Future Scenarios for the German Pharmaceutical Industry

MA-Thesis / Master von Pawel Netreba

Introduction:

The global pharmaceutical industry has been a great success story in recent years. The pharmaceutical industry’s innovative power has significantly contributed to the improvement of the quality of health care. Medical innovations have completely transformed the treatment paradigm, have dramatically increased individuals’ chances of surviving certain diseases such as cancer and heart disease, and have reduced the likelihood and impact of diseases such as HIV/AIDS or arteriosclerosis. From a business perspective, the pharmaceutical industry has been the most profitable one during the last decade. With a median profit margin of 17 percent compared to 3.1 percent for all other industries on the Fortune 500 list, and representing 20 percent of all global research and development (R&D) investments as well as generating revenues of over USD 700 billion, the pharmaceutical industry has visibly shaped the global business world.

However, the pharmaceutical industry is facing an increasingly volatile and uncertain environment. Evolving challenges such as an increase in regulatory state interference including the cost containment measures of health care reform, decreasing R&D productivity, and many blockbusters going off-patent are just some examples of the complexity and upheaval the industry is exposed to. Due to the increasing complexity and volatility, traditional planning tools are no longer suitable to adequately support conventional decision-making processes, since they insufficiently take uncertainty into account.

This problem can be resolved by implementing scenario-based planning. This tool is applied to depict possible future scenarios, i.e., to identify a wide range of possible developments, which makes it a suitable tool in a volatile and complex environment.

Hence, the objective of this thesis is to develop four plausible scenarios and secondly, to determine a core strategy, as well as strategic options for the pharmaceutical industry in Germany. First, an overview of the pharmaceutical industry in Germany is presented and major industry-related opportunities and challenges examined. Second, the theoretical foundation of scenario-based planning and its methodology is discussed. The HHL scenario-based approach to strategic planning is presented and briefly explained. Third, the approach is applied to the pharmaceutical industry in Germany, and four distinct scenarios developed. Finally, a core strategy and strategic options are derived.

Table of Contents:

Text Sample:

Chapter 2.4.2, Business challenges:

Business model:

The current blockbuster model of Big Pharma companies is outdated and does not meet current needs and market requirements. The business model is based on the notion that physicians are the key decision makers in drug prescription. Hence, the pharmaceutical industry focused on physicians as the primary target of their intensive sales and marketing efforts to influence physicians in their decision-making process. However, physicians are increasingly constrained by regulations and guidelines driven by public and private regulators. However, the industry’s target customer is changing as health care policymakers and payers increasingly gain control over prescription decisions. This shift requires the industry to refocus its sales and marketing efforts on new stakeholders and to adopt corresponding strategies.

Patent cliff and protection:

One of the greatest challenges the pharmaceutical industry faces is the 'patent cliff' and the protection of patents. The ‘patent cliff’ refers to the period - starting in 2009 and peaking in 2011-12 - when many of the leading blockbusters will lose their patent protection and other produced drugs will not be able to balance the lost sales. According to Bernstein, over the next five years, revenues of USD 157 billion will be lost because of the expiration of patents. This patent cliff will result in a massive decline in sales for some of the world's largest pharmaceutical companies. Consequently, the patent cliff needs to be overcome by introducing innovative drugs which may guarantee a future income.

The second challenge is patent protection. Intellectual property (IP) is one of the most valuable assets of a Big Pharma company. An IP on a drug guarantees the company exclusive rights to promote and sell the respective drug for a period of time and thus recover its high R&D investments. However, a rise in the number of ‘patent challenges’ is evident. Patent challenges, for instance, result when generic manufacturers produce patented drugs before the patent’s actual expiration, thus affecting the sales of the patented drug. According to Bernstein Research, the number of such challenges increased from 35 to 162, by a five-fold, between 2001 and 2007. In many cases, the patents can be protected, e.g., through a court decision, and a halt in the production of the generic version enforced, yet this requires much time and effort and inevitably results in a loss of sales. Due to increasing price pressures and patent challenges, patent protection is one of the most critical challenges the industry will face in future.

Competition:

Another challenge pharmaceutical companies increasingly face is inter- and intra-industry competition. Within the industry, generic companies are aggressively competing with Big Pharma companies. They offer drugs at a much cheaper price since they do not have to recover any R&D costs (see Chapter 2.2.5). Once a patent expires, the Big Pharma companies experience considerable losses in sales and market share. One example is Schering-Plough’s Claritin which is used for allergies. Its sales fell from 3.2 billion to 0.37 billion USD in just two years after the patent had expired.

In addition to intra-industry competition, inter-industry competition is also on the rise. Competition from other industries is increasingly evident as non-traditional competitors gradually move into areas that have traditionally been covered by the pharmaceutical industry. Food companies, for instance, have expanded their product lines to include health-related areas and are increasingly carrying out R&D in these areas. Nestlé, for example, offers functional foods and is also involved in the field of 'personalized nutrition' with products and services that focus on diet and nutrition. Cosmetics companies have begun to target the overlap between their traditional goods and health & wellness. Wal-Mart, for instance, offers mail delivery service for generic drugs and offers over 1,000 OTC items in its stores. A recent study by Ernst & Young underlines the potential threat emanating from such non-traditional competitors. 92 percent of the Ernst & Young survey respondents believe that non-traditional competitors will enter the market and have a high impact on the pharmaceutical industry. As a consequence, the industry will also face competitive pressures from other industries, thus exerting additional pressure on the margins.

R&D productivity:

Paired with the patent cliff, R&D productivity represents one of the most critical challenges the pharmaceutical industry will face in the future. First, it takes an average of 10-15 years to successfully develop a new drug. Thus, the careful planning of the long-term R&D pipeline is imperative for Big Pharma companies.

Second, as mentioned in Chapter 2.2.3, R&D expenditures are soaring. The industry’s R&D processes have become so complex and cumbersome that additional investments are required in order to achieve a reasonable result, i.e., the discovery of a successful drug. Several studies indicate that the chance of discovering a promising, new, and marketable drug is astonishingly low: The number ranges from 1:5,000 to 1:10,000. Once they have reached the market, only 20 percent of the marketed drugs will actually generate sufficient income to amortize the initial investment. The costs for developing a drug in 2005 were estimated at USD 1.3 billion, over four times higher than in 1987 (318 million USD). The main reasons for this surge in R&D costs are the high clinical trial costs, the high failure rates, and the intensive efforts required to obtain drug approval by the regulatory authorities.

At the same time, the efficiency of R&D and the discovery process have declined over the years. The introduction of new products, as measured on the basis of new drug applications (NDA), has dropped dramatically. In Europe, the number of NDA fell from approximately 90 to nearly 40 between 2004 and 2008. The reason for this is the decreasing rate of approval for new chemical/molecular entities (NCE/NME) and the generally slow regulatory approval process. In Germany, the number of NCEs decreased from 35 to 31 between 2004 and 2008. Consequently, a Boston Consulting Group (BCG) study estimates that current R&D investments provide a risk-adjusted yield of 11 percent compared to 15 percent five years ago. In other words, the pharmaceutical industry faces a severe R&D productivity problem which could jeopardize the entire business model of Big Pharma companies. Hence, short-term and even more so long-term measures and strategies need to be developed to effectively deal with the R&D productivity problem.