Patent expirations will slice profits as industry produces fewer new drugs
Over the next few years, the pharmaceutical business will hit a wall.
Some of the top-selling drugs in industry history will become history as patent protections expire, allowing generics to rush in at much-lower prices. Generic competition is expected to wipe $67 billion from top companies' annual U.S. sales between 2007 and 2012, as more than three-dozen drugs lose patent protection. That is roughly half of the companies' combined 2007 U.S. sales.
At the same time, the industry's science engine has stalled. The century-old approach of finding chemicals to treat diseases is producing fewer and fewer drugs. Especially lacking are new blockbusters to replace old ones such as Lipitor, Plavix and Zyprexa.
The coming sales decline may signal the end of a once-revered way of doing business. "I think the industry is doomed if we don't change," says Sidney Taurel, chairman of Eli Lilly & Co.
Just last week, Bristol-Myers Squibb Co. announced plans to cut 10 percent of its work force, or about 4,300 jobs, and close or sell about half of its 27 manufacturing plants by 2010.
Between 2011 and 2012, annual industry revenue will decline, estimates Datamonitor, a research and consulting firm. That would be the first decline in at least four decades.
Patent expirations are a big problem. Drugs are granted 20 years of patent protection, although companies often fail to get a product to market before half of that period has elapsed. Once it hits the market, however, the patent-protected drug is highly profitable: Typical gross margins are 90 percent to 95 percent. When patents expire, generic makers offer the products at a price much closer to the cost of production.
Pfizer Inc. will be particularly hard-hit when the patent expires as early as 2010 on Lipitor, the cholesterol-lowering blockbuster that ranks as the most successful drug ever. Pharmacists and managed-care companies will aggressively fill prescriptions with generics, reducing annual Lipitor sales to a fraction of last year's $13 billion.
By 2012, Merck & Co. will face generic competition to its three top-selling drugs: the osteoporosis treatment Fosamax, Singulair for asthma and the blood-pressure drug Cozaar. Those three represent 44 percent of the company's current revenue. Following the loss last year of patent protection for Merck's cholesterol-lowering Zocor, sales this year are expected to fall 82 percent from $4.38 billion in 2005. A Merck spokeswoman said the company has several products in the pipeline that will offset its patent losses.
End of an era
The rise of generics wouldn't matter so much if research labs were creating a stream of new hits. But that isn't happening. During the five years from 2002 through 2006, the industry brought to market 43 percent fewer new chemical-based drugs than in the last five years of the 1990s, despite more than doubling research-and-development spending.
While many patients are benefiting from lower-cost generics, others are waiting in vain for relief of their suffering.
"In anxiety disorder, the field has imploded in terms of drug development," said P. Murali Doraiswamy, chief of biological psychiatry at Duke University's medical school. "Ten years ago, we had eight or nine different" anxiety-disorder drugs under development, but that has now "come to a halt."
As patent expirations loom, pharmaceutical companies are reorganizing. In five years, many may look very different. They will be in new businesses. Their cost structures may be slimmer and more flexible. Some familiar names may disappear in mergers. Companies are installing new leaders.
"The era that created the modern pharmaceutical industry is in fact over," said Richard Evans, a pharmaceutical consultant.
To be sure, the industry is still highly profitable. Sales will continue to benefit from the Medicare drug benefit for the elderly and from growth in overseas markets. The industry will continue to produce new drugs, though at too slow a rate to sustain its size and cost structure, analysts assess. Some players, such as Merck, may fare better because of a more productive R&D operation, according to Sanford C. Bernstein & Co. analyst Timothy Anderson.
It has never been easy to take a drug from the lab, through animal testing and into human trials. The industry estimates only one out of every 5,000 to 10,000 candidates makes it to human trials. And many drugs that work in animals fail in people.
But those odds seem to have worsened in recent years, prompting debate about whether the cause is government regulation, corporate structure or an excessive scientific reliance on chemicals rather than biology.
Many drug-company executives blame the FDA for pulling back on approvals.
"Very few products are being approved today," said Bernard Poussot, incoming chief executive of Wyeth.
Would-be blockbusters such as Novartis AG's diabetes drug, Galvus, and Sanofi-Aventis' weight-loss drug, rimonabant, recently have been delayed by the FDA over safety concerns.
Safety concerns also have prompted the agency to require larger studies of new drugs. Novartis CEO Daniel Vasella says this trend has done more than any other to drive up the industry's R&D costs. He cites Novartis' blood-pressure drug Tekturna, approved earlier this year, which had more than 6,000 patients in its late-stage trial. A decade ago, a similar study might have had fewer than 1,000 patients, according to Vasella.
FDA spokesman Christopher DiFrancesco said: "The number of approvals have declined because companies are submitting fewer drugs to the FDA for approval. The threshold for what we consider to be a safe, effective drug hasn't changed."
Budgets and biotech
Some say the industry's ballooning research budgets may be working against productivity. Most companies use a centralized system to allocate research money, and the growing budgets have left the decisionmaking to too few people who are too far removed from the research, suggests Evans, the consultant. He calls the system "a nightmare of complexity."
As evidence of this problem, some in the industry point to Pfizer, with an annual research budget that has grown to $7 billion, highest in the industry. Yet only a handful of drugs discovered in its internal research labs have come to market in the past decade. And late last year, the company lost its most promising hope when the cholesterol drug torcetrapib failed in late-stage trials.
In a statement, Pfizer said it has the largest pipeline of midstage drugs in company history and plans to triple the number of late-stage drugs in its portfolio by 2009. A few companies, notably GlaxoSmithKline, have begun breaking R&D into smaller groups.
Some believe the industry, which grew out of the European chemical business of the late 1800s, has remained too reliant on that foundation.
The future, many believe, lies in biotechnology. Unlike traditional, chemistry-based drug development, biotechnology uses biological tools to create entire proteins, often similar to those that occur in the human body. This approach has yielded successful drugs to treat diseases such as anemia, cancer and rheumatoid arthritis.
Biotech drugs are especially appealing because they face no competition from generics: No regulatory pathway yet exists in the U.S. for bringing to market generic biotech drugs. So until Congress creates such a pathway, no generic threat will exist to the $4,400 a month that Genentech Inc. charges for its cancer drug, Avastin, or the $200,000 a year that Genzyme Corp. gets for Cerezyme to treat Gaucher disease.
And biotechnology products tend to target specialized areas of medicine that don't require mass advertising or armies of salespeople.
So big pharmaceutical companies have spent nearly $76 billion since 2005 to buy biotech companies, according to Health Care M&A Information Service. Meanwhile, Novartis and Pfizer recently announced the formation of in-house biotech units.
The dearth of new products has led the industry to invest heavily in marketing and legal tactics that squeeze as much revenue as possible out of existing products. Companies have raised prices; the average price per pill has risen 63 percent since 2002, according to industry analyst Michael Krensavage. Companies raised advertising spending to $5.3 billion in 2006 from $2.5 billion in 2001 and since 1995 have nearly tripled the number of industry sales representatives to 100,000.
The industry spent $155 million on lobbying from January 2005 to June 2006, according to the Center for Public Integrity, on "a variety of issues ranging from protecting lucrative drug patents to keeping lower-priced Canadian drugs from being imported." The industry also successfully lobbied against allowing the federal government to negotiate Medicare drug prices, the center said. The lobbying has drawn fire from politicians, doctors and payers, and damaged the industry's public image.
Joining the generics
Aware that seven of the top 10 drug launches of 2006 were generics, pharmaceutical giants are pushing more deeply into that business. In the first nine months of this year, Novartis' generics unit, Sandoz, grew roughly three times as fast as its branded-drugs business and accounted for nearly 20 percent of overall revenue.
After Pfizer's antidepressant, Zoloft, went off-patent last year, the company's own generics unit, Greenstone, launched a generic version of the drug. Johnson & Johnson has its own generics unit.
Other companies cut deals with generics manufacturers, licensing them the right to sell "authorized generics" that are identical to a branded drug that has gone off-patent.
Diversification is another hope. Roche Holding AG is pursuing a $3 billion hostile takeover of Ventana Medical Systems Inc., a diagnostics company that makes the test used to determine whether women with breast cancer should receive Herceptin, a targeted biotechnology drug that Roche sells in some markets. The bid is part of a broad push further into diagnostics by the company.
Yet none of these moves are forestalling cost slashing. Pfizer is cutting 20 percent of its sales force, AstraZeneca is cutting 10 percent of its employees, and Johnson & Johnson is shrinking its staff by 4 percent, according to Bernstein Research. As many as 50,000 industry positions will be displaced over the next 10 years, according to wealth-management company RegentAtlantic Capital of Chatham, N.J.
"There are lots of people in India, China and Eastern Europe who can make products of the same quality as ours but at significantly less cost," says Bristol-Myers Squibb CEO James Cornelius.
The outsourcing is expected to extend to research.
"We don't do any basic research yet in the lower-cost countries, but over the next few years, to be successful you'll have a constant emphasis on looking for that," Cornelius says.
The coming difficulty is threatening every industry tradition.
"I'm talking to you from the 44th floor of an office on Park Avenue," Cornelius says. "A year from now, I won't be talking to you from the 44th floor because we're going to move downstairs out of these very expensive offices."