Charging towards a bleak future

Many reporters, analysts and other observers over the past decade have remarked on how the traditional big pharma business model has been running out of steam. Proposed solutions have included buying biotech companies (as Roche did) and forming generic divisions (as has Sanofi). Still, from outside, the (in)actions of big pharma resemble the controlled flight into terrain of other IP companies.

Last week, two consultants from Booz & Company published their own analysis of the problems in the Booz house journal, strategy+business.

Alex Kandybin and Vessela Genova deduced the strategic choices of 10 major pharma companies (Abbott, AstraZeneca, Bayer, GlaxoSmithKline, Johnson & Johnson, Merck, Novartis, Pfizer, Roche, Sanofi) through their acquisitions and divestitures from 2004-2010. Nine of the 10 have bet on biologics, five on OTC, four on generics and one (Sanofi) on animal health.

They draw an analogy to the choices of the computer industry:

Most industries go through periods of both deterministic and stochastic development. For instance, the computer industry in the 1960s and ’70s had all the characteristics of a deterministic process. IBM, Burroughs, Cray, and others pursued similar strategies, selling giant data processing machines known as main- frames. The personal computer changed the dynamics of the industry, triggering a turbulent stochastic period. It became impossible to predict where the computer industry was going, and in the early 1980s the incumbent players’ strategies diverged significantly.

This is, alas, an inaccurate revisionist view of the industry: in the 1980s, it was quite clear that the PC was democratizing computers and that standardized microprocessors enabled market entry and reduced margins.

More importantly, the computer industry of the 1970s has significant a priori heterogeneity: it was not for nothing that people referred to IBM and the Seven Dwarfs (or IBM and the BUNCH). Cray was in a very narrow and dangerous niche diametrically opposed to commoditization trends and desperately dependent on Cold War spending.

One place where the authors clearly have it right is that big pharma is fleeing from the highest margins in the life sciences (and among the highest margins anywhere) towards average or sub-average margins. The operating margins of pharmaceuticals is 29%, vs. 12% for generics, 8% for services and 2% for drug wholesaling.

This is utterly consistent with the 15-year-old observations of Clay Christensen: lower cost solutions eventually supplant higher cost solutions, destroying margins. Or, as my former colleagues Jason Dedrick and Ken Kraemer showed in their 1998 book, IBM’s shift from hardware to services dramatically grew revenues but cut margins.

What to do? The authors offer fairly generic (i.e. undifferentiated) advice: firms should embrace change, consider multiple scenarios, and assess the firm’s unique capabilities.

In the end, the old model of one-size-fits-all drug is breaking down. What will replace it? One prediction is personalized, genomic-based medicine. But even if that’s true, many uncertainties remain, including how quickly that future will get here and which part of the value chain will be the most unique and thus valuable.