Case Study Report: Analysis of the Current Scenario and Future Outlook of the Global Pharmaceutical Industry

Group Number 12 Module Leader: Nick Potter Date: 23/10/2007

ID Numbers: 911510 903087 902408 911167 898387 898080

Introduction: Pharmaceutical companies are held to the highest standard, as a result of their products cause and effect relationship on a society. Because of the industrys contribution to GDP and social welfare of countries, governments take a strong interest in its internal functions in an attempt to reduce expenditure on healthcare nation-wide as well as improve the quality and safety of medicine. With the emergence of new technologies in the medical field, our understanding of diseases and their underlying causes have resulted in the drug industrys ability to create new treatments and cures at a rapid pace. Still the industry faces many challenges as it attempts to match its need for profit with higher expectations, tighter controls, greater competition, and vitally important social responsibilities. The purpose of this report is to analyze all the influences affecting the changing environment of the pharmaceutical industry and to derive from said analysis the likely direction the industry is headed toward. We have looked at the industry through lens of the PESTEL framework and the Porters Five Forces analysis. Finally, from our conclusions we present here-in a set of alternative paths the industry may take.

Political influences: The industry is considered as an important contributor to GDP, balance of payment and employment. However, governmental policies could hugely influence the choice of strategy that firms may adopt to sustain their competitiveness in the market. Government price controls and free movements of goods across borders within some free trade areas have accounted for parallel trade that created challenges for the industry. This means the free movement of pharmaceutical products among low price and high price markets in major areas such as EU, the US, Canada and the Far East.

Moreover, the parallel trade problem became worse due to the opposing policies of pricing between Canada (stringent and inflexible) and the US (free pricing) generated the huge difference in prices compared in these two enormous markets. This kind of trade brings a little benefit to governments and consumers but significant loss to the industry (profit flows to parallel traders in stead of pharmaceutical companies who would be likely to use it to re-invest into R&D). In developed countries which are also the major markets of pharmaceuticals such as the EU, the US and Japanese healthcare systems are mainly funded by governments or insurance-funded systems. Overspending on healthcare services due to the increasing number of elderly have prompted these governments to apply a wide variety of methods to control spending on pharmaceuticals, both on the supply and demand sides. For example, [there are extended price negotiations in formularies, deferring payment schedules, and by requiring endorsement of industry standard (from the NICE in the UK, the FDA in the US, etc) (See Appendix 2)]. These challenges have resulted in a number of strategies adopted by companies such as increasing cooperation with healthcare providers and demonstration of added value of newly improved drugs.

Economic factors: Economic factors in each country affect the growth of the industry in particular markets as well as in the global market. For instance, the strong market and positive economic growth trends in the US has helped firms there to grow faster than their competitors in other parts of the world and to expand their global reach. Globalization of the pharmaceutical industry has had a profound impact on mergers and acquisitions of pharmaceutical companies in concentrated markets such as the US, EU and Japan. However, the economic recession in Japan and slowing economies within the EU are still a constraining factor influencing the market growth of domestic companies there and the synergy of the industry at large. Nevertheless, the improving economies in Latin America and Pacific Rim countries with enormous populations makes these emerging markets become more important. The number of wealthy people in these countries a well as in China are

increasing demand for western medicines, bringing potential opportunities for the pharmaceutical industry. Social factors: Aging populations are increasing demand for drugs in multiple markets requiring investment in high technology solutions. However, some national systems are less likely to satisfy the dramatically increasing market demands. For example, both universal coverage systems in the UK and insurance-funded systems in the US have faced difficulty supporting healthcare expenditures proportioned to these governments. Another challenge is whether the drug companies can satisfy increasing demand for lifestyle conditions such as impotence, obesity, liver and lung diseases, and many more. As awareness of these issues comes to light, the result has been an increase in the trend towards healthy living including better eating habits, less smoking, less drinking, more exercise. Issues of social responsibility are rampant in the industry. Drug companies more concerned with bottom-line profitability are interested more in their own interests than the broader benefits of their products. One issue often overlooked is an unfortunate tendency for drug companies to leverage themselves heavily into one area in hopes of developing a blockbuster drug the most successful companies attribute the bulk of their profits to. While the company is leveraged into a particular area that may never fruition, the board members are paying themselves handsomely and ignoring alternative research endeavors that may aid sick and dying people in the world. It has been proposed that pharmaceutical companies be responsible for contributing to developing countries by providing essential drugs to relieve the burden of disease in these areas. [However there is a concern among multinational companies that supplying free or very low priced drugs through parallel trade would have negative impact on their higher priced markets] (See Appendix 2). Technological factors: With R&D controls increasing, time to market is longer and this phase is costing more than ever before. Technological advances are crucial to the sustainability of the

industry. Since the 1980s, molecular biology and genetic engineering have seen rapid innovation but their successes have thus far been limited. The Human Genome Project is a newly developed area of interest which has resulted in a wealth of research dollars devoted to preemptively curing diseases in newborns as well as reversing conditions in adults. Some technology has not yet been considered acceptable practice in most of the world such as cloning and research using human stem cells. Legal issues: Intellectual properties right is one of the key legal issues in the pharmaceutical industry. An increasing concern for companies is how to protect their huge efforts and enormous investment in time and capital necessary to bring a new product to the market. Companies compete more severely to establish and retain a patent by which they attempt to defend against imitators and recoup R&D. Patent protection becomes a more fatally legal issue in some newly emerging markets. Bio-piracy involves international companies patenting traditional medicines or foods that are free of patent rights but that other countries have been supplying to domestic markets for sometimes centuries. It is not only that they seek to make money from resources and knowledge that rightfully belongs to the developing countries, but in so doing, they squelch domestic firms that have long provided the products (See Appendix 3).

Industry Rivalry: Surviving in the drug industry requires lean and flexible R&D, innovation, strong intellectual property rights, strong marketing and sales, and strategic alliances. Gaining a competitive advantage however is difficult to do, depends on the industry segment in which the company belongs, and since the outcomes of R&D are more or less unknown until after time and money have been spent, it is sort of like winning the lottery. Four functionally different company profiles (referred to as segments herein) make up the pharmaceutical industry; Ethical (prescription based drugs) where industry R&D is most centralized, Generics replicating the effects of the Ethicals drugs with their

own concoctions without infringing on patent rights, Biotechs who are the most modern and most unstable, and Over-the-Counter (OTC) remedies. both within their segment as well as from the other segments. Ethicals are the most invested in terms of R&D giving them the best possible chance of bringing new products to market. Companies leveraged into seeking blockbusters are increasing their risks significantly by placing all their eggs in one basket. If they dont succeed, they will realize the value of diversification. If they do succeed, they may still be highly vulnerable to generics and watch all their R&D spending dwindle as new discoveries can often be imitated or improved. Generics arguably are the best positioned for return on investment because, in essence, Ethicals do all the research for them. Arguably generics loose some money competing on a cost basis, but the idea is they are able to make up for the loss because of low R&D expenditure. Over the Counters focus on direct consumer marketing and are the easiest drugs to access for consumers. Because of this accessibility, consumers may forgo purchasing more expensive and less known drugs that may address the underlying ailment, in lieu of OTCs that simply eliminate or reduce symptoms. Biotechs are the most vulnerable in that they are heavily leveraged into technology that is new and evolving at a rapid pace. As a result they are also the most vulnerable to takeovers. They are also heavily dependent on multinationals to market their products through licensing of their drugs for sale by the multinational in other locations and through strategic alliances. While each of these four major players must adopt completely separate strategies at the corporate and business levels, they are all to some degree in competition not only with companies whose corporate intent is in line with their own, but also across the four mentioned segments. To what degree pharmaceutical companies compete with the four industry segments is dependent upon which company segment they belong. For example, competition amongst Ethical companies pales in comparison to that of Ethical-Generic competition to the detriment of the Ethical (though there is some two-way competition to Depending upon which segment a company decides upon, they must plan their efforts in light of competition

consider). Over the counter drugs can provide temporary and in some cases permanent relief of symptoms and can by bought by anyone with access to a supermarket. While Biotechs have been around for nearly 50 years, until the late 1970s they were only known in the food processing and agricultural industries. Though the pay-off so far has been minimal relative to the amount of dollars invested in biotechnology research for medicinal applications, there have been some recent successes (such as Genentechs Avastin) and the other industry segments will have to keep an eye on the Biotech sector now and in the future (See Appendix 4). Bargaining Power of Buyers: At one extreme, sickly patients ultimately determine whether or not they even want to get better. If they do not have a desire to improve their condition or if they think they can get better by other means than a drug, their insurance company will likewise not be paying for that treatment and buyer power is high. On the other extreme, some patients are not in a position at all to make such a decision perhaps because they are in a comma or are otherwise incapable of making a decision, in which case they will be fed drugs of all manner until they either get better (in which case they may change their mind), they could die, or some third party is in a position to make the decision on their behalf (perhaps a family member). In this instance, buyer power is low. However, somewhere in the middle are patients who fit one of three segments. The first has an ailment with a known treatment or cure. If an Ethical company has already created a relevant drug that has been subsequently improved upon or replicated in some way by a Generic company, buyer power will be high and companies will compete on a cost basis. It will be even higher today than a decade ago as more and more patients are able to access medical information instantly via the internet. This capability has put a wealth of knowledge in reach of patients wanting to learn about their alternatives. The second type of patient has an ailment with a known treatment or cure but only one Ethical company controls intellectual property rights on the most effective drug available for that treatment. In this case, buyer power will be much lower especially if

there is no government price control involved and the pharmaceutical company can charge whatever they want because buyers have no other alternatives. The third type of patient has an ailment for which there is no known treatment or cure. These patients are absolutely powerless neither having low power or high power. They are however a potential market and drug companies race to provide applicable treatments. Bargaining Power of Suppliers: Two supplier types are worth mentioning in the pharmaceutical industry. The first supply all of the material components of research laboratories from test tubes, pipettes, and flasks, to various chemical compounds as well as manufacturing equipment. Their power is very low as many companies compete and products are not exclusive to one supplier. The other type of supplier has an intangible but invaluable input that is not easily replaceable. Knowledge is key in drug development as often research can take many years before results are successful. Each research attempt uses and builds upon the knowledge acquired from past attempts. The suppliers with the greatest power are the scientists who devote their lifes work to creating a marketable drug. Threat of Entry: For a new company wishing to enter the industry at any segment, it will meet very high barriers to entry. The barriers have been rising higher for decades and take mega amounts of capital to overcome. As governments tighten down controls over clinical development stages, R&D productivity declines and time to market is longer than ever before for a new drug. Without an existing product line from which to recycle revenue into R&D, many companies find themselves at high risk for take over before there is a chance to spend money on the manufacturing and then marketing and sales. This presents a tempting alternative. Instead of starting a pharmaceutical company from the ground up, why not acquire an existing company? Most drug companies for sale are now cash poor and bankrupt because they did not get through clinical trials before running out of money or investors who saw them as a risk worth taking. Furthermore, if by some miracle, a drug company without an existing product line, and without strategic alliances,

does get passed clinical trials, manufacturing has always been a challenge because of high fixed costs, low utilization, and low profitability (See Appendix 1). Threat of Substitutes: Diseases can be treated or cured in a variety of fashions, and some osteopaths and other natural healing doctors argue methods more sustainable than the medicines drug companies produce. These methods cover a whole range of medicinal practices and beliefs from ancient Chinese medicines, acupuncture, massage therapy, and meditation to harnessing the placebo effect, household remedies, and practice of self-healing through preventative medicine. Which one method a patient will adhere to is also dependent on a variety of factors beginning with what is most affordable, then their knowledge about these alternatives, and their cultural bias. Strategic Alternatives and Likely Implications: In the light of the analysis stated above, the pharmaceutical industry has faced some difficulties as companies seek to establish their sustainable position in the changing environment. It may be suggested that Ethical pharmaceutical companies should focus on specific fields which are likely to have increasing number of patients in the near future such as cancer, arthritis, diabetes and Alzheimers diseases. An effective drug product, as a result of successful R&D, for such kinds of diseases will surely bring huge benefit. On the other hand, it may be a significantly risky choice because many companies would rush into a small number of targets. There are also issues of social responsibility as mentioned in the social factor of the PESTEL analysis. It is obvious that creating consecutive pipelines and early launches are crucial to survive as a branded ethical drug manufacturer. Companies should review the efficiency of their R&D activity and may rearrange their organization to be more productive because large R&D spending tends to correlate with high creativity. Alternatively, they can establish firm alliance with R&D oriented companies in order to reinforce their pipelines.

Pharmaceutical companies can also pursue niche market for targeting rare diseases if the chances of success appear likely. There are fewer competitors in this field and a special status, which includes some [benefits such as taxation incentives and marketing exclusivity stipulated in the Orphan Drug Act of the US] for example, can be obtained. But it might not be suitable for big companies to survive in this segment because the market size itself is too small for them to earn sufficient profit by its nature (See Appendix 5). Concentrating on generic business is another option because the development of generic drugs is more profitable than branded drugs in terms of the amount of investment. Although generic market has shown rapid growth, it has been becoming a more and more fierce battlefield because of its low barriers to entry. Generic drugs have much narrower margin range than branded ones so pharmaceutical companies should consider seriously reducing their cost throughout all operations. Specializing in-house R&D may be another alternative. If a company possesses a patent, regarding drugs with less side-effects for example, its status should be significantly competitive. Moreover, development productivity should become more important and big companies, which concentrate on sales and marketing, are likely to seek external R&D resources more frequently. How they find the most suitable partner for sales and marketing may be the most important element to success. The pharmaceutical industry faces many difficulties, from persistent government intervention, issues of social responsibility, and price erosion, to ever-increasing competition. The industry is constantly evolving new challenges with the innovation of biotechnologies, ageing populations and appearance of huge markets in Asia. Pharmaceutical companies which concentrate on accurately identifying diseases which will prevalent in upcoming decades and perform efficient R&D exploiting external resources, abide by the ethical standards, will be the main players in this industry.

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Appendix: 1) Holland, S., & Batiz-Lazo, B.; The Global Pharmaceutical Industry; 2004. 2) Johnson, G., Scholes, K., & Whittington, R.; Exploring Corporate Strategy, Text and Cases, 7th Edn.; Prentice Hall; 2006; p. 64-106. 3) Stiglitz, J.; Globalization and Its Discontents; Penguin; 2002 4) Genentech, Inc.; http://www.gene.com/gene/products/information/oncology/avastin; last updated on 22/10/2007 5) Food and Drug Administration; http://www.fda.gov/orphan/oda.htm; last updated on 22/10/2007

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