading to promising new treatments that target critical areas of unmet medical need while also increasing the efficacy of interventions geared to the individual patient. Evidence that these next-generation innovations can advance the science while improving outcomes will hopefully lead to ready acceptance in the market, despite the growing leverage of a much more skeptical and discerning customer base.

Getty Images / Jason Hawkes

The challenge is that many new treatments may not complete the move from 'bench to bedside' in time to plug the yawning revenue gap from a second record year of patent expiries. This year's drop off the patent cliff is the longest and steepest, with a $50 billion loss coming on top of the $30 billion ceded to generics in 2011. Most companies will struggle to play catchup, with margins under intense pressure due to the immediate fallout from genericization of the product base; in the U.S. alone, off-patent penetration has reached 80 percent of all scrip, and IMS forecasts this figure will rise to 86 percent by 2015.

Meanwhile, the fiscal crisis in Europe has voided the entire concept of patenting as a reward for innovation in providing a temporary period of price exclusivity. Therapeutic reference pricing is clustering brands with the cheapest generics, and some countries in the region are now moving toward a straight bulk procurement model for drugs reimbursed through state-sponsored systems. Quality? Innovation? These are yesterday's questions.

Trade Winds Go Generic

The erosion of patent cover means that 2012 will be a golden harvest for the generics industry. While it is premature to condemn all new medicines to the slashing scythe of the grim reaper, innovators, at least for the near term, must adjust to a world where only slightly more than one out of every 10 U.S. prescriptions will be written for products with the potential to obtain a real price premium against the competition. Who will pay for innovation is a question deferred—but it will loom large as the cycle shifts back toward large biologics and the discovery payoff from the genomics revolution begins to empower the patient seeking a cure or a better quality of life.

So what is the preferred Big Pharma strategy to manage through this year of transition? Pharm Exec contacts with a range of industry players reveals that the dominant theme for 2012 is a relentless focus on managing costs. Pressures to cut back are mounting, not just in the expected areas such as R&D or field force management, but also through the rich incentives that companies are laying out to breach the access barriers and contract pricing ultimatums imposed by payers exercising their market clout. These payer tactics now incorporate the specialty segment, oncology, and other high-margin categories, which have, to date, been largely immune to pricing constraints.

Trim the Sails on Costs

As far as the investor community is concerned, one number counts. "Wall Street will be looking for evidence that companies know how to manage their expenses, and the best gauge of progress here is the difference between gross and net sales," says Amundsen Group managing director Mason Tenaglia. That view is echoed by St. Joseph's University Business School Professor Bill Trombetta, author of Pharm Exec's annual industry audit series, whose latest report in our September 2011 issue makes "lean management" a key theme. "2012 is all about the edge that will go to companies that achieve operational excellence against their peers. The logic is that the best way to cope with the uncertainties of a complicated business climate is by mastery of the internal environment, where management can exercise a stronger degree of control."

Slashing costs is necessary to minimize the immediate impact of the patent cliff on revenues. It also represents a welcome change in mindset, away from the complacency and tolerance for bloat that characterized the industry response to market churn in the previous decades. And as the pharma workforce is trimmed—a bloodletting long deferred—it provides fresh opportunity to revise the skill set required to prevail against the competition. Financial planning, manufacturing, competitive intelligence (the new costume for traditional market research), and IT have all been elevated to status as strategic functions rather than an operational activity.

Missing Link: A Growth Strategy

Few observers see day-to-day management efficiencies as a solution to the industry's larger problem, which is reviving organic growth. This requires an understanding of how profound the forces remaking the overall market for healthcare really are. "The strategic driver for Big Pharma today must be a sense of urgency; the tectonics of change—mainly involving the customer base—are rapid and unyielding," says Carolyn Buck Luce, global pharmaceutical sector leader at Ernst & Young. "Healthcare is transitioning to a different business, which we characterize as 'the third place(s) in healthcare,' where drugs and other health services are manufactured, delivered, consumed, and paid for by a far wider nexus of stakeholders than currently reside in the hospital and the physician."

Buck Luce cites Starbucks Coffee as a precedent, one that creates that "third place" around the consumer and which spins profits not only by marketing a product that people want but also by acting as a facilitator of contacts—the provider of a community service. "The Starbucks model is brilliant, as it is centered on the customer is experience. This model is analogous to what pharma has to do in adjusting to the pace of change in healthcare. Its network of neighborhood outlets cements that elusive long-term and intimate relationship with the customer, whose preferences can be tracked in a manner that allows for early readouts on behavioral change. In fact, our thesis is that success in pharma will depend on how well companies position themselves as agents of behavioral change: If you are not able to enter the patients' mind to understand and then motivate him or her around the most appropriate interventions, you are not likely to be rewarded by payers and others inhabiting this new third place."

Are You in the Business of Behavioral Change?

Simply put, failure to extend the pharma model to seize opportunity from activities taking place outside the brick and mortar hospital or that challenge the dominance of the physician in apportioning treatment resources will marginalize companies within a cycle of diminishing returns. Revival of growth based on the double-digit returns routinely delivered to Wall Street during the glory days of the 1990s will require a higher tolerance for financial risk as well as the acceptance of a different organizational culture: decentralized decision-making, less bureaucracy, and the kind of "skunk works" experimentation built around learnings from other industries.

Evidence suggests the industry is moving in this direction, although in the incremental manner typical of a sector that for years has had it good. One has only to observe the play-out from hundreds of individual company transactions, all taking place without much media scrutiny. Their imprint may be low compared to the giant M&A deals of the past five years, which itself evidenced the conviction—now in disrepute—that organic growth could be delivered through consolidation. Collectively, these smaller deals could prove a more consequential and enduring stimulus to growth due to their focus on moving the industry beyond the pill to that of an integrated information, process, and service provider—with the ultimate goal of improving outcomes for the patient.

Aging and Public Debt—The Perfect Storm

Unlocking new sources of growth will be complicated by the convergence of two contradictory forces this year. The first is acceleration of the demographic transition toward an aging society. In many OECD countries, pensioners are beginning to outnumber able-bodied workers, a trend that will gather pace through 2025. In Belgium and Italy, fewer than half of males over age 50 are still working, while in the U.S. the first wave of the 77 million baby boomers became eligible for participation in Medicare last year. Enrollments in the program are slated to nearly double through the end of this decade.

The second is the unexpected revolt of the lender community in servicing government debts on social entitlements, including healthcare. The OECD forecasts that member states will need $1.5 trillion in fresh borrowing to fund entitlements this year, or almost twice as much as in 2005. Promises that governments would "ring fence" healthcare, protecting it from the budget axe, have been abandoned, and cutbacks in drug spending are spreading throughout Europe. Currently, the industry is owed nearly €10 billion in unpaid bills by payers in high-debt markets led by Spain, Portugal, Greece, and Italy. A significant portion of this debt is being repatriated to manufacturers in the form of government bonds, the face value of which begin to depreciate from the date of issue.

In the U.S., another "contribution" from PhRMA member companies to help push deficit reduction around health reform is likely after the coming November presidential election, regardless of which party wins. It will push Big Pharma's total givebacks to more than $100 billion through 2019, when "Obamacare" is scheduled to be fully phased in. Actually, the final bill will probably never be known—another blow to the predictability required by an industry facing unusually long development time frames.

Politics, Politics

The fiscal crisis will scuttle the industry's optimism about the impact of aging on demand for innovative medicine and healthcare overall. With budgets facing unprecedented pressure, how to pay for drugs is becoming a prominent function of—guess who?—the government. It is no surprise that price regulation, rather than market-friendly instruments like patient contributions, is the preferred policy response. Even emerging country markets are moving in this direction, as the bill falls due on required investments in basic health infrastructure (China, India, and Turkey are cases in point.) And the imperative to pay down debt is jeopardizing activities where governments can play a positive role, such as tax incentives for basic research and investments in public health infrastructure.

There is an added element: Politics will be front and center this year, with potentially game-changing elections slated in key markets, including the U.S., Russia, France, Mexico, and Korea. China, which is midway toward extending basic health coverage to 900 million people (300 million over age 60), will undergo a generational leadership transition at year end amid signs the domestic economy is slowing. Sharp regional variations in living standards and the escalating expectations of the middle class are already on the table for the new regime. Health reform is one tool that the government can apply to address these challenges, which is why many China observers expect a more aggressive regulatory approach to pharma and biotech, already singled out as one of seven "strategic sectors" of the economy deserving government attention.

To put it bluntly: Is the China star shining so bright it keeps you up at night? Then perhaps it's time to pull the shade down a bit—and that goes for other emerging markets as well.

Tracking the Transitions

With this broad survey of the landscape as backdrop, Pharm Exec highlights four strategic drivers that should compel the attention of our "C-suite" readers in 2012:

1) A reinvented business model won't change what is fundamental: Higher pipeline productivity in the form of new patented products is still the best source of future profits. This year will see new therapeutic breakthroughs that may revitalize the blockbuster, to include biologic drugs intended for targeted patient populations with few treatment alternatives. Many are novel not only for their indications and superior efficacy and safety profiles; they also mark an advance in the mode of delivery, replacing injectables with a once-a-day pill or acting in combination with other compounds to provide more precise dosing with fewer side effects.

Overall, the trend illustrates the impact of company efforts to integrate within their R&D organizations a more overt commercial benchmark in addition to science and regulatory indicators. If trial and regulatory milestones are an ingrained part of the development timeline, why not add criteria for achieving access or reimbursement as well? Few companies today are inclined to say no.

Says Peter Tollman, Global Leader of Boston Consulting Group's biopharma sector, "Successful R&D organizations are being forced to justify their investments in discovery and development around a precise estimate of value, one that includes consideration of the payer perspective and the impact on patient outcomes." He notes that tomorrow's R&D organization must look beyond the drug toward process and organizational innovations that facilitate consultation with the customer. "We are seeing a higher level of engagement around information tools like patient registries that highlight practice patterns relevant to a particular drug candidate. It's a way to differentiate against existing therapies and bring both the innovator and the payer to a consensus on value." Companion diagnostics is another model for this kind of interaction, where the payoff can be measured in ways beyond that of the technology itself.

Growing optimism about a return to innovation doesn't mean that the debate over the best blueprint for R&D will be resolved—at least not in 2012. It takes on average a decade to commercialize a promising compound from proof of concept, so much of the current discussion around alternative approaches—from outsourcing key aspects of development to the "string of pearls" focus on science generated in-house—amounts to sheer background noise. Consultants can't charge for this, and the evidence is purely anecdotal, but what does seem to matter is a long-term commitment to the science; retaining good people; acknowledging that internal competition can boost overall productivity and performance against agreed targets; a knack for finding and keeping a diverse circle of partners; and a healthy helping of luck. Analysts call it the "hybrid" model and companies will continue to tailor R&D strategies to fit their own circumstances.

2) 2012 will signal the industry is transitioning to an era of lowered expectations; pricing, reimbursement, value, and policy will combine in complex ways to drive down margins. The bottom line is that it is becoming harder to make the contacts that drive sales with providers and the patient. Consolidation in the payer community gives them greater leverage in controlling the use of medicines, generic penetration limits the scope of argument about competitive differentiation, and increased government regulation has ended many of the promotions that helped build relationships with physicians. More therapeutic "crowding" in the specialty segment is another trend that will depress margins because payers now have a choice and can restrict access or demand rebates and discounts, as they have done with devastating effect in primary care.

Moreover, to cope with these developments, brand manufacturers are spending heavily on incentive programs like copay cards as well as patient support activities geared to raising adherence to therapy. "We estimate that industry spending on these copay card and rebate programs will exceed $34 billion this year, which is roughly three times the cost of deploying the field force," Tenaglia tells Pharm Exec. Much of this activity is geared toward influencing the commercial business, and the added cost exposures will sharply depress margins there just as higher rebates mandated by health reform turn the public Medicaid and Medicare Part D programs into loss makers. "In Medicaid, you're lucky if you get paid at the level of the cost of goods—there is no margin left there," Tenaglia says.

As a result, 2012 will see more effort to change the incentive package for sales reps, on the premise that "not all prescriptions are considered equal." Pay incentives will motivate reps to win more non-controlled, third-tier reimbursed prescriptions rather than just focusing on the volume of scrip. This in turn will provide the rationale for more culling of the ranks—selective deployment of this human resource is key.

Tensions between brand manufacturers and pharmacy benefit managers over the impact of these incentive programs will also shape the competitive landscape this year. Nevertheless, some observers are optimistic that both sides will recognize that such conflict is misplaced. Paul Kandle, general manager for Cegedim Relationship Management's OPUS Health business unit, focused on patient adherence programs, notes that there is value for all parties in these programs—if their impact is measured in terms of better health outcomes. "It's less than meaningful to evaluate copays and other dollar offset plans as just a way to cut costs to the patient without considering their overall impact within a well designed adherence program. Their real value is unlocked when we understand how they improve adherence to treatment, enhance quality of life, or produce a gain in public health outcomes. At OPUS Health, we are focused on accurate assessment of these programs, improving analytics, and we are committed to designing the most well thought out programs to maximize overall value."

3) Advances in information technology will continue to shape the conversation with customers on access, value, and price. That conversation is going to take place in public, as evidenced by the growth of cloud computing, which "hyper-democratizes" access to the vast resources of the Web—it's the everyman's Google. But Big Pharma is a business, with proprietary interests, so a key priority that will play out through 2012 is marking progress in defining basic standards on the application of IT. The goal is to ensure those business interests are protected while adding benefits through agreed channels for data sharing—the new Pistoia Alliance of companies engaged in precompetitive research is a good example—as well as improved IT management processes that raise efficiencies and lower costs.

Government regulators can help speed this trend—or delay it. The problem is that key agencies like the FDA are way behind industry in adapting to the IT revolution.

Internal reforms are vital, because done right IT can help advance the portfolio through faster lead times and building that better case for competitive differentiation. "IT can be a driver or a drag on productivity—the results depend on whether IT is mapped to optimize business processes that control how data is accessed, aggregated, and utilized and where these processes are conformed across the company," says Oracle senior vice president Neil de Crescenzo. Conformed is a key word, because the best systems balance the global scope of today's pharma business model against the importance of local due diligence and each local operation's specific challenges.

Another asset, says de Crescenzo, is how effective IT systems act as a safeguard against the misinterpretation of data. "Data vendors today have the technology to create databases so large they literally defy the laws of physics. It is analytics at the speed of thought, which if not handled correctly can produce signal detection problems and an overemphasis on population-based surveys against specific patient interests. We need to work cooperatively with industry and regulators to develop the tools to monitor and assess data on the basis of heterogeneity, as the use of these large data sets to drive healthcare decision accelerates."

Finally, IT is already established as the "fourth hurdle" in obtaining access and reimbursement. Says Terry Hisey, national sector leader for life sciences at Deloitte, "In a registration environment where proof of safety, efficacy, and quality are givens, what now makes the difference is cost effectiveness. The link is still implicit here in the U.S., but promotion of the accountable care organization model under health reform—where providers are rewarded on the basis of the total cost of the condition under treatment—makes it a central part of the approval equation." Scale-up this year of Obamacare's Patient Centered Outcomes Research Institute (PCORI) and, more importantly, its billion-dollar budget, promises to make the U.S. the global epicenter for value-based drug assessment. This is true even though PCORI's mandate is to conduct comparisons among therapies that avoid an explicit focus on cost. The UK's Commission on the Value of Medicines is another group to watch.

4) Preserve those reputational assets. Maintaining a "license to operate" is becoming more important as the reach of governments extend from regulatory oversight to direct involvement in the business—as a payer and customer. The gap between strict legal prohibition and the more murky terrain of ethical lapses is narrowing; overall, the "zone of vulnerability" is expanding and is now global in scope. 2012 will see major new efforts by U.S. and European regulators to apply anti-bribery statutes to companies' overseas promotional activity, including inducements by CROs and other third parties to influence the conduct of foreign clinical trials. Active management of the drug shortage problem is another imperative; it is not enough to blame the problem on FDA or on quality issues linked to generics.