Adapt or Perish

A new report from A T Kearney’s highlights what the pharmaceutical industry must do to survive.

“Over the past few years, there has been a dramatic change in what payers want to achieve”

It's no secret that things in the pharmaceutical industry are far from rosy. Patents expiring, pipelines drying up, blockbusters thin on the ground. After years of progress and breakthrough treatments – not to mention high profits – something is clearly wrong. A recent report from global management consulting firm A T Kearney, 'Pharmaceuticals out of balance: Reaching the tipping point,' authored by Jonathan Anscombe, Michael Thomas and Omar Sawaya, gets to the root of the problem by identifying the industry's current 'tipping points'.

The report points out that the pharmaceutical industry has enjoyed one of the greatest success stories in recent history. "The industry has created technologies that have redefined the concept of old age. Vaccines have eradicated diseases such as polio and smallpox, and research in genetic medicine has led to huge gains in the treatment of lethal diseases such as cancer and AIDS." On the business side, the authors point out, the industry accounts for 20 percent of all global R&D investments, and generates revenues of more than $700 billion.

What, then, has gone wrong? As the report points out, even as healthcare budgets are rising, drug dales in most developed markets are forecast to be flat. "Spending on sales and marketing in the United States," it goes on to say, "has increased 13 percent a year over the past eight years, while return on that investment has dropped by 15 percent."

Efforts to improve efficiencies through cost-cutting and consolidation have not solved the problem, and shareholder returns are plummeting. And the future, according to Anscombe, Thomas and Sawaya, also looks bleak. Pricing pressures are increasing across the globe, and even the US has become a challenging market.

The authors believe these problems are symptoms of a shift in the nature of healthcare systems. They say healthcare is out of balance, and so is the pharmaceutical industry. "Each company in this innovation-based industry will soon face a choice of either playing in ever-smaller niches or re-asserting its position as a key partner in improving global healthcare outcomes," they maintain. "This new role will require companies to move away from selling molecules and toward addressing health needs; to look away from traditional markets; to be driven by the way their therapies are used, rather than by the discoveries they've made; and to restructure away from the integrated models that have dominated the industry to more fluid forms that allow companies to respond to new challenges across the value chain."

The report's authors believe these increasing problems are a sign that the industry is approaching a time of rapid change. They have identified three inter-related 'tipping points' relating to what the industry sells, to whom, and how it should organize itself. Below, we summarize their descriptions.

From therapies to service models

The first tipping point relates to the pharmaceutical sales model, which until now has assumed that the prescribing doctor is the primary decision-maker, making decisions based solely on the doctor's perception of patient need. This assumption has led to the current model of investing heavily in sales and marketing to influence doctors.

But physicians are subject to many outside influences: the constraints of formularies, the influence of guidelines, the prompts delivered by IT systems, the incentives offered by financial mechanisms. All of these are driven by payers and regulators or by providers responding to payer costs and political pressure.

Increasingly, which drug is prescribed is less important to pharmaceutical companies than whether a drug is prescribed at all. For example, where patients move through increasingly expensive levels of treatment – from NSAIDs to DMARDs to biologics ­– a company providing biologics could benefit more by persuading payers to allow their earlier use than by trying to prove that there drug is more effective than a competitor's.

Another issue is increasing elasticity in pricing. The traditional view is that selling a drug more cheaply does not mean more volume because doctors do not prescribe based on price, but this is changing with the growing influence of payers. However, the way payers perceive value is different from the way pharmaceutical companies do.

Over the past few years, there has been a dramatic change in what payers want to achieve. Rarely are drugs the only intervention used to treat a disease: payers are often more interested in the effectiveness of the treatment pathway than the clinical effectiveness of a particular drug in a clinical trial.

However a pharmaceutical company chooses to define a drug's value, it will need to be demonstrated in a way that is compelling to payers. While phase III randomized control trials can demonstrate the clinical value of a therapy in a controlled environment, payers need to know how it will perform in the real world before providing funding.

The problem with many drugs is not their efficacy, but the lack of patient compliance. The report states that within six months of agreeing to take a prescribed drug, about 50 percent of patients stop taking it – and this holds true even for those with life-threatening illnesses. As the focus shifts increasingly to payer needs, a service model in which drugs are actually used will confer a competitive advantage.

From niches to mass markets

The US dominates the pharmaceutical industry, with more than half of all drug sales and R&D spend. Because of this, much R&D focuses on those areas that are important to the US market, and prices also reflect what the US market will bear.

As the US market begins to falter, developing markets are emerging as the new engine of growth. Ninety-six percent of population growth in the next 50 years is expected to occur in developing countries, which at the same time are experiencing a dramatic increase in diseases – such as diabetes – that are more common in the developing world.

The developing world is characterized by high levels of self-pay and very little in the way of public health systems. However, spending per capita is growing, and the report's authors feel that most countries will develop some form of comprehensively funded healthcare system as soon as they can afford to. They say that emerging state-funded systems will need to develop cost-effective solutions to these new health problems, but will not be prepared to pay Western prices.

As the US tightens up on pricing and developing markets continue to grow, volume at a lower cost will become increasingly attractive. Anscombe, Thomas and Sawaya think pharma companies should forget their obsession with high-priced solutions focused on the US market and establish prices to maximize revenue over a drug's lifecycle and across global markets. They believe that the industry will be forced to view emerging markets in a new light: not just as an opportunity for lowering R&D costs or demonstrating market commitment, but as a source of low-price breakthrough innovation.

Making connections

The report argues that against this new world order, the traditional model of a globally integrated pharmaceutical industry will struggle to survive - it will be too large, unwieldy and unfocused to connect payers, providers and potential partners in the many markets it seeks to serve. It notes that the most successful companies of the future will shift from being R&D driven to being market-driven, and that this will require a complete rewiring of their organizations.

The challenge for pharmaceutical companies will be choosing the therapy areas on which to focus. The authors believe the current trend to specialize in specific niches will accelerate, with even the biggest companies building expertise in a few selected clinical areas.

The requirement to integrate drugs into delivery models and demonstrate value in the real world will introduce new requirements to build broader relationships with healthcare systems and form partnerships with local providers. A new kind of sales and marketing organization will be required, with traditional sales forces dramatically reduced in favor of localized market access organizations.

With the move toward service delivery, companies will need to have closer integration between researchers and marketers. Researchers will increasingly need to understand not just the science of the disease, but also the operational, human and political barriers to effective treatment. Innovative solutions will increasingly encompass establishing delivery platforms that unite multiple technologies.

Sources of innovation are also becoming more diverse. The report's authors pont out that new biomedical centers are emerging in places such as Singapore and Shanghai. The proportion of drugs that are in-licensed is increasing, and in-licensing is happening earlier in the product development process. Companies will also need to seek out low-cost, breakthrough innovations, which are more likely to occur in the developing world.

The shift toward mass market solutions will also introduce a dramatically different dynamic to the supply chain. Anscombe, Thomas and Sawaya underline the fact that when margins are 80 percent or more, working capital, manufacturing costs and distribution costs have little impact on profitability. The advise companies to look closely at their manufacturing and distribution models to help drive down supply chain costs.

Future manufacturing and supply-chain organizations will have to be more streamlined to bring more therapies into mass production quickly and cost-effectively. The authors expect to see outsource manufacturing continue to grow, not just in late life-cycle or periphery technologies, but also for core technologies.

A consequence of the need to focus on specific capabilities means that three types of companies will operate in the space currently occupied by integrated pharmaceutical companies. Value-delivery companies will focus on specific therapies in certain countries, and will gear their value propositions in response to local market needs. Health innovation companies will develop and leverage technologies in as many applications as possible to gain a return on investment at a reasonable cost, thus maximizing profit.

The report conlcludes that the pharmaceutical company of the future will have to decide which of these functions it wishes to deliver, and with which companies it need to partner to access world-class capabilities. Competitive advantage will come from the ability to connect these capabilities to address critical health needs on a global scale.

For more information on the full report, please see www.atkearney.com.

Jonathan Anscombe is a partner and co-head of the firm's pharmaceutical and healthcare practice.

Michael Thomas and Omar Sawaya are principals in the global pharmaceuticals and healthcare practice.