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Published: Jul 18, 2007 in Knowledge@Emory

Prescription drug prices rose only 1.9% in 2006, according to the most recent Consumer Price Index – the smallest increase in 33 years. Between the pressure from insurance companies and managed care providers, Wal-Marts; program to offer a long list of generic prescription drugs for $4 a month, and threats of Congressional Democrats to rein in drug prices, the pharmaceutical industry appears to have lost a lot of its pricing power.

So what’s next for Pharma? Professors at Emory University and its Goizueta Business School say that these pricing pressures are likely to encourage some dramatic changes in an industry that has been reaching a critical point in the last few years. “The pharma industry is finding itself in an untenable position,” says Jagdish Sheth, a professor of marketing at Emorys Goizueta Business School and corporate strategist. “There is no way that they can sustain themselves in the way they do business today.”

For many years, the less-regulated U.S. market has provided roughly half the profit for the world pharmaceutical industry, professors say. Going forward that is going to have to change if regulation and market-pressures such as the Wal-Mart factor push down what the U.S. market will bear, while at the same time, the most promising new customers from emerging nations, including China and India, simply cant afford to pay Western-level prices, observes Sheth.

Faculty and other experts see a variety of unsustainable expenses in Pharmas current business model that need to be trimmed substantially. In marketing, for example, the Consumers Union estimates that pharmaceutical companies spend more than $8000 a year per physician. On average, according to a Consumers Union white paper, physicians see 28 sales reps a week, meeting with them a total of 2 hours and 13 minutes, as of 2004.

“Their job now is to go and arrange luncheons for physicians offices and pass out free pens and pads and things like that. Nobody is fooling anybody,” says Charles Frame, an adjunct professor of marketing at Goizueta and a professor at Emorys School of Medicine. They may not even have much influence over lunch: Its become such an institution, he says, that some physicians offices keep printed requests on hand when they see a rep – “We need x number of lunches, four need to be vegetarian and we prefer turkey,” Frame says.

At one time, sales representatives were a vital link for doctors to learn about new advances in medicine, answer questions to help distinguish their drug from a competitor, and to provide perks to physicians to encourage their allegiance to prescribing a particular drug. It was gross misconduct with the latter which brought Congressional pressure to legislate change. Add to that the availability of the Internet and advertising directly to consumer, and the role of the sales rep has changed.

Although the industry has spent more in recent years to try to reach consumers directly, through television and online, this approach has been largely unsuccessful in some respects. In 1996, a survey of the Kaiser Family Foundation found that 79% of consumers surveyed said they believed that pharmaceutical companies do a good job with their customer service. Yet by 2006, the same survey found that only 44% of consumers now think that Pharma companies do a good job with their customer service – and 48% say they do a bad job. In fact, many polls show that the public regard for pharmaceutical companies is now down near tobacco and the petroleum industry. Add to that the influence of popular culture, with such offerings as the recent thriller “The Constant Gardener,” where pharmaceutical executives are often cast as villains, more like drug dealers than drug inventors.

More seriously, R&D costs keep growing. Now, says Sheth, research and development costs for a new drug cost on average $900 million – and few of those are successful. Even when they are, he says, the payoff is often lower than a few years ago.

In recent years, drug researchers have found it increasingly difficult to discover the kind of ‘blockbuster drugs needed to feed the drug machine. “The days when you could have a Lipitor or something like that are gone,” says Frame, referring to Pfizers profitable anti-cholesterol drug.

The reason is that a growing understanding of genetics and chemistry is enabling researchers to develop drugs that are more targeted towards increasingly specific groups of people. This trend may be good medicine for patients, but its apparently not good medicine for Pharma, since most companies were designed to convey a single new drug into many consumers medicine cabinets, not many drugs into many different cabinets.

Recouping investment of a patented drug also is more difficult than was once the case. Trials take longer now than they once did: some industry experts say that even aspirin would have a difficult time making it out of the lab today. Longer trials not only mean more development expense, some say, but a shorter time period for recouping investments while the drug is still under patent protection. Its also easier to engineer copycat drugs that avoid patent infringement, Frame says. “The standard idea of having a 20-year window in which to have a virtual monopoly are long gone because competitors are getting so good at finding legally acceptable ways of getting around your patent,” notes Frame. Now, he says, the window is more like 10 years.

Companies will likely keep trying to cut costs through mergers and consolidation, Sheth says. They are also likely to continue to cut down on marketing expenses, professors say, such as supporting all those sales reps. If blockbusters are no longer going to be the dominant way in which pharmaceutical businesses succeed, the marketing machines designed to sell blockbusters may no longer be necessary. “Pharma needs to realize that maybe they dont need that entire infrastructure,” says Frame.

“The ultimate conclusion is that the drug industry has to learn how to create breakthrough innovations at very affordable R&D expenses,” contends Sheth.

Some changes are underway. Increasingly, Frame says, Pharma companies are buying promising late-stage research rather than taking their chance on purely internal development. Buying a late-stage project from a small biotech startup or a professor working with a few graduate students may be a cheaper way to fund drug research in the long run than maintaining a larger lab. Another and more common approach is to shift R&D to India, China and Eastern Europe where the cost of a scientist is significantly lower than the U.S., notes Sheth.

However, in the case of universities, what makes business sense for Pharma executives, professors and university finance officers may have some unintended consequences. Kira R. Fabrizio, an assistant professor of organization and management at Goizueta who has studied technology-transfer between universities and pharmaceutical companies, believes that in some cases the push of universities to patent their own inventions may be reducing the amount of general knowledge that was once shared with the industry.

With universities standing to make money on patents—and professors typically taking 1/3 of the gains, with the school taking the rest—academics at some schools are less likely to share promising results publicly than they once were, according to Fabrizio.

This may mean that the industry as a whole—and the public—may sometimes lose out because more patents by universities will mean a slower circulation of general knowledge in the field. Fabrizio recounts one story that illustrates what may be happening: one professor she interviewed told her that he used to worry about the conflict between research for drug development and research for publication, but he doesnt anymore. Now, he told her, they just publish after their idea is patented.

“For patents on late-stage innovations, such as specific drugs, patenting and licensing of university research is appropriate and likely beneficial to technology transfer,” Fabrizio explains. “However, many patented university research results are embryonic in nature, or serve primarily as an input to follow-on research processes.”

For early stage or general purpose technologies from universities, Fabrizio favors a more open model of knowledge transfer than the kind of exclusive license that now dominates university-Pharma contracts. One best practice would be to follow the practice Stanford University used with the Cohen-Boyer patent: rather than license the Cohen-Boyer gene-cloning method to only one company, the university licensed the know-how to anyone who wanted to pay a flat fee to use it, she explains. This encouraged competition between companies and led to the development of more drugs than if it had licensed to one company – which might or might not have been able to take advantage of it. “Think of how different the world would be if they had tried to extract the value from one licenser,” she says.

Another potential big change is the breakup of vertical integration between discovery, manufacturing and marketing, observes Sheth. “In other words, companies will specialize by value chain. This is already happening with emerging pharmas such as Vertex, a Boston based small company.” In June, Vertex Pharmaceuticals and Johnson & Johnson announced a collaboration to develop and market experimental hepatitis C treatment. Terms of the deal call for J&J to pay Vertex roughly $450 million for European manufacturing rights.

Besides relying more heavily on universities, Pharma companies also need to look east to low-cost markets for their research, professors say. Generic drug production is already moving East – most ibuprofen, for example, is now manufactured in India – but soon higher-end development will be moving East as well, Sheth says. Drug development in the East will cost a fraction of what it does in the West. Sheth, who sits on the board of an Indian pharmaceutical company, says that some experts in the field have told him, that the $900 million average drug development bill may cost no more than $50 million in Eastern Europe, India or China. The reason is not only because researchers salaries are cheaper, he says, but because its cheaper to recruit people for a drug trial than it is in a developed country.

The value of these offshore clinical studies may be limited because of ethnic and regional differences in biochemistry, in Frames view. However, Sheth believes that it will be possible to find analogous groups in low-cost markets, such as Eastern Europeans who would be reasonable proxies for European-Americans.

Nor will it only be Western companies that profit from this growth. Although its common to think of Pharma as a special club belonging to a few American, British, and Swiss companies, Sheth believes that Indian companies, such as Dr. Reddys Laboratories, will eventually become important players in the global pharmaceutical market. To begin with, Sheth says that many of those companies are likely to try buying smaller to medium size western companies, and then work up, much as the Indian aluminum and steel giants already have.

Although it may not do much for the Princeton, NJ property tax base, this shift East may be good for the world as a whole. The growth of companies in poorer markets is likely to lead to the development of more drugs, Sheth says, and closer attention to the billions of people in the world who were not previously an attractive target market for pharmaceutical companies because the cost of drugs was out of reach. If development costs are so much lower, Sheth believes that some developing-world companies will find it profitable to develop new and better treatments for such predominately poor-country diseases as malaria.

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