Beware the patent cliff!
Blockbusters have been driving growth in the pharma sector. But looming patent losses are forcing companies in new directions
FACED WITH patent expiries and pressure on prices, pharmaceutical companies are transforming their growth strategies. They are decreasing their reliance on blockbuster drugs, diversifying their product mixes and moving into emerging markets.
Almost all big pharmaceutical companies have a number of large patent expiries coming up between now and 2012, says Chris Stirling, European head of chemicals and pharmaceuticals at global financial consultancy KPMG. "It is clear that relying on a small number of blockbusters is more risky now than it was in the past."
At the same time, drugs companies are finding it more difficult to develop new products. The easy targets have been plucked, and markets for drugs to treat primary care diseases, such as hypertension, heartburn and depression, have become saturated.
The disease areas that companies are now looking at are more complicated to understand, says Andrew Jones, senior pharmaceutical analyst at global consultancy Ernst & Young. "Time and money is being spent now just to try and understand these diseases, before you can even begin to develop therapeutic agents that might have a benefit in treating patients."
The industry is in decline because key drugs have gone off patent and new products are not in place to replace them, says Jones. "The product throughput required to offset the lost revenues on patent expiry hasn't happened," he remarks.
Brokerage ING warns that some pharmaceutical companies will suffer a long-term earnings decline, starting in 2010, as a result of the patent expiries. In the US, 45% of branded pharma sales are expected to face generic competition in the next five years, according to IMS Health, a global provider of pharmaceutical market intelligence.
The timing of an intellectual property meltdown could not be worse, according to Craig Maxwell, pharmaceutical analyst at ING. A new US president and substantial budget deficits for US and EU governments will, he argues, be a catalyst for government action leading to a significant erosion of pricing power for drug companies. At the same time, the regulatory environment has become more challenging, as drug approval bodies such as the US Food and Drug Administration (FDA) become more cautious.
"The pharma industry is entering uncharted territory over the next few years," Maxwell remarks.
To maintain their growth prospects in challenging conditions, the big pharma groups are already realigning their strategies to decrease their dependence on high-margin, high-risk blockbusters. The pharmaceutical industry will always be attracted to blockbusters, says Jones, but "there is a recognition that you can also make returns on products that are selling less than $1bn a year, particularly in specialty markets where sales force overheads are smaller."
Companies including UK-based GlaxoSmithKline (GSK) and France's Sanofi-Aventis are increasing their focus on consumer products. And US-based Pfizer has acted decisively by announcing the purchase of compatriot rival Wyeth.
The $68bn (€52bn) Wyeth acquisition was driven by Pfizer's need to bolster its product pipeline ahead of the expiry of patent protection on its blockbuster cholesterol drug Lipitor in 2011. The deal also enables Pfizer to diversify its product mix. "By buying Wyeth, Pfizer inherits a vaccines business, an animal health business and a consumer business," says Jones. "It also gains access to Wyeth's biologics capability."
Another pharmaceutical megadeal is not expected any time soon, although smaller-scale acquisitions – of individual products or biotechnology companies with promising drugs in late-stage development, for example – will continue to help producers fill gaps in their portfolios, observes Stirling. Putting two large R&D organizations together can harm the atmosphere of innovation, he says, and the consensus view is that the last major wave of consolidation in the pharma sector, resulting in the creation of UK-based AstraZeneca and the former Glaxo Wellcome, for example, did not work.
GSK's new chief executive, Andrew Witty, has indicated that he does not intend to pursue major acquisitions, preferring to buy niche players, and plans to expand further into emerging markets in Asia, The Middle East and South America. In the past six months, GSK has announced the purchase of the Egyptian mature products business and the Pakistani business of US-based Bristol-Myers Squibb (BMS), plus more than 50 operations from Belgium's UCB.
"GSK and other companies are investing in the channels, infrastructure and routes to market in those countries," comments Jones.
AstraZeneca, too, says it is not looking for any major deals. The company says it is more likely to seek licensing partnerships and small-scale acquisitions. It is also conducting deals to share risks, such as its partnership with BMS for the development and commercialization of compounds under study for the treatment of Type 2 diabetes.
AstraZeneca is one of the companies highlighted by ING as facing a decline in earnings as a result of the expiry of a series of patents. In response, AstraZeneca says it is bolstering its pipeline. "Our goal is to have about 12 projects in late-stage development," says chief executive David Brennan. "Each year, we hope to be launching two new treatments from the pipeline, starting in 2010."
Companies are combining a move into emerging markets with an increased focus on generic pharmaceuticals. This could be seen as a hedging strategy, but more interestingly, gives companies access to emerging markets, comments Jones. "In addition to diversifying their product mix, it's also about the opportunity to capitalize on the growth that is occurring outside Western markets. Increasingly, Western markets are coming under pricing pressure, growth is slowing, the marketplace is saturated and there is lots of competition."
GSK entered a deal with South Africa's Aspen Pharmacare last year that paved the way for it to sell generic medicines in emerging markets. Japanese pharma group Daiichi Sankyo bought a controlling stake in Indian generics company Ranbaxy last year, and Sanofi-Aventis is acquiring Czech generic drug maker Zentiva.
But ING questions whether companies' emerging market strategies will provide sufficient growth. "We have deep concerns over the new focus by Sanofi-Aventis on growth driven by emerging market generics and away from innovation," says Maxwell. He believes GSK's emerging market strategy could deliver modest earnings growth, "however, we believe a fundamental return to innovation is required."
It is also essential that the current rounds of cost-cutting exercises in the pharmaceutical sector do not harm innovation. Companies are slimming down in preparation for the dramatic drop-off in revenue at the edge of the patent cliff, and in response to the global economic downturn. "Most pharmaceutical companies are in the process of taking out $1bn-2bn of their costs over the coming years," says Jones.
To cut costs, players are looking externally to see whether they can operate more effectively via collaborations with third parties, observes Andrew Hill, head of the European pharma R&D group at Accenture. "Lots of companies are looking at how you get the best out of what they have in-house, and how they get the best out of other organizations, either through alliances, partnerships and outsourcing."
Companies are seeking opportunities outside their traditional boundaries, and are cooperating with different types of organizations such as biotechnology companies, continues Hill. They are reviewing the way they allocate capital, making decisions about which businesses are core and should be invested in and which are noncore and can be disposed or outsourced to third parties. Business areas that could be outsourced include manufacturing, clinical trials, distribution and packaging and sales.
As big pharma stares down the patent cliff, players agree that the blockbuster model needs to be adapted. They are already developing new growth strategies, but need to strike a balance between cutting costs and ensuring that the R&D operations are equipped to ensure future growth. "The R&D function is the engine room of the pharmaceutical business," stresses Jones. "If that isn't working, the business model isn't working."