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J A N U A R Y, 2 0 0 4

Key Forces Driving the Pharmaceutical Industry into 2004 Written by Andrew F. Branca

As we enter 2004, Cambridge Healthtech Advisors takes a quantitative view of several long-term challenges with which the industry will continue to grapple in the coming year. Overcoming these challenges will be a difficult, complex, and risky journey, and we do not here purport to offer straightforward solutions. Rather, our goal with this brief is to bring additional clarity to the nature of these hurdles, and assist our clients in effectively articulating these challenges, and their responses to them, throughout their organizations.

The pharmaceutical industry’s skyrocketing investment in research and development—which has increased over 7-fold (in 2003 dollars) since 1980, and more than 2.5-fold in the last 10 years (see Figure 1)—continues to yield diminishing returns.
Improved marketing, rather than R&D, has bolstered recent revenues. R&D productivity, in terms

of dollars of revenue per dollar of R&D investment, has fallen by half since 1980, and by 27% since 1990. (See Figure 2.) It is notable, however, that since 1995, this measure of productivity has been essentially flat, as the industry has become more skilled at leveraging assets other than R&D to generate revenues—primarily through improved marketing techniques, such as direct-to-consumer advertising and increased detail forces.
R&D productivity has fallen by half in five years. R&D-specific return on investment has not enjoyed such a flattening out, however, and continues to plummet. R&D productivity in terms of the ratio of NCE approvals to R&D expense has fallen by 75% over the last 20 years and by more than 50% in the last five years alone. (See Figure 2.)

BRIEF: KEY FORCES DRIVING THE PHARMACEUTICAL INDUSTRY INTO 2004 35 (INFLATION-ADJUSTED TO 2003 DOLLARS) 30 25 20 15 10 5 0 1980 ‘81 ‘82 ‘83 ‘84 ‘85 ‘86 ‘87 ‘88 ‘89 ‘90 ‘91 ‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 YEAR 2002 U. (2) R&D costs have been offset five years earlier than revenues and approvals. (3) All revenue and cost figures have been inflation-adjusted to 2003 dollars.S. 1980–2002 SOURCES: PhRMA and CAMBRIDGE HEALTHTECH ADVISORS (1) Measure of approvals is based on a three-year trailing average.$ BILLIONS Figure 1 Increasing Pharmaceutical Investment in R&D. .S. PUBLICLY AVAILABLE INDUSTRY SOURCES 25 RATIO OF APPROVED NCEs TO R&D COST 5 RATIO OF APPROVED NCEs TO R&D COST RATIO OF REVENUE TO R&D COST 20 4 15 RATIO OF REVENUE TO R&D COST 3 10 2 5 1 0 1980 ‘81 ‘82 ‘83 ‘84 ‘85 ‘86 ‘87 ‘88 ‘89 ‘90 ‘91 ‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 YEAR 2002 0 Figure 2 Notes Declining Pharmaceutical R&D Productivity. Reproduction Prohibited. dollars SOURCES: CAMBRIDGE HEALTHTECH ADVISORS. in 2003 U. 2004 © Cambridge Healthtech Advisors.

000 900 800 700 600 500 400 ‘86 ‘87 ‘88 1985 5.S. INDUSTRY SOURCES 1.200 1.5% CAGR ‘89 ‘90 ‘91 ‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 7. . in 2003 U.$ MILLIONS) 1.100 COST (U. dollars SOURCES: CAMBRIDGE HEALTHTECH ADVISORS. Reproduction Prohibited.BRIEF: KEY FORCES DRIVING THE PHARMACEUTICAL INDUSTRY INTO 2004 500 400 NCEs NEEDED TO SUSTAIN 10% ANNUAL REVENUE GROWTH # OF NCEs 300 NCE GAP 200 100 NCEs INTRODUCED/FORECAST FROM INTERNAL R&D 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 YEAR Figure 3 The Pharmaceutical NCE Gap SOURCES: CAMBRIDGE HEALTHTECH ADVISORS.7% CAGR ‘99 ‘00 ‘01 ‘02 ‘03E ‘04E 2005E YEAR Figure 4 Increasing Cost of Developing a New Chemical Entity. TUFTS CSDD 2004 © Cambridge Healthtech Advisors.S.

It is. the number of such post-marketing commitments (PMCs) in the period 1998 through 2000 was more than 30% greater than for the previous three-year period.” Although pharma has long sought to improve their win-loss ratio. “The FDA Seizes the Initiative: Implications of the Draft Guidance on Pharmacogenomics Data Submissions. the industry’s NCE gap between what it needs to sustain its historical growth rates and what it can actually produce will continue to expand. The average total cost for running a complete clinical trial (Phase I through Phase III) tripled during the 1990s. but the greatest increases in cost will be driven by the need to further investigate and understand the implications of additional hypotheses generated as a result of pharmacogenomic studies. (See Figure 5. however. constitute an additional trial expense. and no compelling evidence for near-term improvement. During the period 1985 through 1995. the demand for trial participants will continue to increase. Reproduction Prohibited. Increasing use of post-marketing commitments extend trial process. the CAGR will have grown to 7. Per-patient expenses will likely increase over the next several years. is that of conducting clinical trials. please refer to Cambridge Healthtech Advisors’ November 2003 Brief. par- ticularly following the FDA’s recent push in the area of pharmacogenomics data gathering in clinical trials. in 2003 dollars— is widely cited throughout the industry.7%—a 40% acceleration in the increase of cost. had been rather rare.) Three key drivers will continue to drive these costs: Increasing per-patient costs. the cumulative annual growth rate (CAGR) of this cost was 5. the prospects for near-term improvement are not immediately clear. Indeed.5%. until recently. with a small number of highly profitable NCEs rather than a larger number of compounds with more modest potential.) A key driver of this cost acceleration is the tremendous investment made in recent years in innovative R&D technologies—particularly the various -omics approaches—that have as yet failed to deliver a satisfactory return on investment. A key component of drug development costs that will certainly increase. likely to be several years—perhaps even a decade or more—before the body of accumulated pharmacogenomic data will enable the industry to conduct such focused trials (and effectively recruit the patients needed for them) on a routine basis. The corollary.) One consequence is that many large pharma are increasingly inclined to pursue the blockbuster model. The increased incidence of PMCs adds a cost component to the trial process that. 2004 © Cambridge Healthtech Advisors. at least over the next several years. of course. and avoid the large patient populations currently needed to ensure the statistical significance of trial results. Pharmacogenomics and related approaches promise to allow for increasingly focused clinical trials involving fewer numbers of more biologically relevant patients. during the period from 1996 through 2005 (estimated). Perhaps more important. but less frequently noted. is that the rate of increase in the cost of bringing a drug to market has accelerated substantially in recent years. THE COST AND COMPLEXITY OF CLINICAL TRIALS CONTINUE TO INCREASE Much of the cost of drug development may be attributed to the cost of capital—a factor directly tied to the long timelines inherent to the pharmaceutical business. . Until then. With the rate of NCE approvals essentially flat for the past several years.”) The mere collection of such data will. those costs associated with the absolute number of patients and their recruitment may decrease over time. (For more information on this issue. The estimate by Tufts that it costs in excess of $800 million to bring a new drug to market—and we estimate that today it exceeds $1 billion. (See Figure 4. If so. Growing demand for trial participants. There has been a substantial increase in the role of post-marketing (“Phase IV”) study commitments in the FDA approval process.BRIEF: KEY FORCES DRIVING THE PHARMACEUTICAL INDUSTRY INTO 2004 Growing NCE gap increasingly undermines industry valuation. is that the loss of a latestage compound in a portfolio focused primarily on blockbusters is far more damaging than would be a similar loss to a more diversified development portfolio. (See Figure 3. driven by the need for both a greater number of patients and increased per-patient expenses. of course. The cost of drug development is accelerating. and which can be mitigated only with difficulty—and the need for “winning” drugs to cover the costs of the “failures. however.

Much of the cost-savings benefit is offset by increased uncertainty. The most immediately realizable source of value is in the ability to eliminate duplicative functions. of this theoretical benefit is offset by the uncertainty the mergers create among all levels of staff.000 2. and company B perceives the same of company A. This suggests that in at least some mergers. it has yet to demonstrate that such mergers add long-term—or even short-term—value to the enterprise.000 5. Yet.000 8. $ MILLIONS) 7.) Moving forward. many of these mergers appear to include an element of the “grass is always greener on the other side”—company A perceives that company B’s pipeline is at least complementary to its own.S. and the negative impact the merger process has on efficient decision making for a period of many months. $) AND NUMBER OF PATIENTS TOTAL CLINICAL TRIAL PATIENT-RELATED COSTS 45 40 TOTAL COST (U. .S. the number of NCE projects that progress to clinical development. 2004 © Cambridge Healthtech Advisors. much. and the total number of clinical projects in development all decline precipitously.000 10 1989 1990 1991 1992 1993 1994 YEAR 1995 1996 1997 1998 1999 Figure 5 Increasing Clinical Trial Patient-Related Costs SOURCES: CAMBRIDGE HEALTHTECH ADVISORS.BRIEF: KEY FORCES DRIVING THE PHARMACEUTICAL INDUSTRY INTO 2004 50 9.000 COST PER PATIENT (U. this unfortunate outcome is believed to be more likely to occur among mergers-of-equals than outright acquisitions. the total number of new molecular entities.000 25 4. Strength cannot be achieved by aggregating weak pipelines.000 NUMBER OF PATIENTS PER NDA 20 15 3. FDA LAW JOURNAL THE VALUE OF PHARMA MERGERS REMAINS UNCERTAIN Although the pharma industry has gone through a whirlwind of consolidations over the last few years. if not all. However. Reproduction Prohibited. BOSTON CONSULTING GROUP.000 CLINICAL TRIAL COST PER PATIENT 35 30 6. the whole is substantially less than the sum of the parts—two weak pipelines do not add up to a single strong pipeline. and perhaps superior. In addition. within only a few years of the merger. (See Figure 6. however. and we expect the latter to become the increasingly favored mode of pharma company aggregation.

(See Figure 9. premium-priced drugs subject to generic competition as their periods of patent protection expire. Drugs worth $70 billion in annual sales will lose patent protection by 2006. In addition. (See Figures 7 and 8. the competitive market advantage enjoyed by first-to-market drugs has been declining steadily for years. and today it is not unusual for a competitor drug to be only a few months behind the leader. representing an increasingly significant share of the industry’s revenues. In essence. The leading pharmaceutical companies have adopted increasingly similar R&D strategies over the last several decades. however. representing about $70 billion in revenues. CENTRE WATCH PATENT EXPIRATIONS AND FAST-FOLLOWERS UNDERMINE PORTFOLIO VALUES At the end of the day. even relatively new drugs with many years of patent protection remaining are finding their innovation advantage eroded by fast-follower compounds possessing similar capabilities. nearly 100 currently protected marketed drugs.) 2004 © Cambridge Healthtech Advisors. the industry is finding many of its leading. Indeed. Increasingly. large pharma companies sustain their activities by selling innovative drugs at premium prices. Reproduction Prohibited. will go off patent—and both of these numbers will double by 2010. The next sev- eral years will see an unusually large number of compounds. the value of the industry’s drug portfolios is being undermined by an effective degradation of intellectual property protection at both the beginning and the end of the compound’s life cycle. .) Periods of market exclusivity compressed by fast-followers. it is rare that any successfully developed drug does not have a competitor following close behind. with the result that they are often focused on similar therapeutic areas and developing similar classes of compounds.BRIEF: KEY FORCES DRIVING THE PHARMACEUTICAL INDUSTRY INTO 2004 160 AVERAGE NUMBER OF PROJECTS IN CLINICAL DEVELOPMENT 140 RELATIVE PRODUCTIVITY (100 = PRE-MERGER) AVERAGE NUMBER OF NCE SUBMISSIONS/YEAR 120 100 80 60 AVERAGE NUMBER OF NCE PROJECTS IN DEVELOPMENT 40 Pre-merger 1 year post-merger 3 years post-merger Figure 6 Impact of Mergers on Pharmaceutical Productivity SOURCES: CAMBRIDGE HEALTHTECH ADVISORS. By 2006. As a consequence. go off patent—and with few similarly profitable compounds ready to take their place.

$ BILLIONS) 100 80 100 60 40 20 0 2003 2004 2005 2006 YEAR 2007 2008 2009 2010 CUMULATIVE MOLECULES LOSING PATENT PROTECTION 50 0 Figure 7 Cumulative Impact of Patent Expirations. 2003–2010 SOURCE: CAMBRIDGE HEALTHTECH ADVISORS 2004 © Cambridge Healthtech Advisors.BRIEF: KEY FORCES DRIVING THE PHARMACEUTICAL INDUSTRY INTO 2004 180 160 140 CUMULATIVE LOST PEAK SALES CUMULATIVE LOST PEAK SALES 250 120 (U. 2003–2010 SOURCES: CAMBRIDGE HEALTHTECH ADVISORS.S. IdDB Year 2003 Drug Neurontin Flovent Cipro-floxacin Procrit Lovenox Duragesic Diflucan Zocor Pravachol Zithromax Zoloft Actos Ambien Paxil Neupogen Norvasc Fosamax Effexor Risperdal Serevent Levaquin Aciphex Prevacid Cellcept Topamax Gemzar Aricept Singulair Advair Company Application(s) 2004 2005 2006 2007 2008 2009 2010 Pfizer Neuralgia/epilepsy GlaxoSmithKline Asthma Bayer Antibiotic Johnson & Johnson Anemia Aventis Antithrombotic Johnson & Johnson Chronic Pain Pfizer Antifungal Merck Cholesterol control Bristol-Myers Squibb Cholesterol control Pfizer Antibiotic Pfizer Antidepressant Lilly Diabetes (II) Sanofi-Synthelabo Insomnia GlaxoSmithKline Antidepressant Amgen Neutropenia Pfizer Hypertension Merck Osteoporosis Wyeth Antidepressant Johnson & Johnson Antipsychotic GlaxoSmithKline Asthma Johnson & Johnson Antibiotic Johnson & Johnson GERD TAP Pharmaceuticals GERD Roche Immunosuppressant Johnson & Johnson Epilepsy Lilly Chemotherapy Pfizer Alzheimer’s Disease Merck Asthma GlaxoSmithKline Asthma Figure 8 Leading Drugs Scheduled to Lose Patent Protection. Reproduction Prohibited. PATENT PROTECTION 150 CUMULATIVE NUMBER OF MOLECULES LOSING 200 .

It seems clear that some fundamental changes must be made to the R&D process. competitor drugs aligned on graph. We hope that during the coming year. we can help clients to identify the best new technologies to bring to bear on these challenges.BRIEF: KEY FORCES DRIVING THE PHARMACEUTICAL INDUSTRY INTO 2004 14 12 10 8 6 4 2 LOPRESSOR YEARS OF EXCLUSIVITY ZANTAC VASOTEX PRAVACHOL HISMANAL ZOLOFT SPORANOX KOGENATE NORVIR VIOXX Mevacor (1987) Seldane (1985) Tagamet (1977) Diflucan (1990) Inderal (1965) Capoten (1980) Recombinate (1992) Ivirase (1995) Prozac (1988) Figure 9 Note Declining First-to-Market Advantage SOURCES: CAMBRIDGE HEALTHTECH ADVISORS. Reproduction Prohibited. and quantify both the investment and the likely results from these new approaches. R&D leaders within major pharmas will be increasingly trying to help their companies break out of the productivity vise. 2004 © Cambridge Healthtech Advisors. With these challenges as the backdrop to their activities in 2004. Celebrex (1999) 0 . PhRMA (1) First-to-market drug aligned on x-axis. and that these changes are most likely to arise from new technologies that are optimally applied. share among our clients the practices and experiences of their peers in applying these technologies.

630 -1386 617-905 -2800 jtalalas@chadvisors. For additional copies of this Brief. This report is part of the Pathways series. and technologies affecting drug discovery and development. regulatory issues. which helps leaders in pharmaceutical research develop effective strategies. Analyst Contact Andrew F. Talalas is Senior Vice President. consulting. decision support. clients may contact John at: Office: Cell: Email: 617. and private member events to help clients make the most of their efforts in pharmaceutical research. Clients and research participants may contact Andrew at their convenience at: Office: Cell: Email: 617-630-1375 617-838-1438 abranca@chadvisors. Sales and Marketing at Cambridge Healthtech Advisors.ABOUT CAMBRIDGE HEALTHTECH ADVISORS Cambridge Healthtech Advisors is the premier membership organization for leaders in the pharmaceutical and biotech industries who need insight into the latest management techniques. Our advisory services offer primary research. 2004 © Cambridge Healthtech Advisors CHA CAMBRIDGE HEALTHTECH ADVISORS .com Sales Contact John This Brief was produced as part of the Pathways advisory service from Cambridge Healthtech Advisors. Branca is Vice President and Senior Analyst at Cambridge Healthtech Advisors.