Pricing is only a symptom of drug company woes

Drug companies have been in the news a lot this year. Valeant and Mylan (with the EpiPen) made themselves whipping boys (or girls) through their self-inflicted PR debacles. Next Tuesday, California citizens will vote on an initiative by anti-pharma activists (aided by a failed presidential candidate) who seek price controls for 12% of the drug purchases in the state.

This morning’s WSJ reminds us that none of this controversy changes the stark reality of the drug business: since the Hatch-Waxman Act was passed in 1984, most* drugs have a narrow window to generate profits from their R&D before they lose their pricing power due to a flood of generic competition — and for the largest product categories, they will face competition prior to patent expiration.

Heard on the Street

Big Pharma Sales Need a Booster Shot​

By CHARLEY GRANT

Wall Street Journal, November 2, 2016, C14

The coming election has pharmaceutical investors feeling anxious. But this earnings season has highlighted a more solid reason for worry about the sector: Sales of key blockbuster drugs are slowing down.

This year has been one to forget for the industry. Political risk surrounding the high cost of health care has contributed to the trouble: The Nasdaq Biotechnology Index is down nearly 30% since a furor erupted over high drug prices in September of last year.

Price pressure has been among the reasons sales are weaker.

The article lists a number of examples of such competition:

• More products (and thus greater price competition) for hepatitis C treatments
• Disappointing revenue growth for Ibrance (breast cancer) and the Humira and Enbrell anti-inflammatories
• Slowdown in diabetes sales
• Price resistance for new cardiovascular drugs

It then concludes:

A basic truth of drug development is the nature and timing of economically significant breakthroughs can be hard to predict. Today’s slow patch doesn’t mean that the industry has become worse at developing blockbuster drugs.

But investors tend to prefer companies with easily predictable growth prospects. And it isn’t clear what new drugs can generate growth in the near future.

Even in areas where there have been discoveries, the outlook may not be great. A number of companies have developed impressive immunotherapy drugs to treat cancer, but that is a crowded field with lots of competition. And since these drugs are new, just how many cancer patients this class of drugs can help isn’t yet known.

In other words, pharma faces the same challenges they have always faced: attractive markets attract competition, buyers exploit competition to reduce pricing power, and then they have to develop new compounds to replace those going off patent. If a firm doesn’t address such problems year in and year out, its revenues, profits and market cap will collapse. We needn’t cry for Big Pharma, but neither should we underestimate the magnitude and complexity of their challenges.

In many ways, the free market works better for expensive drugs than for healthcare services. Payers and providers are organized enough to bargain for better prices from manufacturers, and the overhang of generics (the “Better than the Beatles” syndrome) forces manufacturers to produce markedly better outcomes to justify proprietary prices.

Meanwhile, in the U.S. our third party payer system (a side-effect of WW II wage controls), provider networks and high switching costs mean that patients rarely have pricing information, quality information or purchase alternatives to bargain based on price or quality. In single-payer countries, patients have less choice than public school students (who at least have charter, private or home school alternatives).

*PS: For technical and regulatory reasons, large molecules do not yet face generic competition because biosimilars are not generics. It seems likely that this will eventually change, but for now an expired patent on a biologic is worth a lot more than an expired patent on a small-molecule drug.

Beginning of the end for big pharma distribution?

Since taking my job at KGI nearly two years ago, one of the questions I’ve been asking is when the existing pharmaceutical distribution model is going to disappear. It’s an important question for graduates of our current school (School of Applied Life Sciences), and also for our newest school, the School of BioPharmacy, where I now spend some of my time. Both schools send (will send) many of their graduates to biotech and traditional pharma companies.

The existing commissioned sales force model is both expensive, and also a barrier to entry that separates traditional pharma from upcoming biotechs and the various generic producers. At the same time, in industry after industry over the past two decades, we have seen expensive distribution channels disrupted by e-commerce and other more efficient delivery mechanisms. Here we have both competition from more efficient channels and also the lost of margins as drug patents expire.

This week, Indianapolis-based Eli Lilly announced it would lay off “less than 1,000” sales representatives. But the Wall Street Journal reported that the total would be close to that ceiling, amounting to 30% of its US sales force. The changes will take effect by July.

The proximate cause is the company’s patent cliff for Cymbalta and Evista. The former accounts for nearly $5 billion annually, $3.9 billion of that in the US, and its patent expires at the end of 2013. Evista accounts for another $1 billion, and will face generic competition in early 2014.

So on the one hand, Lilly is losing the margin that supports this expensive sales force. On the other hand, it wouldn’t be firing nearly a third of the people promoting its products if they continued to be effective at generating sales. As the WSJ dryly noted:

[T]he influence of sales representatives has shrunk, as many physicians no longer have the time to take the calls and some doctors refuse to see pharmaceutical representatives out of concern about improper promotions. Growing numbers of doctors prefer digital marketing.

Lilly's U.S. sales force "will move to a smaller structure that is more directly aligned with our business realities—along with the realities our customers face, and the way they want to interact with us," a spokesman said.

Instead, big pharma is using computerized tools (such as iPad apps) to communicate with doctors.

This reminds me a lot of airlines, which used to have travel agents, ticket offices, customer support personnel and so on. When I started teaching strategy in 2002, I drew the distinction between full service and discount airlines, but after a few years the post-9/11 bankruptcies eliminated almost all of the distinction. (In a separate article this week, the WSJ noted that Pfizer and GSK cut free lunches and other doctor perks last year, in part to save money.)

The WSJ article on Lilly continued:

Today, there are about 60,000 pharmaceutical sales representatives, down from a peak 104,000 in 2006, according to ZS Associates, a sales and marketing consultant that advises many drug makers.

By 2020, I’m convinced that the traditional sales force will be a thing of the past. Those 60,000 employees will be under 10,000, with 90+% of the young salespeople (earning six figure compensation with commissions) looking for other work.

The industry needs to figure out another way to accomplish the same goal. How will doctors keep up with all the new medications — when they’re already having major difficulties doing so? Consistent with other trends, are they going to rely on pharmacists to stay on top of this and let others make the final decision on selecting therapies?