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Case Analysis : Pharma Industry

Case Analysis : Pharma Industry


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Category: Business Autor: anton 06 June 2011 Words: 4000 | Pages: 16

Introduction Overview of the Industry The pharmaceutical industry has enjoyed great prosperity as nineteen-ninety-eight marked another stellar year for the industry. Profits stayed in a sharp up-trend as 28 of the 37 stocks in the industry beat the Standard & Poor's 500 Index, which rose by 26.7%. The pharmaceutical industry includes establishments primarily engaged in manufacturing, fabricating, and processing medicinal substances into finished pharmaceuticals for human and veterinary use. Ethical brand name drugs, generic products, and nonprescription or over-the-counter medication constitute the pharmaceutical industry sub-sector. Strong and consistent growth in the mid-single digits is expected in the global pharmaceutical market over the next 5 years. Worldwide sales are estimated to reach $335 billion in 1999, up from 1998 sales of $310 billion. Key factors driving this projected growth include long life expectancies, strong demographic expansion in older segments of the population, a rising standard of living in developing countries and large untreated populations, such as persons with elevated cholesterol levels. Increases in life expectancies create more health problems. As the world's population ages, the demand for pharmaceuticals increases. The elderly are the single largest group of users of prescription drugs. Another major factor fueling the continued growth of the industry is the introduction of breakthrough drugs. The new products are especially in the areas of heart disease, cancer, arthritis, diabetes and HIV. Another trend is the development of quality of life products, which help to keep people looking and feeling young. The pharmaceutical industry has a history of mergers, acquisitions, and buyouts that are not limited by national boundaries. Joint ventures with small drug discovery companies and research institutions have become popular as a way to access new technologies. In the early 1990's, the mergers were primarily driven by a desire to cut cost. In the late 1990's research and development opportunities appear to be the driving force. The pharmaceutical industry is one of the most research-oriented sectors in the U.S. economy. R&D outlays in 1998 are expected to equal 20% of total industry revenues, compared with 15.9% in 1990 and 11.7% in 1980. The industry experienced a more industry-friendly environment in 1997, which helped the growth of the market. Food and Drug Administration approval times are now shorter than in the past years, and the number of the approved drugs is on the rise. After several years of a relatively stable pricing environment, prescription drug-makers have also recently being increasing prices. Overview of Four Companies. Abbott Abbott Laboratories principle business are pharmaceuticals, nutritional, hospital products, diagnostics and chemical and agricultural products. Abbott serves customers in more than 130 countries through out the world and has a workforce of more than 56,000 employees worldwide. Abbott's mission statement is "To improve lives by providing cost-effective health care products and services"(5). Headquartered in north suburban Chicago, Abbot discovers, develops, manufactures, and markets health care products all over the world. Abbott's CEO, Miles D. White has been in office for two years, and he has helped the company reach record sales in 1998 of $12.5 billion, up 5% from 1997. Net earnings increased 11.4% to $2.3

billion, and earnings per share rose 12.7 percent to $1.51. This marked Abbott's 26th consecutive year of double-digit growth in earnings per share. In December 1998, the board also declared the 300th consecutive dividend to be paid by Abbott since 1924. Abbott's strategy is to remain competitive, by expanding and continuing to develop innovative products that will deliver better health care. They also want to focus on internally developed products, external collaborations, and well-targeted acquisitions that possess similar financial discipline. Abbot is committed to discovering, developing and marketing innovative drugs that improve human health. Abbott also strives to increase value for their shareholders, in order to keep investing heavily in science and technology. Eli Lilly Eli Lilly is a global research based-based pharmaceutical corporation dedicated to create and deliver health care solutions to enable people to live healthier and more active lives. Lilly focuses in one single segment of the market by producing life-science products. Lilly's total sales rose in 1998 to $9.2 billion from $7.9 billion in 1997, a 16 percent increase. Net income also experienced a significant increase to $2.1 billion, and earnings per share increased by 4% to $1.91. Lilly is based out Indianapolis, Indiana, and it employs 29,000 people around the world. Lilly's CEO, Sidney Taurel, divides their mission in to four parts: "Ensure that all internal and external stakeholders have the information resources..., to support Lilly's innovation strategy, to provide health care solutions, and to build shareholder value"(4). Lilly's five main products are Zyprexa, Prozac, Evista, Gemzar, and ReoPro; they generated 2.4 billion in sales and aided to 93% of the growth in the sales. Lilly has two main strategies for growth: "discovering, acquiring, and developing promising candidates; and to realize their full potential in the global marketplace. In 1998 for its first strategy, Lilly increased its R&D investments by 27%, to $1.7 billion. For the second strategy Lilly expanded sales forces in key markets and increased their direct consumer advertising in the United States. Lilly's does face some challenges on the upcoming years, such as the expirations of their U.S. Prozac patents. Once generic competition for Prozac comes into the market sometime in the year 2001, Prozac will very likely be out of the market. Lilly must pursue the development of new antidepressants in order to stay competitive in this market. Merck & Co Merck is a global, research driven pharmaceutical company that discovers, develops, manufactures, and markets a broad range of human and animal health products, directly through joint ventures, and provides services through Merck-Medco Managed Care. Merck is based in Whitehouse Station, NJ, and its CEO is Raymond V. Gilmartin. Merck's mission is to: "Provide society with superior products and services, innovations and solutions that satisfy customer needs and improve the quality of life; to provide employees with challenging work and advancement opportunities, and to provide shareholders with superior rate of return"(3). Merck's major products include Vasotec, Prinivil, Mevacor, Pepcid and Prilosec; these products accounted for 22% of worldwide human health sales in 1998. Unfortunately many of these products will go off patent in the years 2000 and 2001, and this will seriously hamper Merck's growth over the next 3 to 5 years. Total sales for Merck in 1998 were $26.9 billion, a 14% increase compared to 1997, and net income increased to $5.2 billion from $4.6 billion in 1997. Merck's strategy for growth is driven by six major components: discover important new medicines through breakthrough research, demonstrate the value of their medicines to patients, and to be the top-tier company in the health care industry. The other three components are their operating priorities: maximize revenue growth through commitment to research, to achieve the full potential of managed pharmaceutical care, and to preserve the profitability of their core pharmaceutical business. Pfizer Inc. Pfizer Inc. is a major producer of health care, consumer and agricultural products; they focus on discovering, developing, and bringing to market innovative medicines to enhance the lives of humans and animals. Pfizer closed out 1998 on an extraordinarily strong note. Worldwide revenues increased 23% to $13.5 billion, and net income rose by 26% to $3.3 billion. Fortune magazine named Pfizer one of the most admired companies in the world and the world's most admired in the pharmaceutical industry. Also in January of 1999, Forbes named Pfizer "Company of the Year". Some of the company's major products include Norvasc, Zoloft, Zithromax, Lipitor, Viagra, Cardura and Ben-Gay. Pfizer headquarters is located in New York, NY, and its CEO is William C. Steere, Jr. Mr. Steere states their mission statement in a very simply way, "At Pfizer, life is our life's work"(2). To fulfill this mission Pfizer focuses in four strategies, which have driven the company to be among the best in the world. Their strategies are to deliver shareholders value, in the past 5 years Pfizer shares have generated a total return of more than 690%. They have narrowed their focus to only produce what they do best, pharmaceutical products. They want to enable people to live better lives, and research shows that more than 17 million people around the world turn to Pfizer every day to help them live healthier. Another strategy is to build powerful partnerships in order to come up

with breakthrough medicines. Pfizer has more than 70 new product candidates in development, and nearly all of its major medicines are #1 or #2 in their categories. Industry Analysis Dominant Economic Characteristics and Trends within the industry The market size for pharmaceutical products in 1998 was $310 billion and expected to rise to $335 billion in 1999. The market is divided between prescription-based and over-the-counter medications. Approximately 60% of worldwide pharmaceutical sales is devoted to prescription medications and 40% to over-the-counter medications. The majority of worldwide sales is by companies based in the United States. With expected revenues of $140 billion in 1999, U.S. pharmaceutical companies will derive approximately 65% of their sales from domestic operations and 35% of sales from foreign customers. The growth rate for years 1994-1998 in domestic sales was 60% while sales abroad increased 61%. Since 1985, pharmaceutical spending in the United States as a percentage of total health care expenditures has risen from 4.9% to 7.2% in 1997.(6) The pharmaceutical industry ranks as the number one industry in the world in terms of return on assets, return on revenue and number three in terms of return on equity for year 1997 among Fortune 500 companies. Among the 14 pharmaceutical companies in the Fortune 500 for 1997, Merck was ranked 1st, Pfizer 5th, Abbot 6th, and Eli Lilly 7th in terms of revenues. The prescription drug industry consists of hundreds of companies around the world. During 1997, U.S. sales were primarily dominated by 10 large corporations which accounted for 53% of domestic market sales. Approximately 36% of research and development is conducted by U.S. pharmaceutical companies followed by Japan with 19% of worldwide research. Of 152 new drugs introduced into the world market between 1975 and 1994, 45% were introduced by American companies, 14% by British companies and 9% by Swiss firms with the balance divided among corporations around the world. U.S. firms lead in their ability to patent their innovations, globalize products, and develop new products through biotechnological research. The United States accounts for 40% of worldwide pharmaceutical sales, Europe 32% and Japan 24%. Other areas of the world account for 4% of sales and this segment of the market is expected to rise as pharmaceutical companies expand their sales in developing countries.(6) Although the United States is the biggest consumer of pharmaceutical products, it spends less on pharmaceuticals as a share of total healthcare expenditures than most industrialized nations. U.S. spending per capita ranks fourth in the world behind Japan, France and Belgium. For pharmaceutical spending as a percentage of gross domestic product, France leads with 1.7%, Japan with 1.5%, and the U.S. with 1.1%. Daily U.S. per capita spending for pharmaceutical products in 1997 was $0.64 as compared with daily per capita spending for alcohol of $0.91, $1.07 for telephone service, $2.84 for clothing, $7.94 for food and $8.45 for housing.(13) The over-the-counter category of pharmaceutical sales has nearly doubled since 1987. This is due to an increasing effort by manufacturers to increase advertising aimed at consumers with an emphasis on product information and self-medicating information. During 1997, the over-thecounter market had domestic sales of $16.6 billion. Rivalry among competitors is intense as brand recognition has become increasingly important as an approach to capturing market share. Companies are increasing advertising budgets to promote the therapeutic benefits of their drugs in an effort to differentiate their products from competitors. Many existing pharmaceutical compounds are standardized formulations that vary little in efficacy among manufacturers. The search for a differentiated product that will lead to blockbuster sales is one reason R & D, advertising and sales force budgets have increased in recent years. Research and development expenditures are currently 19.6% of total industry revenues versus 4% of sales for the average U.S. manufacturing industry. Approximately a third of R & D expenditures are allocated to promising drug compounds in clinical human trials. Phase I, II, and III account for 26% of R & D expenses while phase IV after product introduction trials account for 5.8%. Process development consumes 10% of research expenses, 41% is allocated to pre-clinical functions, 11.8% goes towards extraction of chemical compounds for evaluation, and toxicology and safety account for 5.4%. New products are allocated aproximately 80% of total R & D expenditures with the balance going towards improvement of existing products.(13) Risk is high in the pharmaceutical industry as expenditures for research and development for each drug typically last through a period of 10 to 15 years before a compound makes it to the market. FDA approvals generally take 16 months which is down from 32 months in 1987. It is very unlikely that a compound developed by a pharmaceutical company will ever be used in the retail market. Only 1 in 5000 compounds will eventually be sold and less than one third of all marketed drugs will provide a return to recoup R & D expenditures. The average costs associated with bringing a drug to market is $500 million while the product life of a prescription drug averages 10 years.

The majority of pharmaceutical distribution is through wholesalers with hospitals, managed care organizations and retail pharmacies as the biggest customers. Direct sales to physicians, retailers, hospitals and others accounts for approximately 30% of distribution. Bulk purchasing practices have given large buyers considerable buying power as hospitals and managed care organizations continue to seek reductions in expenses. There are several underlying trends in the world that are contributing to the demand for pharmaceutical drugs. The aging of the baby boom generation and increasing life expectancy rates are expected to increase the demand for prescription drugs over the next 25 years. The number of people between 45 and 64 years old will increase 41% by 2015. Given the rise in age population and life expectancy rates around the world and the level of pharmaceutical use by aging individuals, growth in the industry should remain in an upward trend. Increases in advertising budgets have increased overall demand for pharmaceutical products. Total direct-to-the-consumer (DTC) advertising in 1998 was $1.3 billion, up from $163 million in 1993. Total advertising expenditures during the first half of 1998 was $3.1 billion with 80% targeted towards physicians and 20% towards DTC in the form print media and television advertisements. The increase in advertisments is a response by the industry to the greater degree of influence consumers have in the choice of their pharmaceutical treatments.(6) General Economic Conditions Affecting the Industry The pharmaceutical industry is relatively immune from the effects of economic cycles. Demand for the industry's product remains constant in up and down economic cycles as market demand is a function of the overall health of the population. However the globalization of the pharmaceutical industry increases the risk associated with foreign investments and exchange rates. The firms in this industry seek to minimize risks by using hedging practices such as foreign currency forward-exchange contracts, borrowing in foreign markets, and using currency swaps. Porter Model Rivalry among competitive sellers- This is a strong force as competition has increased among the major players in this industry. Standardized formulations of drug compounds have increased price competition in categories such as the hypertensive and coronary care market. Differentiation strategies have been focused on alternative use research for drug formulations in an effort to increase the product life of individual pharmaceutical products and extend their use to treatment of other diseases. Niche market concentrations have been used to provide higher returns by some competitors but the majority of manufacturers have an extensive assortment of products to offer users. Recent price increases across the board for all manufacturers have put pressures on companies to derive greater profits through the implementation of operating efficiencies in an effort to increase profit margins. Firms in other industries offering substitute products- A strong force affecting branded pharmaceutical products is the increasing demand for generic pharmaceuticals as a way to contain cost. In 1997, 44% of all prescriptions written were for prescription drugs with that figure expected to increase to 66% by 2003. Generic drug companies do not have the costs associated with research and development. As a result, generic drugs typically sell for retail prices 60-90% below branded prices. Porter 5-Forces Model Potential New Entrants- This is a weak competitive force. The pharmaceutical market in the United States is among the highest ranking in terms of barriers to entry. The cost associated with years of research and development, government regulatory compliance and risk associated with the industry discourages new entrants from entering the market. Buyers- This is a moderate competitive force. Recent pressure has been put on pharmaceutical manufacturers to contain price increase. The power of large bulk buyers such as managed care organizations and hospitals has had some pressure on manufactures to contain costs. However, recent price increases in alternatives such as generic drugs have reduced buyer's bargaining leverage.Branded pharmaceuticals continue to be a cost-effective treatment. Suppliers- The concentration of the majority of industry sales among 10 large pharmaceutical companies has decreased the bargaining power of suppliers. The pharmaceutical industry is a major customer of the chemical industry. The chemical industry has an incentive to maintain competitive pricing practices which enhance the competitiveness of the major player's products in the pharmaceutical industry. Industry Prospects and Overall Attractiveness The industry will benefit from the aging population and increasing life expectancy rates throughout the world , and an increase in the potential number of candidates for pharmaceutical use. Increasing emphasis on health standards around the world and on the cost-benefit relationship of

pharmaceutical use will further increase the demand for the industry. The industry is attractive with operating profit margins exceeding 30% which is approximately twice the S & P Industrial Index, and net earnings as a percentage of sales averaging 17.9% versus 5.4% for general industry over the last 5 years. Pharmaceutical corporations have lower interest expenses, raw materials costs, tax rates and general and administrative cost as a percentage of sales when compared with most industries. Overall the pharmaceutical industry is very attractive with above-average profitability.(6) Performance Analysis Total industry sales have been increasing steadily for the last 5 years. In 1998, the pharmaceutical industry had sales of $124,609.4 million in the US. From 1994 through 1997 sales were $77,611.1 million, $91,039.0, $101,580, and $110,848.1 million, respectively.(13) Industry sales growth have grown by 60% over the last five years and the trend is expected to continue in 1999. Industry sales growth for each year has also increased for the last five years. The greatest sales growth realized was 1995 with 17.3% growth from the previous year. The second greatest growth was in 1998, with sales growth of 12.41%, 1996 had a sales growth of 11.57% and 1997 with 9.12%. The least growth realized was in 1994, with only a 3.4% growth from the previous year. Industry net profits have also been steadily rising along with sales. In 1997, the industry had net profits of $21,985 million, up $2,899 million from 1996. Overall the pharmaceutical industry sales growth is strong and is likely to continue, especially with the innovation of new drugs in the future. The profitability ratio for the pharmaceutical companies looks good compared to the industry average. The average gross margin for the four companies was: Pfizer with 81.88%, Abbott with 62.65%, Lilly with 78.12% and Merck with 61.84%. The gross margin for the companies were quite stable and there were no dramatic changes in the gross margin during the past five years. The industry had an average return on asset (ROA) of 10.96% for years 1993 through 1997. Abbott, Merck, and Pfizer were above the industry average with 17.64%, 14.4%, and 11.6%, respectively. Lilly had the lowest percentage compared to the other companies and the industry, its average ROA was only 4.4%. The average return on equity (ROE) for the industry was 24.4%. Abbott, Merck, and Pfizer were above the industry average with averages of 24.4%, 38.9%, and 29.1% respectively. Lillys ROE was below the industry with 10.7%. (10) Comparing the liquidity ratios with the companies and the industry, we see that all four companies were below the industry average of 1.63 for current ratio and 1.11 for quick ratio. The current ratios for Abbott, Lilly, Merck and Pfizer were 1.001, 1.27, 1.48, and 1.29, respectively. The industry had an average debt to asset ratio of 55.1 and debt to equity ratio of 123.185. All four companies were close to the industry average however, Lilly and Pfizer were slightly above. One reason was in 1994 both companies carried some debt and had trouble liquidating their assets. They had an average fixed asset turnover of 1.47 and total asset turnover of .77. Abbott and Pfizer was more efficient in utilizing its plant and equipment compared to the other companies. On the other hand, Merck and Lilly were not. They were below the industry averages. Merck had the highest earnings per share given to their shareholders compared to the other companies. In 1997, Merck had earnings of $3.83 while Abbott had $1.08, and Pfizer with $1.21. All four companies had steady increases in earnings except for Lilly, their earnings fell to a $3.50. There were many factors that contributed to Lillys low earnings but the main factor was their write down of their PCS subsidiary. Recommendations 1.Continue to seek intellectual property rights protection in developing nations. Protecting the pharmaceutical property rights will eliminate copy-cat drugs and lost profits in those countries. 2.Given the increase in life expectancy, continue to pursue research in pharmaceutical products, which enhance the quality of life for the aging population. These products such as wrinkle creams, hair loss prevention products, and early prevention pills for Alzheimer disease will be in high demand. 3.Expand awareness of pharmaceutical benefits in less developed regions, such as South America, China and India. As of 1998, 96% of pharmaceutical global sales are concentrated in three main regions U.S., Europe and Japan. Global awareness of pharmaceutical benefits will produce opportunities for the pharmaceutical industry to expand. Investment Evaluation The pharmaceutical industry has a below-average sensitivity to the state of the economy. This industry will tend to outperform others when the economy eventually enters a recession. Stocks of major pharmaceutical companies tend to have betas lower than the market portfolio due to lower

average market risks. The stocks of Abbott, Pfizer, Lilly, and Merck all have betas of less than one. Merck has several patents expiring in the near future, which could significantly affect future earnings. Although Merck has a consistent upward trend in earnings and dividend payments, the lack of patent protection for some of its major products may leave the company in a position unable to continue market dominance. With an outstanding product line and patent protection, we have chosen Pfizer as the best investment among our four companies. Pfizer has a P/E of 43 times earnings versus an industry average of 30 reflecting investor's willingness to pay a premium for Pfizer's earnings. Pfizer has the largest sales force in the industry consisting of 14,500 sales representatives worldwide exceeding industry leader Merck's 12,600. With drugs such as Viagra and Lipitor, Pfizer is gaining on the market share currently held by Merck. During 1998, Pfizer's market capitalization rose 70% placing Pfizer among the world's 10 most valuable companies. Pfizer has consistently raised dividends for 32 consecutive years. During the last five years Pfizer has rewarded its shareholders with a total return of 690% reflecting reinvested dividends and capital gains. An investment of $10,000 in 1993 would be worth $79,140 as of December 31, 1998, assuming dividend reinvestment.(7) Bibliography http://www.stockmaster.com Pfizer 1998 Annual Report, http://www.pfizer.com Merck 1998 Annual Report, http://www.merck.com Lilly 1998 Annual Report, http://www.lilly.com Abbott 1998 Annual Report, http://www.abbott.com Standard & Poor Industry Surveys, Healthcare: Pharmaceuticals, December 17, 1998. Why Pfizer is So Hot, David Stipp, FORTUNE Magazine, May 11, 1998. Inside the Fortune 500, FORTUNE Magazine, April 27, 1998. Valueline Compustat http://yahoo.com Wall Street Journal Pharmaceutical Research Manufacturing Association, http://www.phrma.org