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The future for pharmaceuticals in a health care crisis
18
00244301/89 $3.00 + .OO Pergamon Press plc
Long Range Planning, Vol. 22, No. 1, pp. 18 to 27, 1989 Printed in Great Britain
The Future for Pharmaceuticals a Health Care Crisis Heinz
in
Redwood
When an industry reaches a turning point, everyone in it is drawn into the turmoil. Not that it happens frequently, but most industries pass more than one major turning point in the course of an executive career of average length. The experience is unsettling-especially if preceded by a generalreluctance to anticipate it or its consequences. Corporate strategy is usually concerned above all with the competitive positioning of a company within an industry or, if diversified, in a number of industries. To this two-dimensional picture, which takes the company and its competitors as the main variables, we need to add the changing background of the industry itself: a third dimension that challenges the powers of adaptation of all the competitors. It compels them to acknowledge as real the forces that are unleashed by time as industries mature and society changes. This paper explores the turning points that have occurred during the past 30 years in one particular industrypharmaceuticals-and seeks to distil from it a number of lessons that may be relevant to industrial strategy in a wider framework.
The Industry Life Cycle For corporate planners and strategists, it is vital to understand the shape of their company’s life cycle, and where on that curve it stands today. A company may, however, stand on shifting sand if its industry is itself in a state of transition.
cardboard cut-out, ing is depth.
What
is miss-
Industrial history is not bunk. One look at the industries that are dead or dying shows that much of the time, history has pointed the way very clearly, but governments and industrialists have preferred to tly in its face. Before looking forward, it pays to look backward into an industry’s history: how it has arrived at today’s position. What it has achieved and where it has failed. ‘Why and how have today’s problems arisen?’ is a question that goes usefully beyond the customary ‘What are today’s problems?‘. The why and how of history can often point to more valid solutions than whut alone. Such questions need to be resolved before a company determines how to position itself within an industry. Science-based Industries The biography of science-based particular interest in this respect, reasons :
industries is of for a number of
They generally pass through Discovery, and some through
a GoIden Age of more than one.
They acquire a youthful Wonders Of Science aura, and glamour in the eyes of the media, which later turns to fear, mistrust and the resentment born of disillusion.
It is often assumed that all industries follow the same pattern of birth, maturity, decay and death, but in fact they differ in longevity, in their susceptibility to disease, and in their capacity for recovery and selfrenewal.
They find it extremely difficult to adapt to the problems of maturity after their golden youth.
In common practice, an industry and the environment in which it operates are evaluated as they are today, and then projected forward. But an industry without a past is like a man without a shadow: a Dr Heinz Redwood was for 15 years Head of Corporate Planning at Fisons plc and a Director of a number of operating divisions. He is now a Business Planning Consultant. This article is based on the author’s book: The Pharmaceutical Industry-Trends, Problems and Achievements. Oldwicks Press (1988).
two-dimensional.
Many governments, in their dealings with such industries, ignore the time cycles of science and technology and seek short-term answers to longterm questions. There is a widespread belief that, because science can rejuvenate a dying industry, the moribund will always recover. It is not so. The
pharmaceutical
industry
shares
many
of the
The Future attributes that are typical of science-based but it has some features that are unique.
industries,
The End of After 1960, new drugs, were not heyday of ment was innovative
The first occurred during the 15 years from 1817 to 1832 when a dozen or more important alkaloids (for example morphine, quinine and codeine) were first isolated and purified-which enabled them to be manufactured industrially.
The third and most recent Wonder Drug era lasted roughly 25 years from 1935 to 1960. It began with the discovery of the sulphonamides (1935) and the purification of penicillin (1940) which made it possible to harness its therapeutic activity industrially. It ended with the worldwide withdrawal of thalidomide. This period of 25 years revolutionized transformed the pharmaceutical drug therapy, industry, and created most of the problems with which the industry has had to contend ever since. Patent protection and brand name promotion made it possible to sell highly differentiated ‘single-source’ industry drugs at high prices. A run-of-the-mill suddenly soared to extraordinary heights of profitability. The focal point of competition became the research laboratory rather than the market place. The market mechanism for prescription drugs is indeed an unusual one: the user (i.e. the patient) does not exercise consumer choice, and in many countries pays little or nothing for the prescribed drug; the prescriber (i.e. the doctor) selects drug and brand
Figure
1. Turning
the Golden Age there was a sharp fall in the number of and many that were chemically new therapeutically innovative. It was the ‘Me-Too’ inventions whose developjust as costly as that of genuinely drugs.
By now, the time span between discovery and market introduction had trebled as a result of the severe regime of regulatory control (requiring proof of drug safety and efficacy) that had been precipitated by the Thalidomide affair. As a conscquence, the period of effective patent protection (from market introduction to patent expiry) shrank to less than half of nominal patent life. A clear turning point had occurred in the ground rules by which the industry worked and to which it and the authorities had grown accustomed (Figure 3) : It took most of the next two decades for the strategic implications to sink in and, by the time they did, a further turning point was in sight. There are four main reactions to an unpleasant turning point that will change an industry’s ground rules for the worse (Figure 2): The first is to ignore it and plough on regardless, steering blindly. The second is to deny it, unearthing every conceivable argument why what is happening is only a temporary aberration, after which things will broadly be as they used to be. The third is to resist it, recognizing that there has been a turning point but responding with the aim of putting the clock back. Denial and resistance arc both quite common. They may sound foolish in print but are highly persuasive in the corridors of power, both in industry and in government. The final response, adaptation to change-or still, ahead of change-is far more effective
Event
Symptoms
End of Golden Age
l
Decline in Major Discoveries
l
More Intensive Marketing
l
Thalidomide
l
Delayed Shock (pessimism in 1970s)
l
Strict Regularion
l
Reluctant Acceptance Regulation
l
Trebling of Period From Test Tube to Market
I jints in the pharmaceutical
Industry’s
Affair
industry:
19
but does not pay for it; while health care authorities (National Health or other public or private sector institutions) have to pay but cannot select the drugs for which they pay. That, at least, was the position during the Golden Age of Discovery and for some time after it ended in a creative hiatus.
The Pharmaceutical Industry Its origins as an indttstry-as distinct from the mortar and pestle activities in the backrooms of pharmacies which go back to antiquity-dates from the early part of the 19th century. Sincethen, the industry has passed through three ‘creative bursts’.
The second burst took place between 1880 and 1910 when the therapeutic activity of many new synthetic drugs, based on the chemistry of coal tar, was the barbiturates and Paul discovered (aspirin, Ehrlich’s first ‘chemotherapeutic’ drug Salvarsan against syphilis are examples). During the same period, the epoch-making microbiological discoveries of Pasteur and Koch led to the industrialization of immunology.
for Pharmaceuticals
1960
Response
of
better in the
20
Figure
Long
Range
2. Reactions
Planning
Vol.
February
22
Reaction
Diagnosis
Consequence
Ignore
‘Strategic Dyslexia’
Victim
of Circumstance
Deny
Refusal to Face the Facts
Victim
of Circumstance
Resist
May be Refusal to Face the Facts. Could be a Brilliant Counter-Stroke
Usually Victim/ Sometimes Victor
Adapt/ Anticipate
Conventional Wisdom, but Often Comes Too Late
Survival and Competitive Advance if Recognised Early and Acted Upon
to turning
points
long run, but is rarely seen as the battle cry with which to rally the troops, as corporate planners (one of the few pockets of management that thrives on change) often discover to their cost.
The Crisis in Health Care In the developed world as a whole, health care expenditure nearly doubled from 4.1 per cent of GNP in 1960 to 7.6 per cent in 1983, and in some countries (like the U.S.A., Japan and France) it more than doubled (see Figure 3).’
The pharmaceutical industry is an interesting example of roughly 20 years of impasse between successive turning points. Quite successful years on the surface, with operational results well ahead of the average for industry as a whole, but in terms of an industry’s progress and its relationship with the authorities, an impasse.
Governments
1989
Everything conspired to push health care spending to new and unprecedented heights: the steady, demographic rise of the older age groups in the population of the industrialized countries; high rates of inflation; advances in expensive medical technology; changing disease patterns with a growing accent on prolonged treatment of chronic disease in place of short course for acute infections which had increasingly come under control; rising popular expectations of more and more expensive health benefits that it seemed politically suicidal to resist; and the increasing transfer of funding from individuals to institutions and government which meant
and Industry
For governments and health authorities, the 1970s were a prolonged struggle based on the denial that a turning point in the economy had occurred after 25 years of post-war prosperity.
28
l-w_ 1214-
&-&
--•,,
1 24 \ \
g u ; &e ? 9 r ” $ I
\
lo-
\
Pharm. % of
\
8-
6-
4-
4.1 OECD
2-
0
Data from ref. 5. Original Sources: U.S.A.-ref. 4.
Figure
3. The health
-4
I 1960
I 1965
I 1970
Health Care % of GDP-ref.
care crisis. Pharmaceutical
I 1975
I I 19781980
I 1983
0
1 (average of 24 countries; Pharmaceutical % of Health Care, EEC-ref.
and health
care spending
ratios
196&1983
3,
The Future that rising expectations could be paid for with someone else’s money.’ It was a case of insatiable demand outrunning the means to pay for it. When the need to control public sector budgets became pressing, the authorities selected the pharmaceutical industry as a prime target for cost containment (Figures 3 and 4). The choice was not logical but it was politically convenient. Soon, it was lodged as firmly in the minds of budget cutters as a metal filling in a hollow tooth. The illogical element was not to ask the drug industry to make its contribution to budgetary economies in health care, but to make it the principal target for such a policy. Drugs account for no more than around l&15 per cent of public sector health care expenditure in most industrialized countries, and this proportion has fallen steadily (see takes the Figure 3) ,3,4 whereas hospital expenditure lion’s share of around 50 per cent in many countries and this has risen inexorably. It was convenient to choose pharmaceuticals as the main target, because the industry was highly profitable, politically vulnerable and not loved by the media. Tackling hospital expenditure, on the other hand, involved emotive politics and measures that would hit patients, doctors and nurses-in other words You And Me and those who look after Us. Recent events in Britain illustrate the problem very clearly.
Contuining the Drug Bill The movement to contain the drug bill has become worldwide, both in developed countries and in the Third World. In the more dirigiste countries (Latin Europe, Japan), this involves price control of individual drugs; in ‘free market’ economies (the U.S.A., West Germany) where price control is regarded as inadmissible by most governments, more subtle systems of intervention in the framework of drug choice are used as the alternative weapon in keeping drug costs down. These range from allowing and encouraging pharmacists to substitute a cheaper ‘generic’ equivalent on prescriptions for expensive, branded multisource drugs (U.S.A., Canada); urging doctors to practise more economic prescribing, with personal
4. Turning
For the pharmaceutical industry, there is much at stake and it has resisted the growing pressure on prices by every means at its disposal. The industry has grown accustomed to high prices and high profits in the wake of its Golden Age of Discovery. Only thus, it claims, can it finance the high risk of research and development to the benefit of innovative drug therapy which, in fact, has been financed from the start largely by the industry itself. It points to slow and bureaucratically complex regulatory procedures which have caused huge escalations in development time and expenditures for new discoveries, and as a result have foreshortened the period of marketing under patent protection. It is demonstrated that costs have risen while prices have been pegged or reduced by edict of the authorities, cutting into margins. In effect, the authorities have used inflation development delays as a means of forcing
In the longer term, passive erosion of ‘real’ prices and of patent protection are government policies that have produced the state of semi-permanent paralysis of the pharmaceutical industry in several European and practically all Latin American countries where it has become the exception rather than
Crisis in Health Care
l
Cost Containment (Drugs the Main Target)
l
l
Generic Revival Following Patent Expiry
0 Agitation for Longer Patent Life
points
in the pharmaceutical
Industry’s
industry:
and the
expensive ‘single-source’ segment of the pharmaceutical market into a smaller corner, and inducing lower ‘real’ prices as well as earlier competition. These tactics of erosion are far easier for officialdom to implement than direct intervention, and are just as effective. Effective, that is, in the short term.
Symptoms
Attack on the Industry’s Business Ethics
21
penalties for those who refuse to yield to admonition (West Germany); leaning on the pharmaceutical industry to organize a ‘voluntary’ price freeze for fear of something worse (West Germany) ; and an array of rules, regulations, limited lists and formularies determining which drugs will be reimbursed partially or wholly by the public or institutional purse: one or other of these forms of containment is now practically universal. The U.K. authorities devised a unique system of controlling pharmaceutical profit without dictating prices for individual drugs.
Event
l
Figure
for Pharmaceuticals
Response
Resistance 0 Rise of the Multinational Company
l
More and Better R & D (1980s)
l
Technology
l
Code of Practice (1981)
mid-1970s
Bargaining
22
Long
Range
the rule to shoulder and devclopmcnt.
Planning
Vol.
22
the risk of innovative
February research
The Industry’s Response The research-based sector of the pharmaceutical industry which dominates the market, has developcd as its main dcfence mechanism the Multinational Company (MNC) which had already become customary in other industries that were habitually in conflict with government or had world-wide market potential for innovative technology. Both factors are relevant to pharmaceuticals. The industry has long been ‘international’, but it was not until the mid-1970s that it could truly be termed ‘multinational’. An international company may export to 88 countries, but it becomes multinational only when it passes from exports and desultory local investment in finishing operations abroad, to investment decisions that involve the transfer of substantial technology as well as capital, and when it begins to replicate functional miniparent companies in country after country. By the mid-1970s a majority of the world’s leading pharmaceutical companies had set up foreign production facilities for active ingredients (i.e. pharmaceutical chemicals) as well as finished products. Moreover, about one-third had at least one major research unit abroad whose aim was innovative and not solely developmental. In the last decade, multinational ‘cloning’ has grown apace, and it has gradually become more difficult to distinguish national pharmaceutical industries because MNCs have become deeply embedded in the national fabric. This trend, highly developed in Europe, began in the 1980s to spread into the U.S.A. and Japan which had long resisted foreign penetration of their national pharmaceutical industry. The multinational movement conspiracy against national truth is more complex.
is often regarded as a sovereignty, but the
(1) Pharmaceutical
MNCs need to exploit foreign markets for new ‘products from R & D in the most rapid, most effective manner before patent protection is lost. To do so, requires local implantation at least of product development and marketing facilities, and usually benefits from a deeper level of local commitment.
(4
It is a response to government policies in countries that offer inducements for local investment to foreign companies in order to foster employment, production, exports, import substitution, and research or the transfer of technology; and who penalize foreign companics who refuse to invest locally in line with government policy.
1989 (3) Multinational development is a defence mechanism to make companies less vulnerable to government actions in any one country, by spreading the base of investment and technology to others where conditions are regarded as reasonably safe. The controversial area is the division of the financial cake between countries through the medium of transfer prices and the location of tax liabilities. The multinational mode, then, is not a matter of choice for research-based pharmaceutical companies but part and parcel of the effort to sustain a costly research base and technological leadership. The need for global revenues from multinational implantation is imperative if future research is to be funded from past or present cash flows. Confrontation It is here that the irresistible force of government in pursuit of cheap drugs meets the immovab?e obstacle of a research-based industry whose future output depends on high selling prices and high profits. This has hitherto proved to be an insoluble equation in many countries, or it has been solved unilaterally without being resolved, and with unsatisfactory results. In matters that are within government jurisdiction, government will win the day. A number of test cases in the 197Os, when some drug firms refused to toe the line laid down by government, clearly demonstrated who is master. Government can make life difficult for any single firm. It also holds the strongest cards, short-term, in negotiations with the industry as a whole through its trade association, short-term. The pharmaceutical industry is built on long-term strategy. Short-term failure can be deceptive, and short-term success transitory. It takes 10 or more years for a newly discovered drug to reach the point of market introduction. There is a high risk of failure, and large funds are needed to sustain that risk over long periods of time in the hope of reaping very high rewards for the rare real success. The long-term card that is held by the pharmaceutical industry is its advanced technology: new products, new processes, proprietary dossiers of regulatory data demonstrating safety and efficacy; manufacturing expertise and secret know-how; effective control over the supply of novel active ingredients or essential chemical intermediates : these are the fruits of high-risk research when it succeeds. The governments of many countries have sought to clip the industry’s wings by breaking into its technological treasury. Some have refused patent protection for drugs altogether (Italy until 1978, and
The Future most Third World countries); others have made it difficult to enforce patents (Spain and Portugal) or have encouraged compulsory licensing during the ostensibly protected period (Canada). Others yet have pursued a policy of encouraging the transfer of technology but without creating the political climate of confidence between government and MNCs that will persuade the latter to take the plunge. To sustain health care programmes, every country needs technology that is owned by MNCs. Technology is never static. Not even the most advanced countries are remotely self-sufficient in pharmaceutical technology. In effect, the industry’s normal strategy is to diffuse its technology widely and rapidly, so that MNCs can penetrate all important drugs markets-unless stopped or discouraged from doing so. in the Developed Countries, technology has been used as a bargaining counter. Threats by multinational companies to withdraw from countries whose ground rules are deemed to be too harsh are not taken very seriously, because MNCs need large, developed markets as much as national governments need the influx of advanced technology from MNCs. On the other hand, acts of confrontation provoked by a government whose eye is too sharply focused on short-term budgetary benefits from cheap drugs, have induced multinationals in a number of countries to change their strategy. They have not withdrawn from the country but have lowered it in their investment and development priorities. The next production unit or research facility has been placed elsewhere, and the transfer of additional technology has in effect been switched. Countries like Canada and Australia, which have long pursued such policies, have as a result seen their pharmaceutical industries stunted in development, since neither has a large enough indigenous pharmaceutical industry to walk into the vacuum created by multinational investment restraint. After several decades of drift, the Canadian authorities eventually
Event
l
Industry’s
There is thus a delicate balance between government and industry in the world of drugs. The irresistible force will try to prevail against the obstacle that does not wish to move; but in fact, there arc times when government is resistible and others when industry will yield.
The Next Turning
Point
Anyone who drives a car at top speed along a mountain road and takes no notice of signs warning of S-bends ahead, will crash. Even in the hands of a stunt man, it is only he who escapes, while the car bounces down the ravine to drown in the lake below. Signposts Along the industrial road, turning points arc not signposted with the same clarity as on public highways, but there are warnings galore. These are their often ignored and, even when observed, significance is not easy to interpret. The earlier the warning, the greater the temptation to turn a blind eye, and the worse the eventual crash. Translated into the affairs of an industry like there arc implications both for pharmaceuticals, industry and for the authorities. The two central issues described earlier in relation to the past, will also illustrate the way ahead: they arc the price squeeze, and the commitment to research and proprietary technology (see Figure 5). The Price Squeeze In countries with pricing freedom, the pharmaceutical industry has traditionally enjoyed high prices, high margins and high profits. All of these have been low in countries with price control, especially when applied directly to individual products.
Industry’s Costs Exceed
Response
l
Structural
Change
l
Rationalization
l
Concentration
l
Acquistion of the Less Successful Firms
Buyer’s Willingness to Pay l
Surplus of Expensive, Unproductive R 81 D
0 Pressure on Prices in ‘High Profit’ Countries l
Convergence of ‘High’ and ‘Low Profit’ Countries
0 Emergence of Superstars
Figure
5. Turning
points
in the pharmaceutical
industry:
23
recognized that it was better to have a pharmaceutical industry dominated by multinationals than to have none at all; they have now restored a degree of protection in order to induce renewed flows of technology and the resumption of investment by foreign companies in locally based research.
Symptoms
The Squeeze
for Pharmaceuticals
1990s
24
Long
Range
Planning
Vol.
22
February
The turning point of the 1990s will be price competition as one of the dominant themes in markets with pricing freedom, as a result of the encouragement of cheaper generic versions of expensive pioneer brands of drugs whose patents have expired. The statement, put thus, is obvious to the point of boring anyone who knows the industry. It has been obvious for about 10 years. Less obvious are the longer-term consequences. Hitherto, the reaction to the price squeeze on both sides of the negotiating table have taken the form of essentially circular arguments, each side being caught in its own vicious circle. The authorities have taken the line that budgetary savings in health care must be found, with cheap drugs in the forefront of ways and means. The pharmaceutical industry has apparently remained highly profitable despite crying wolf year after year-so why should the pressure be relaxed? Morcovcr, much of the profit is known to move abroad into multinational coffers, a factor that reinforces the convcnicncc and popularity of squeezing ‘foreign’ drug prices. The flaw in this form of reasoning is that the resilience of a national pharmaceutical industry is seriously damaged along with that of ‘wicked foreigners’ when such policies are pursued consistently for several decades. Progressive damage to profitability and cash flow weaken the industry’s capacity for taking risks which, in pharmaceuticals, means investment in research and in multinational expansion. The international competitive ranking of national pharmaceutical industries-expressed in terms of multinational implantation and the national pharmaccutical trade balance-is an almost perfect mirror of past intervention by the authorities in drug pricing in the home market. Where this has been direct and fierce, often reinforced by the absence or weakness of legislation to protect industrial property, the pharmaceutical industry of that country has generally failed to achieve a fully competitive stance internationally, as in Italy, Spain, Japan, Canada and Australia among the world leaders in drug consumption. Elsewhere, under similar conditions, the national industry has gradually lost touch competitively with the world leaders : France, historically in the vanguard of drug discovery and now lagging behind, is the most striking example of the consequences of long-term squeezing of drug prices. For the authorities, there is a conflict between industrial strategy and budgetary constraint. To select a science-based industry for the persistent imposition of lower prices for budgetary reasons to the extent of weakening it over the longer term, is worse than supporting moribund lame ducks in the
1989 vain hope of making them fly again: it is putting a healthy business on the industrial sick list-as if that list were not long enough already. The drug industry, however, is also caught in a vicious circle. Those national industries which have so far avoided being crippled by pricing pressures (the American, German, British, and the essentially multinational Swiss pharmaceutical industry), have reinforced their success by more intensive investment in research and development and in multinational market penetration. This formula has been spectacularly successfui as long as the profit base in the home market and in one another’s markets has been high and relatively secure. The assumption of such a secure base is likely to be challenged by the events of the 1990s which may prove to mark a turning point of fundamental impact. In all the ‘Secure Base’ countries, budgetary problems in national or institutional health care expenditure have begun to take their toll. Intcrvention in Britain has increased at governmental level; in the U.S.A. and West Germany it is developing both legislatively and through pressures on and by health care institutions to encourage doctors to select generics in preference to pioneer brands, and suppliers to complete aggressively on price. Until now, the pharmaceutical industry’s reaction has reflected the hypothesis that ‘the unthinkable cannot happen’. It is, for example, unthinkable that a pioneer brand should be forced to enter into aggressive price competition with cheap generic copies. The disastrous financial consequences for a research-based company of such a marketing strategy can be demonstrated on the back of an envelope. Relying on brand loyalty in the medical profession and in the trade, the preferred riposte to the generic invasion in the U.S.A. has been firstly, to raise (not cut) prices of pioneer brands; and secondly, to invest more heavily in research and development in order to create new and protected industrial property. Evidently, such a strategy must be timed to succeed before the old pioneer brands fall victim to the concerted attack on brand loyalty which is taking the form of reducing the power of the doctor to determine brand choice. That too, was unthinkable not so long ago. The Economics of Creativity Over a period of 20 years, the pharmaceutical industry’s investment in R & D as a proportion of the value of its production has doubled. In the same time span, the number of newly discovered chemical compounds introduced into drug markets has practically halved (see Figure 6, ‘The R & D Scissors’).
The Future
for Pharmaceuticals
10-
25
-500
431
8-
h
- 400
6-
\
>o E
- 300 _----. NCEs* Introduced
L3 02!
a
s
r!
4-
-200
2-
- 100
O-
I 1964
I
1961165
1966170
Key: R & D % VOP-Fi & D spending as % Value of production Chemical Entities’ (source: ref. 6).
Figure
z 3
6. The pharmaceutical
industry:
I 1973
I 1978
I 1980183
R&D
1971175
1976180
1981185
NCEs
(source: ref. 5); NCEs-World
R & D ‘scissors’
The odds against developing a drug that will not only reach the market but will become commercially successful and capable of sustaining intensive financial commitment to R & D long-term, are extremely high. In the most advanced countries, these odds are lowered by a greater emphasis on research based on scientific drug design. Major advances in therapy have recently been achieved in this way, and genuinely innovative drugs continue to command the high prices, margins and profits on which the industry’s prosperty rests. To mistake the exception for the rule is a common fallacy of long-term strategy. In roulette, some may succeed in breaking the bank at Monte Carlo, but the majority will leave the tables empty-handed. In industrial terms, a high-risk strategy in which most of the competitors are prepared to shoulder
introduction
5 r
-0
of discoveries,
number of ‘New
1961-1985
that risk, combined with the gradual erosion of the historic basis of profitability, is a classic recipe for an eventual shake-out. Normally, a shake-out is painful but not fatal. It leaves an industry in a slimmer but healthier state. It is only when the process of adjustment are distorted by intervention from the authorities in search of budgetary advantage, that the outcome can become lethal. For a national pharmaceutical industry, a turning point can then become a point of no return. To parry that threat, the industry will have to accept a less generous profit structure than that on which it has hitherto relied. In other words, the level of profitability that the pharmaceutical industry ‘requires’ in order to sustain a cost structure that is dictated by R & D commitments, will have to give way to one that the user is actually willing to pay. In turn,
governments
will
need
to reconcile
the
Long
26
Range
Planning
Vol.
22
tactics of cost containment for budgetary with the pursuit of a realistic long-term strategy.
February purposes industrial
Overall, the recipe is one of far-reaching structural change in search of compromise solutions where neither side is going to be able to have it all its own way.
The Management
1989 from case to case, but a starting point for a diagnosis is to group the most important of such factors around a structural model of the industry and then to study their interaction. Taking the pharmaceutical industry as an example, the diagnosis of turning points in its structure revolves essentially around the interaction of four main factors: demand, intervention, competition and high technology (see Figure 7).
of Turning Points
Every industry passes critical turning points at irregular intervals. Examples that spring to mind are : the impact
of the motor
Demand
Competition
I
car on the railways,
the rise and fall of baby foods with changes in the birth rate, the competitive shake-out in personal computers as a result of over-capacity and technological advance, the discovery or exhaustion mineral deposits,
of oil wells
and
the substitution of synthetics for natural products, and the ‘reverse swing’ away from the synthetic or mass-produced and back towards natural or hand-made products, the impact of environmental concern structure of polluting industries.
on the cost
Many industrial turning points are variations on a relatively small number of common themes. In the examples just cited, several such themes emerge clearly : Substitution : cars natural products
for
railways,
synthetics
Competition: between substitutes, technical advance, in oil exploration Supply: puters
shortage
Demand: for synthetics Technology: synthetics,
or glut
cars, baby
of minerals, foods,
oil,
for
following or comcomputers,
better cars, faster computers, reduced pollution
novel
lntervention : by government in polluting industries, in granting mineral concessions, in subsidizing transport. Other themes that are instrumental in producing major turning points are innovation in marketing methods, excessive or inadequate profitability, the rise and fall of inflation, problems in industrial relations, consumerist pressures, and the exposure of scandal. Serious turning points in an industry will precipitate changes in its structure. The causative factors differ
Intervention
Figure
7. Analysing
structural
change
in industry
The demand for drugs is still to all intents and purposes infinite; it is unfulfilled in large parts of the world because of poverty, and reinforced regularly in richer countries by advances in technology to deal with unresolved problems. Health care authorities are chronically short of funds and are driven to intervention in order to restrain demand, especially the ever-increasing appetite for expensive high technology. They do this by encouraging competition from cheaper, generic drugs through intervention in the drug selection process. The impact on the effect on competition. It ‘something has
the industry’s structure arises from profitability of intervention and is a case of circumstances in which to give’.
The identification of critical factors and their interplay, backed by in-depth studies and guided by evidence, will assist managers not only in diagnosing the approach of a major turning point in their industry, but help them to define its character: when? where? how? How far-reaching? How temporary or permanent? Evidently such questions are the prelude to devising strategic moves to grapple with the approaching turning point: to seize opportunities, to anticipate a crisis or to limit its damage. Where the threat is mainly external (intervention), the strategic response must extend beyond the individual company-whose mission is above all to position itself advantageously within the industry-to action through industry or trade associations representing a collective response to a common external threat. Turning points need attention early, persistently
The Future for Pharmaceuticals and professionally. If neglected, they will soon pass beyond the point of no return.
(2)
Robert J. Maxwell, Health Lexington, MA (1981).
and Wealth, D. C. Heath
(3) Office of Health Economics, Trendsin European OHE Briefing No. 14, London (1981).
References (1) OECD Social Policy Studies No. 2, Measuring Health Care 1960-1983; Expenditure, Costs and Performance. Paris (1985).
27 81 Co,
HealthSpending,
(4)
Pharmaceutical Manufacturers Association, Book, Washington, DC, December (1987).
PMA StatisticalFact
(5)
Heinz Redwood, The Pharmaceuticallndustry-Trends, Problems and Achievements, Oldwicks Press (1988). (Distributor: SCRIP World Pharmaceutical News, Richmond, Surrey, U.K.).
(6)
Erika Reis-Arndt, ‘Ein Vierteljahrhundert Arzneimittelforschung. Neue pharmazewtische Wirkstoffe 1961-l 985, Pharmazeutische lndustrie 49 (2). 136 (1987).
00244301/89 $3.00 + .OO Pergamon Press plc
Long Range Planning, Vol. 22, No. 1, pp. 18 to 27, 1989 Printed in Great Britain
The Future for Pharmaceuticals a Health Care Crisis Heinz
in
Redwood
When an industry reaches a turning point, everyone in it is drawn into the turmoil. Not that it happens frequently, but most industries pass more than one major turning point in the course of an executive career of average length. The experience is unsettling-especially if preceded by a generalreluctance to anticipate it or its consequences. Corporate strategy is usually concerned above all with the competitive positioning of a company within an industry or, if diversified, in a number of industries. To this two-dimensional picture, which takes the company and its competitors as the main variables, we need to add the changing background of the industry itself: a third dimension that challenges the powers of adaptation of all the competitors. It compels them to acknowledge as real the forces that are unleashed by time as industries mature and society changes. This paper explores the turning points that have occurred during the past 30 years in one particular industrypharmaceuticals-and seeks to distil from it a number of lessons that may be relevant to industrial strategy in a wider framework.
The Industry Life Cycle For corporate planners and strategists, it is vital to understand the shape of their company’s life cycle, and where on that curve it stands today. A company may, however, stand on shifting sand if its industry is itself in a state of transition.
cardboard cut-out, ing is depth.
What
is miss-
Industrial history is not bunk. One look at the industries that are dead or dying shows that much of the time, history has pointed the way very clearly, but governments and industrialists have preferred to tly in its face. Before looking forward, it pays to look backward into an industry’s history: how it has arrived at today’s position. What it has achieved and where it has failed. ‘Why and how have today’s problems arisen?’ is a question that goes usefully beyond the customary ‘What are today’s problems?‘. The why and how of history can often point to more valid solutions than whut alone. Such questions need to be resolved before a company determines how to position itself within an industry. Science-based Industries The biography of science-based particular interest in this respect, reasons :
industries is of for a number of
They generally pass through Discovery, and some through
a GoIden Age of more than one.
They acquire a youthful Wonders Of Science aura, and glamour in the eyes of the media, which later turns to fear, mistrust and the resentment born of disillusion.
It is often assumed that all industries follow the same pattern of birth, maturity, decay and death, but in fact they differ in longevity, in their susceptibility to disease, and in their capacity for recovery and selfrenewal.
They find it extremely difficult to adapt to the problems of maturity after their golden youth.
In common practice, an industry and the environment in which it operates are evaluated as they are today, and then projected forward. But an industry without a past is like a man without a shadow: a Dr Heinz Redwood was for 15 years Head of Corporate Planning at Fisons plc and a Director of a number of operating divisions. He is now a Business Planning Consultant. This article is based on the author’s book: The Pharmaceutical Industry-Trends, Problems and Achievements. Oldwicks Press (1988).
two-dimensional.
Many governments, in their dealings with such industries, ignore the time cycles of science and technology and seek short-term answers to longterm questions. There is a widespread belief that, because science can rejuvenate a dying industry, the moribund will always recover. It is not so. The
pharmaceutical
industry
shares
many
of the
The Future attributes that are typical of science-based but it has some features that are unique.
industries,
The End of After 1960, new drugs, were not heyday of ment was innovative
The first occurred during the 15 years from 1817 to 1832 when a dozen or more important alkaloids (for example morphine, quinine and codeine) were first isolated and purified-which enabled them to be manufactured industrially.
The third and most recent Wonder Drug era lasted roughly 25 years from 1935 to 1960. It began with the discovery of the sulphonamides (1935) and the purification of penicillin (1940) which made it possible to harness its therapeutic activity industrially. It ended with the worldwide withdrawal of thalidomide. This period of 25 years revolutionized transformed the pharmaceutical drug therapy, industry, and created most of the problems with which the industry has had to contend ever since. Patent protection and brand name promotion made it possible to sell highly differentiated ‘single-source’ industry drugs at high prices. A run-of-the-mill suddenly soared to extraordinary heights of profitability. The focal point of competition became the research laboratory rather than the market place. The market mechanism for prescription drugs is indeed an unusual one: the user (i.e. the patient) does not exercise consumer choice, and in many countries pays little or nothing for the prescribed drug; the prescriber (i.e. the doctor) selects drug and brand
Figure
1. Turning
the Golden Age there was a sharp fall in the number of and many that were chemically new therapeutically innovative. It was the ‘Me-Too’ inventions whose developjust as costly as that of genuinely drugs.
By now, the time span between discovery and market introduction had trebled as a result of the severe regime of regulatory control (requiring proof of drug safety and efficacy) that had been precipitated by the Thalidomide affair. As a conscquence, the period of effective patent protection (from market introduction to patent expiry) shrank to less than half of nominal patent life. A clear turning point had occurred in the ground rules by which the industry worked and to which it and the authorities had grown accustomed (Figure 3) : It took most of the next two decades for the strategic implications to sink in and, by the time they did, a further turning point was in sight. There are four main reactions to an unpleasant turning point that will change an industry’s ground rules for the worse (Figure 2): The first is to ignore it and plough on regardless, steering blindly. The second is to deny it, unearthing every conceivable argument why what is happening is only a temporary aberration, after which things will broadly be as they used to be. The third is to resist it, recognizing that there has been a turning point but responding with the aim of putting the clock back. Denial and resistance arc both quite common. They may sound foolish in print but are highly persuasive in the corridors of power, both in industry and in government. The final response, adaptation to change-or still, ahead of change-is far more effective
Event
Symptoms
End of Golden Age
l
Decline in Major Discoveries
l
More Intensive Marketing
l
Thalidomide
l
Delayed Shock (pessimism in 1970s)
l
Strict Regularion
l
Reluctant Acceptance Regulation
l
Trebling of Period From Test Tube to Market
I jints in the pharmaceutical
Industry’s
Affair
industry:
19
but does not pay for it; while health care authorities (National Health or other public or private sector institutions) have to pay but cannot select the drugs for which they pay. That, at least, was the position during the Golden Age of Discovery and for some time after it ended in a creative hiatus.
The Pharmaceutical Industry Its origins as an indttstry-as distinct from the mortar and pestle activities in the backrooms of pharmacies which go back to antiquity-dates from the early part of the 19th century. Sincethen, the industry has passed through three ‘creative bursts’.
The second burst took place between 1880 and 1910 when the therapeutic activity of many new synthetic drugs, based on the chemistry of coal tar, was the barbiturates and Paul discovered (aspirin, Ehrlich’s first ‘chemotherapeutic’ drug Salvarsan against syphilis are examples). During the same period, the epoch-making microbiological discoveries of Pasteur and Koch led to the industrialization of immunology.
for Pharmaceuticals
1960
Response
of
better in the
20
Figure
Long
Range
2. Reactions
Planning
Vol.
February
22
Reaction
Diagnosis
Consequence
Ignore
‘Strategic Dyslexia’
Victim
of Circumstance
Deny
Refusal to Face the Facts
Victim
of Circumstance
Resist
May be Refusal to Face the Facts. Could be a Brilliant Counter-Stroke
Usually Victim/ Sometimes Victor
Adapt/ Anticipate
Conventional Wisdom, but Often Comes Too Late
Survival and Competitive Advance if Recognised Early and Acted Upon
to turning
points
long run, but is rarely seen as the battle cry with which to rally the troops, as corporate planners (one of the few pockets of management that thrives on change) often discover to their cost.
The Crisis in Health Care In the developed world as a whole, health care expenditure nearly doubled from 4.1 per cent of GNP in 1960 to 7.6 per cent in 1983, and in some countries (like the U.S.A., Japan and France) it more than doubled (see Figure 3).’
The pharmaceutical industry is an interesting example of roughly 20 years of impasse between successive turning points. Quite successful years on the surface, with operational results well ahead of the average for industry as a whole, but in terms of an industry’s progress and its relationship with the authorities, an impasse.
Governments
1989
Everything conspired to push health care spending to new and unprecedented heights: the steady, demographic rise of the older age groups in the population of the industrialized countries; high rates of inflation; advances in expensive medical technology; changing disease patterns with a growing accent on prolonged treatment of chronic disease in place of short course for acute infections which had increasingly come under control; rising popular expectations of more and more expensive health benefits that it seemed politically suicidal to resist; and the increasing transfer of funding from individuals to institutions and government which meant
and Industry
For governments and health authorities, the 1970s were a prolonged struggle based on the denial that a turning point in the economy had occurred after 25 years of post-war prosperity.
28
l-w_ 1214-
&-&
--•,,
1 24 \ \
g u ; &e ? 9 r ” $ I
\
lo-
\
Pharm. % of
\
8-
6-
4-
4.1 OECD
2-
0
Data from ref. 5. Original Sources: U.S.A.-ref. 4.
Figure
3. The health
-4
I 1960
I 1965
I 1970
Health Care % of GDP-ref.
care crisis. Pharmaceutical
I 1975
I I 19781980
I 1983
0
1 (average of 24 countries; Pharmaceutical % of Health Care, EEC-ref.
and health
care spending
ratios
196&1983
3,
The Future that rising expectations could be paid for with someone else’s money.’ It was a case of insatiable demand outrunning the means to pay for it. When the need to control public sector budgets became pressing, the authorities selected the pharmaceutical industry as a prime target for cost containment (Figures 3 and 4). The choice was not logical but it was politically convenient. Soon, it was lodged as firmly in the minds of budget cutters as a metal filling in a hollow tooth. The illogical element was not to ask the drug industry to make its contribution to budgetary economies in health care, but to make it the principal target for such a policy. Drugs account for no more than around l&15 per cent of public sector health care expenditure in most industrialized countries, and this proportion has fallen steadily (see takes the Figure 3) ,3,4 whereas hospital expenditure lion’s share of around 50 per cent in many countries and this has risen inexorably. It was convenient to choose pharmaceuticals as the main target, because the industry was highly profitable, politically vulnerable and not loved by the media. Tackling hospital expenditure, on the other hand, involved emotive politics and measures that would hit patients, doctors and nurses-in other words You And Me and those who look after Us. Recent events in Britain illustrate the problem very clearly.
Contuining the Drug Bill The movement to contain the drug bill has become worldwide, both in developed countries and in the Third World. In the more dirigiste countries (Latin Europe, Japan), this involves price control of individual drugs; in ‘free market’ economies (the U.S.A., West Germany) where price control is regarded as inadmissible by most governments, more subtle systems of intervention in the framework of drug choice are used as the alternative weapon in keeping drug costs down. These range from allowing and encouraging pharmacists to substitute a cheaper ‘generic’ equivalent on prescriptions for expensive, branded multisource drugs (U.S.A., Canada); urging doctors to practise more economic prescribing, with personal
4. Turning
For the pharmaceutical industry, there is much at stake and it has resisted the growing pressure on prices by every means at its disposal. The industry has grown accustomed to high prices and high profits in the wake of its Golden Age of Discovery. Only thus, it claims, can it finance the high risk of research and development to the benefit of innovative drug therapy which, in fact, has been financed from the start largely by the industry itself. It points to slow and bureaucratically complex regulatory procedures which have caused huge escalations in development time and expenditures for new discoveries, and as a result have foreshortened the period of marketing under patent protection. It is demonstrated that costs have risen while prices have been pegged or reduced by edict of the authorities, cutting into margins. In effect, the authorities have used inflation development delays as a means of forcing
In the longer term, passive erosion of ‘real’ prices and of patent protection are government policies that have produced the state of semi-permanent paralysis of the pharmaceutical industry in several European and practically all Latin American countries where it has become the exception rather than
Crisis in Health Care
l
Cost Containment (Drugs the Main Target)
l
l
Generic Revival Following Patent Expiry
0 Agitation for Longer Patent Life
points
in the pharmaceutical
Industry’s
industry:
and the
expensive ‘single-source’ segment of the pharmaceutical market into a smaller corner, and inducing lower ‘real’ prices as well as earlier competition. These tactics of erosion are far easier for officialdom to implement than direct intervention, and are just as effective. Effective, that is, in the short term.
Symptoms
Attack on the Industry’s Business Ethics
21
penalties for those who refuse to yield to admonition (West Germany); leaning on the pharmaceutical industry to organize a ‘voluntary’ price freeze for fear of something worse (West Germany) ; and an array of rules, regulations, limited lists and formularies determining which drugs will be reimbursed partially or wholly by the public or institutional purse: one or other of these forms of containment is now practically universal. The U.K. authorities devised a unique system of controlling pharmaceutical profit without dictating prices for individual drugs.
Event
l
Figure
for Pharmaceuticals
Response
Resistance 0 Rise of the Multinational Company
l
More and Better R & D (1980s)
l
Technology
l
Code of Practice (1981)
mid-1970s
Bargaining
22
Long
Range
the rule to shoulder and devclopmcnt.
Planning
Vol.
22
the risk of innovative
February research
The Industry’s Response The research-based sector of the pharmaceutical industry which dominates the market, has developcd as its main dcfence mechanism the Multinational Company (MNC) which had already become customary in other industries that were habitually in conflict with government or had world-wide market potential for innovative technology. Both factors are relevant to pharmaceuticals. The industry has long been ‘international’, but it was not until the mid-1970s that it could truly be termed ‘multinational’. An international company may export to 88 countries, but it becomes multinational only when it passes from exports and desultory local investment in finishing operations abroad, to investment decisions that involve the transfer of substantial technology as well as capital, and when it begins to replicate functional miniparent companies in country after country. By the mid-1970s a majority of the world’s leading pharmaceutical companies had set up foreign production facilities for active ingredients (i.e. pharmaceutical chemicals) as well as finished products. Moreover, about one-third had at least one major research unit abroad whose aim was innovative and not solely developmental. In the last decade, multinational ‘cloning’ has grown apace, and it has gradually become more difficult to distinguish national pharmaceutical industries because MNCs have become deeply embedded in the national fabric. This trend, highly developed in Europe, began in the 1980s to spread into the U.S.A. and Japan which had long resisted foreign penetration of their national pharmaceutical industry. The multinational movement conspiracy against national truth is more complex.
is often regarded as a sovereignty, but the
(1) Pharmaceutical
MNCs need to exploit foreign markets for new ‘products from R & D in the most rapid, most effective manner before patent protection is lost. To do so, requires local implantation at least of product development and marketing facilities, and usually benefits from a deeper level of local commitment.
(4
It is a response to government policies in countries that offer inducements for local investment to foreign companies in order to foster employment, production, exports, import substitution, and research or the transfer of technology; and who penalize foreign companics who refuse to invest locally in line with government policy.
1989 (3) Multinational development is a defence mechanism to make companies less vulnerable to government actions in any one country, by spreading the base of investment and technology to others where conditions are regarded as reasonably safe. The controversial area is the division of the financial cake between countries through the medium of transfer prices and the location of tax liabilities. The multinational mode, then, is not a matter of choice for research-based pharmaceutical companies but part and parcel of the effort to sustain a costly research base and technological leadership. The need for global revenues from multinational implantation is imperative if future research is to be funded from past or present cash flows. Confrontation It is here that the irresistible force of government in pursuit of cheap drugs meets the immovab?e obstacle of a research-based industry whose future output depends on high selling prices and high profits. This has hitherto proved to be an insoluble equation in many countries, or it has been solved unilaterally without being resolved, and with unsatisfactory results. In matters that are within government jurisdiction, government will win the day. A number of test cases in the 197Os, when some drug firms refused to toe the line laid down by government, clearly demonstrated who is master. Government can make life difficult for any single firm. It also holds the strongest cards, short-term, in negotiations with the industry as a whole through its trade association, short-term. The pharmaceutical industry is built on long-term strategy. Short-term failure can be deceptive, and short-term success transitory. It takes 10 or more years for a newly discovered drug to reach the point of market introduction. There is a high risk of failure, and large funds are needed to sustain that risk over long periods of time in the hope of reaping very high rewards for the rare real success. The long-term card that is held by the pharmaceutical industry is its advanced technology: new products, new processes, proprietary dossiers of regulatory data demonstrating safety and efficacy; manufacturing expertise and secret know-how; effective control over the supply of novel active ingredients or essential chemical intermediates : these are the fruits of high-risk research when it succeeds. The governments of many countries have sought to clip the industry’s wings by breaking into its technological treasury. Some have refused patent protection for drugs altogether (Italy until 1978, and
The Future most Third World countries); others have made it difficult to enforce patents (Spain and Portugal) or have encouraged compulsory licensing during the ostensibly protected period (Canada). Others yet have pursued a policy of encouraging the transfer of technology but without creating the political climate of confidence between government and MNCs that will persuade the latter to take the plunge. To sustain health care programmes, every country needs technology that is owned by MNCs. Technology is never static. Not even the most advanced countries are remotely self-sufficient in pharmaceutical technology. In effect, the industry’s normal strategy is to diffuse its technology widely and rapidly, so that MNCs can penetrate all important drugs markets-unless stopped or discouraged from doing so. in the Developed Countries, technology has been used as a bargaining counter. Threats by multinational companies to withdraw from countries whose ground rules are deemed to be too harsh are not taken very seriously, because MNCs need large, developed markets as much as national governments need the influx of advanced technology from MNCs. On the other hand, acts of confrontation provoked by a government whose eye is too sharply focused on short-term budgetary benefits from cheap drugs, have induced multinationals in a number of countries to change their strategy. They have not withdrawn from the country but have lowered it in their investment and development priorities. The next production unit or research facility has been placed elsewhere, and the transfer of additional technology has in effect been switched. Countries like Canada and Australia, which have long pursued such policies, have as a result seen their pharmaceutical industries stunted in development, since neither has a large enough indigenous pharmaceutical industry to walk into the vacuum created by multinational investment restraint. After several decades of drift, the Canadian authorities eventually
Event
l
Industry’s
There is thus a delicate balance between government and industry in the world of drugs. The irresistible force will try to prevail against the obstacle that does not wish to move; but in fact, there arc times when government is resistible and others when industry will yield.
The Next Turning
Point
Anyone who drives a car at top speed along a mountain road and takes no notice of signs warning of S-bends ahead, will crash. Even in the hands of a stunt man, it is only he who escapes, while the car bounces down the ravine to drown in the lake below. Signposts Along the industrial road, turning points arc not signposted with the same clarity as on public highways, but there are warnings galore. These are their often ignored and, even when observed, significance is not easy to interpret. The earlier the warning, the greater the temptation to turn a blind eye, and the worse the eventual crash. Translated into the affairs of an industry like there arc implications both for pharmaceuticals, industry and for the authorities. The two central issues described earlier in relation to the past, will also illustrate the way ahead: they arc the price squeeze, and the commitment to research and proprietary technology (see Figure 5). The Price Squeeze In countries with pricing freedom, the pharmaceutical industry has traditionally enjoyed high prices, high margins and high profits. All of these have been low in countries with price control, especially when applied directly to individual products.
Industry’s Costs Exceed
Response
l
Structural
Change
l
Rationalization
l
Concentration
l
Acquistion of the Less Successful Firms
Buyer’s Willingness to Pay l
Surplus of Expensive, Unproductive R 81 D
0 Pressure on Prices in ‘High Profit’ Countries l
Convergence of ‘High’ and ‘Low Profit’ Countries
0 Emergence of Superstars
Figure
5. Turning
points
in the pharmaceutical
industry:
23
recognized that it was better to have a pharmaceutical industry dominated by multinationals than to have none at all; they have now restored a degree of protection in order to induce renewed flows of technology and the resumption of investment by foreign companies in locally based research.
Symptoms
The Squeeze
for Pharmaceuticals
1990s
24
Long
Range
Planning
Vol.
22
February
The turning point of the 1990s will be price competition as one of the dominant themes in markets with pricing freedom, as a result of the encouragement of cheaper generic versions of expensive pioneer brands of drugs whose patents have expired. The statement, put thus, is obvious to the point of boring anyone who knows the industry. It has been obvious for about 10 years. Less obvious are the longer-term consequences. Hitherto, the reaction to the price squeeze on both sides of the negotiating table have taken the form of essentially circular arguments, each side being caught in its own vicious circle. The authorities have taken the line that budgetary savings in health care must be found, with cheap drugs in the forefront of ways and means. The pharmaceutical industry has apparently remained highly profitable despite crying wolf year after year-so why should the pressure be relaxed? Morcovcr, much of the profit is known to move abroad into multinational coffers, a factor that reinforces the convcnicncc and popularity of squeezing ‘foreign’ drug prices. The flaw in this form of reasoning is that the resilience of a national pharmaceutical industry is seriously damaged along with that of ‘wicked foreigners’ when such policies are pursued consistently for several decades. Progressive damage to profitability and cash flow weaken the industry’s capacity for taking risks which, in pharmaceuticals, means investment in research and in multinational expansion. The international competitive ranking of national pharmaceutical industries-expressed in terms of multinational implantation and the national pharmaccutical trade balance-is an almost perfect mirror of past intervention by the authorities in drug pricing in the home market. Where this has been direct and fierce, often reinforced by the absence or weakness of legislation to protect industrial property, the pharmaceutical industry of that country has generally failed to achieve a fully competitive stance internationally, as in Italy, Spain, Japan, Canada and Australia among the world leaders in drug consumption. Elsewhere, under similar conditions, the national industry has gradually lost touch competitively with the world leaders : France, historically in the vanguard of drug discovery and now lagging behind, is the most striking example of the consequences of long-term squeezing of drug prices. For the authorities, there is a conflict between industrial strategy and budgetary constraint. To select a science-based industry for the persistent imposition of lower prices for budgetary reasons to the extent of weakening it over the longer term, is worse than supporting moribund lame ducks in the
1989 vain hope of making them fly again: it is putting a healthy business on the industrial sick list-as if that list were not long enough already. The drug industry, however, is also caught in a vicious circle. Those national industries which have so far avoided being crippled by pricing pressures (the American, German, British, and the essentially multinational Swiss pharmaceutical industry), have reinforced their success by more intensive investment in research and development and in multinational market penetration. This formula has been spectacularly successfui as long as the profit base in the home market and in one another’s markets has been high and relatively secure. The assumption of such a secure base is likely to be challenged by the events of the 1990s which may prove to mark a turning point of fundamental impact. In all the ‘Secure Base’ countries, budgetary problems in national or institutional health care expenditure have begun to take their toll. Intcrvention in Britain has increased at governmental level; in the U.S.A. and West Germany it is developing both legislatively and through pressures on and by health care institutions to encourage doctors to select generics in preference to pioneer brands, and suppliers to complete aggressively on price. Until now, the pharmaceutical industry’s reaction has reflected the hypothesis that ‘the unthinkable cannot happen’. It is, for example, unthinkable that a pioneer brand should be forced to enter into aggressive price competition with cheap generic copies. The disastrous financial consequences for a research-based company of such a marketing strategy can be demonstrated on the back of an envelope. Relying on brand loyalty in the medical profession and in the trade, the preferred riposte to the generic invasion in the U.S.A. has been firstly, to raise (not cut) prices of pioneer brands; and secondly, to invest more heavily in research and development in order to create new and protected industrial property. Evidently, such a strategy must be timed to succeed before the old pioneer brands fall victim to the concerted attack on brand loyalty which is taking the form of reducing the power of the doctor to determine brand choice. That too, was unthinkable not so long ago. The Economics of Creativity Over a period of 20 years, the pharmaceutical industry’s investment in R & D as a proportion of the value of its production has doubled. In the same time span, the number of newly discovered chemical compounds introduced into drug markets has practically halved (see Figure 6, ‘The R & D Scissors’).
The Future
for Pharmaceuticals
10-
25
-500
431
8-
h
- 400
6-
\
>o E
- 300 _----. NCEs* Introduced
L3 02!
a
s
r!
4-
-200
2-
- 100
O-
I 1964
I
1961165
1966170
Key: R & D % VOP-Fi & D spending as % Value of production Chemical Entities’ (source: ref. 6).
Figure
z 3
6. The pharmaceutical
industry:
I 1973
I 1978
I 1980183
R&D
1971175
1976180
1981185
NCEs
(source: ref. 5); NCEs-World
R & D ‘scissors’
The odds against developing a drug that will not only reach the market but will become commercially successful and capable of sustaining intensive financial commitment to R & D long-term, are extremely high. In the most advanced countries, these odds are lowered by a greater emphasis on research based on scientific drug design. Major advances in therapy have recently been achieved in this way, and genuinely innovative drugs continue to command the high prices, margins and profits on which the industry’s prosperty rests. To mistake the exception for the rule is a common fallacy of long-term strategy. In roulette, some may succeed in breaking the bank at Monte Carlo, but the majority will leave the tables empty-handed. In industrial terms, a high-risk strategy in which most of the competitors are prepared to shoulder
introduction
5 r
-0
of discoveries,
number of ‘New
1961-1985
that risk, combined with the gradual erosion of the historic basis of profitability, is a classic recipe for an eventual shake-out. Normally, a shake-out is painful but not fatal. It leaves an industry in a slimmer but healthier state. It is only when the process of adjustment are distorted by intervention from the authorities in search of budgetary advantage, that the outcome can become lethal. For a national pharmaceutical industry, a turning point can then become a point of no return. To parry that threat, the industry will have to accept a less generous profit structure than that on which it has hitherto relied. In other words, the level of profitability that the pharmaceutical industry ‘requires’ in order to sustain a cost structure that is dictated by R & D commitments, will have to give way to one that the user is actually willing to pay. In turn,
governments
will
need
to reconcile
the
Long
26
Range
Planning
Vol.
22
tactics of cost containment for budgetary with the pursuit of a realistic long-term strategy.
February purposes industrial
Overall, the recipe is one of far-reaching structural change in search of compromise solutions where neither side is going to be able to have it all its own way.
The Management
1989 from case to case, but a starting point for a diagnosis is to group the most important of such factors around a structural model of the industry and then to study their interaction. Taking the pharmaceutical industry as an example, the diagnosis of turning points in its structure revolves essentially around the interaction of four main factors: demand, intervention, competition and high technology (see Figure 7).
of Turning Points
Every industry passes critical turning points at irregular intervals. Examples that spring to mind are : the impact
of the motor
Demand
Competition
I
car on the railways,
the rise and fall of baby foods with changes in the birth rate, the competitive shake-out in personal computers as a result of over-capacity and technological advance, the discovery or exhaustion mineral deposits,
of oil wells
and
the substitution of synthetics for natural products, and the ‘reverse swing’ away from the synthetic or mass-produced and back towards natural or hand-made products, the impact of environmental concern structure of polluting industries.
on the cost
Many industrial turning points are variations on a relatively small number of common themes. In the examples just cited, several such themes emerge clearly : Substitution : cars natural products
for
railways,
synthetics
Competition: between substitutes, technical advance, in oil exploration Supply: puters
shortage
Demand: for synthetics Technology: synthetics,
or glut
cars, baby
of minerals, foods,
oil,
for
following or comcomputers,
better cars, faster computers, reduced pollution
novel
lntervention : by government in polluting industries, in granting mineral concessions, in subsidizing transport. Other themes that are instrumental in producing major turning points are innovation in marketing methods, excessive or inadequate profitability, the rise and fall of inflation, problems in industrial relations, consumerist pressures, and the exposure of scandal. Serious turning points in an industry will precipitate changes in its structure. The causative factors differ
Intervention
Figure
7. Analysing
structural
change
in industry
The demand for drugs is still to all intents and purposes infinite; it is unfulfilled in large parts of the world because of poverty, and reinforced regularly in richer countries by advances in technology to deal with unresolved problems. Health care authorities are chronically short of funds and are driven to intervention in order to restrain demand, especially the ever-increasing appetite for expensive high technology. They do this by encouraging competition from cheaper, generic drugs through intervention in the drug selection process. The impact on the effect on competition. It ‘something has
the industry’s structure arises from profitability of intervention and is a case of circumstances in which to give’.
The identification of critical factors and their interplay, backed by in-depth studies and guided by evidence, will assist managers not only in diagnosing the approach of a major turning point in their industry, but help them to define its character: when? where? how? How far-reaching? How temporary or permanent? Evidently such questions are the prelude to devising strategic moves to grapple with the approaching turning point: to seize opportunities, to anticipate a crisis or to limit its damage. Where the threat is mainly external (intervention), the strategic response must extend beyond the individual company-whose mission is above all to position itself advantageously within the industry-to action through industry or trade associations representing a collective response to a common external threat. Turning points need attention early, persistently
The Future for Pharmaceuticals and professionally. If neglected, they will soon pass beyond the point of no return.
(2)
Robert J. Maxwell, Health Lexington, MA (1981).
and Wealth, D. C. Heath
(3) Office of Health Economics, Trendsin European OHE Briefing No. 14, London (1981).
References (1) OECD Social Policy Studies No. 2, Measuring Health Care 1960-1983; Expenditure, Costs and Performance. Paris (1985).
27 81 Co,
HealthSpending,
(4)
Pharmaceutical Manufacturers Association, Book, Washington, DC, December (1987).
PMA StatisticalFact
(5)
Heinz Redwood, The Pharmaceuticallndustry-Trends, Problems and Achievements, Oldwicks Press (1988). (Distributor: SCRIP World Pharmaceutical News, Richmond, Surrey, U.K.).
(6)
Erika Reis-Arndt, ‘Ein Vierteljahrhundert Arzneimittelforschung. Neue pharmazewtische Wirkstoffe 1961-l 985, Pharmazeutische lndustrie 49 (2). 136 (1987).