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Big Changes for Big Pharma?

By December 15, 2004February 15th, 2019Opinion
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Published: Dec 15, 2004 in Knowledge@Emory

Lately, the pharmaceutical industry has seemed a bit like the New York Yankees – the team that almost never lost suddenly can’t win. At Emory University and its Goizueta Business School, professors are divided over whether the current slump will pass or if the turmoil signals the beginning of some profound industry-wide changes.

Once a darling of Wall Street, Big Pharma is now causing fund managers to wince. As the money manager of a successful health care and pharmaceutical investment fund told Barron’s recently, investors are growing skeptical that the turnaround is coming. “People expected an eventual turnaround. But every time it seemed as if it would happen, there is some new disastrous event or a product gets pulled,” said John Borzilleri of GRT Capital Partners in Boston.

One of the industry’s latest and greatest disasters: on September 30, Merck announced that it would recall Vioxx, a $2.5 billion-a-year arthritis medicine, because new evidence suggested that the blockbuster drug doubled long-term users’ risk of strokes and heart attacks. The news shocked Wall Street and sliced $27 billion off its $100 billion market cap.

With respect to Big Pharma’s research achievements, the record is increasingly weak as well, even though research budgets have reportedly risen by 250% over the past 10 years. Today, research expenditures of U.S. pharmaceutical companies tops $33 billion annually, according to figures from the Pharmaceutical Research and Manufacturers of America (PhRMA), an industry trade association.

Yet the researchers arguably have less to show for it. Lester M. Crawford, acting commissioner of the Food and Drug Administration, noted in a speech a few weeks ago that applications for the recently ended fiscal year 2004 “lagged far behind the totals of 10 years ago.” In the last 12 months, the agency received 28 submissions for new molecular entities and 20 new biological license applications. By comparison, in 1995, the agency received 44 applications for new biological licenses and in 1996 and 1997, 44 applications for new molecular entities.

To make matters worse, the pharmaceutical business is now one of the most deeply disliked industries in the country. Despite some well-publicized efforts to provide free or reduced costs drugs – Pfizer, for instance, donated over $600 million in 2003 in medicine and medical care and community service to various groups around the world, according to its 2003 annual report – the U.S. public doesn’t seem convinced. An April 2004 telephone survey of 979 Americans conducted by the Harris Poll found that 44% of Americans think that pharmaceutical companies are doing a good job – down from a 79% approval rating in 1997.

Only health insurance, oil companies, HMOs, and tobacco companies now rank lower in the public’s esteem. L.G. Thomas, a professor of organization and management at Emory’s Goizueta Business School whose research interests include the pharmaceutical industry, says the reason for the rancor is simple: “They charge high prices and make a lot of money off people who are sick. “

But that’s always been the case: why the drop now? Matthew Holt, a San Francisco health care strategy consultant, traces the decline in popularity to several sources: the rising profile of the drug expenditure issue in Congress, the publicity surrounding Americans buying their drugs for less across the border in Canada, and the increased use of television ads to the point where pharmaceutical companies now reportedly spend more on marketing than research.

While unpopularity might seem like a minor strategic factor for companies that sell life-or-death products, all that public animosity may ultimately matter to the bottom line. A number of observers speculate that the rise in ill-will may ultimately make Big Pharma more vulnerable to federal price-controls.

Is Big Pharma in big trouble?
Some observers argue that, like the Yankees, the focus on Big Pharma’s current problems ignores the considerable strengths of the franchise. “This is still America’s most profitable business, and it’s still a business that is growing,” says Holt. In the mid-Nineties less than $100 billion in drugs were sold annually, he says; today, that number is up to about $250 billion.

When it comes to the question of those empty research pipelines, the concern there may be misplaced as well. Thomas says that innovations in the pharmaceutical industry tend to run in clusters, and that some decades are simply richer than others.

However, Jagdish Sheth, a Goizueta marketing professor and business strategist, predicts that the good old days won’t be back for the industry. “The traditional pharmaceutical business model is just untenable now,” he says.

In Sheth’s view, the old model in which Western companies synthesized new compounds, tested them, then licensed and sold their own drugs is no longer viable. Sheth believes that the competitive landscape for the pharmaceutical industry is evolving in a number of dramatic ways.

In research, Chinese and Indian laboratories can conduct research at one-tenth of western costs, challenging the old Western monopoly on pharmaceutical research.

The nature of that research is changing as well, he says. Where the traditional strength of pharmaceutical companies was in chemical research, what’s needed now is expertise in stem cells and genetics – a divide as profound for the industry as the move from transistors to digital technology was in the electronics industry. In addition, as the population of advanced countries ages, the direct and indirect subsidies of pharmaceutical companies by governments are becoming too expensive for those governments to sustain, even as the industry’s current cost structure makes its potential for profitable exports limited.

Sheth has three remedies for Big Pharma companies. They need to engage in more mergers to share the fixed costs of research and development; concentrate on over-the-counter, nonprescription drugs; or cut their research costs more by sending increasingly large projects offshore.

Thomas sees the biggest risk the industry faces as being a kind of side effect of one of the sources of its current profitability: third party insurance. The fact that so many drugs in the U.S. are purchased through third party insurance gives consumers “extraordinarily distorted incentives” that encourage people to think of drugs as free, promoting over-consumption and driving up costs, he says.

Thomas favors a restructuring of the system in such a way that individuals would pay a larger share of the cost directly (with protections for the poor and the elderly). However, Kenneth Thorpe, a professor of health policy at Emory’s Rollins School of Public Health, says that although purchasing by consumers would have some positive effects on drug costs and consumption levels, such a plan could inadvertently put more pressure on other parts of the health care system.

Thorpe argues that higher drug costs could, in some cases, actually discourage those consumers who use most of the drugs, people with chronic conditions such as heart disease and hypertension. “The problem with that idea is that if you really do raise the prices a lot, people cut back and stop taking the drugs, and they end up getting sick and hospitalized, [because] those are parts of their benefit package that would be covered,” he explains.

“We have seen some evidence that, certainly, increasing prices to patients does result in lower drug spending, but for some chronically ill patients, it could increase overall spending if patients stop taking their drugs,” Thorpe says. PhRMA claims that drugs are quite cost competitive compared to hospitalization: the trade group estimates that each additional dollar spent on newly developed medicines saves $4.44 in hospitalization costs.

Thomas argues that this lack of price-sensitivity also encourages companies to develop unnecessary knockoffs of more successful drugs because consumers have no incentive to choose the best and most cost-effective drug. “What they really need are sophisticated consumers who are willing to pay a lot for important advances but are very frugal when it comes to trivial advances,” he says.

And he fears that if consumers aren’t made more price-sensitive to drug costs, those rising costs will “continue to eat up more and more resources, and probably — and inescapably – [create] more and political pressure for price controls.”

Why would price controls be such a bad thing? After all, almost every other industrialized country has them. Thomas notes that many of the countries that introduced price regulation have inadvertently destroyed their pharmaceutical industry. Germany, for example, had the largest pharmaceutical industry in the world in 1980. Now, he says, German companies are almost entirely out of the pharmaceutical business. He notes that the same thing also happened in Canada, Australia, New Zealand and Italy when price controls were introduced there.

If price controls were put in place in the U.S., Thomas argues that the same thing would happen to the U.S. industry as has happened elsewhere. “It wouldn’t move. It would just die,” Thomas says. “They would go kicking and screaming, but in time they would go.”

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