* excluding title page, table of contents and in-text references

The future of the

pharmaceutical industry

The good times of billion dollar blockbusters are far behind us. What are large

pharmaceutical incumbents doing, or what can they do to innovate and

transform the sector business model for the future

July 2015

Word Count*:

Submitted by:

Maria Zaritskaya

CID: 01011573

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Abstract Market share in the pharmaceutical sector is inexorably shifting from former denizens

of the industry (Eli Lilly, GSK), to rivals that have adopted drastic changes to their

business models (Allergan, Valeant).

In many ways, pharmaceutical companies are victims of their own success. Heavy

reliance on blockbuster drugs, immense past financial success, significant in-house R&D

investments –these factors contribute to the reservations involved with innovating

business models and identifying novel ways of creating value.

Although there can be no single recipe for success in the pharmaceutical industry,

understanding key trends, and applying them to particular companies’ profiles can

result in novel and lucrative value-creating business models.

This report can be logically divided into two parts: chapters 2-3 analyse what

pharmaceutical incumbents are currently undertaking to distance themselves from the

‘blockbuster’ mind-set, the advantages, drawbacks and risks of their strategies; chapters

4-5 explore future trends in the industry and evaluate changes to business models that

can be implemented to adapt to the changing social and market environment.

6 pharma companies with largest revenue decline rates 2013-2014

Company Decline rate %

Eli Lilly -18%

Daiichi Sankyo -14% Boehringer Ingelheim

-12%

GlaxoSmithKline -11%

Merck KGaA -9%

Pfizer -5%

5 pharma companies with largest revenue growth rates

2013-2014

Company Growth rate %

Gilead Sciences 127%

Actavis (now: Allergan) 51%

Biogen Idec 41%

Johnson & Johnson 15%

AbbVie 8%

Data by: Global Data (PMLiVE, 2014)

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Table of Contents

Abstract…………………………………………………………………………………………………………

1. Introduction…………………………………………………………………………………………………

1.1. Subject overview…………………………………………………………………………………………………

1.2. Report objectives………………………………………………………………………………………………

1.3. Research resources……………………………………………………………………………………………

1.4. Clarification of terms………………………………………………………………………………

2. Mergers and acquisitions – does bigger really mean better? …………………………

2.1. Acquisition of generic drug manufacturers………………………………………………………

2.2. Acquisition of biotech companies ………………………………………………………

2.3. Precision M&A and specialty drug development………………………………………………

3. Diversification – supplementing the core business…………………………………………

4. Collaboration: within the sector and beyond…………………………………………………

4.1. Industry trends – a case for increasing co-operation…………………………………………

4.2. Forms of collaboration ………………………………………………………………………………………

5. Key routes for business model innovation……………………………………………………

Conclusion………………………………………………………………………………………………………………

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1. Introduction

1.1. Subject overview

The golden age of the blockbuster drug seems to be over. Gone are the days, when a

pharmaceutical company could develop a promising molecule, battle through the

difficulty-wrought path of obtaining the necessary approvals to successfully launch the

drug, and generate billion-revenue streams from the blockbuster, directing profits in

the search for the next ‘cash cow’.

As outlined in Pharma 2020: The vision, until recently the established pharmaceutical

business model has been to undertake all steps of drug development in-house: from

R&D to commercialization (PricewaterhouseCoopers, 2007). However, by 2020 this

model is predicted to lose its efficacy for most industry incumbents

(PricewaterhouseCoopers, 2009). In this respect the veracity and clairvoyance of J. P.

Garnier, former CEO of GSK, as cited by K. Phelps, naming the blockbuster-development

drug model: ‘a business model, where you are guaranteed to lose your entire book of

business every 10 to 12 years’, cannot be disputed. (Phelps, 2007).

In the past blockbuster drugs were targeted towards treatment of chronic diseases and

used in primary care (Rickwood, 2012). Yet, there has been a shift in the share of

primary care blockbusters in favour of specialty therapies: drugs targeting ailments

affecting an increasingly smaller population are achieving billion-sales due to niche

positioning and high prices, effectively becoming modern-day blockbusters. Many

lucrative blockbuster drugs have recently lost patent protection, further exacerbating

their rapid market share decline.

Furthermore, certain segments of the pharmaceutical industry are increasingly being

dominated by innovative biotech start-ups and large acquisitive entities amassing

significant drug portfolios through M&A. Given these developments, it is inevitable that

pharma incumbents must identify ways to modify their business models to remain

profitable in the rapidly changing tides of the pharmaceutical industry.

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1.2. Report objectives

This report represents an analysis of how pharma industry players are adapting to the

shifting business environment and innovating their business models. The aim is,

drawing on real life examples and recent industry developments, to establish the

benefits and drawbacks of the paths currently taken by incumbents, to explore industry

trends and suggest potential courses of action to secure a promising future for

companies, its investors and patients.

1.3. Research resources

To fully develop the report topic and relate it to the present-day business environment,

a wide variety of sources have been consulted: from up-to-date newspaper articles

(Financial Times, The Economist, Fortune Magazine) and specialist publications

(Pharma 2020 series, The Pink Sheet) to statistical data and video interviews with

industry experts.

1.4. Clarification of terms

Before proceeding with the analysis, a clarification of terms used must be sought.

Blockbuster drugs are drugs with sales of £1bn or more (Caroll, 2009), specialty drugs

are defined as ‘high-cost, scientifically engineered drugs used to treat complex, chronic

conditions that require special storage, handling, administration and involve a

significant degree of patient education, monitoring and management’ (Robinson, 2014).

Orphan drugs are a subset of specialty drugs developed to treat a rare medical condition

affecting a small number of patients (U.S. Food and Drug Administration, 2015).

Furthermore, 2 distinct types of pharma incumbents: ‘Big Pharma’ and ‘specialty

pharma’ must be defined, due to, as shall be seen further, fundamental differences in

their business models and paths to innovation.

Largest Specialty Pharma by market capitalization

Company Market cap., USD

Allergan Inc. $120.45B

Valeant Pharmaceuticals International, Inc. $78.17B

Shire plc. $47.82B

Endo International plc. $16.55B

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The definition of what constitutes

‘specialty pharma’ is debated upon.

An excellent classification is provided in the Financial Times (Crow, 2015), whereby

specialty pharma consists of 2 parts. One are ‘highly acquisitive’ entities that have

marginal investment in in-house R&D, but depend on M&A to grow their business.

These companies are aided by current low debt interest rates and potentially lower tax

rates due to tax inversions.

Another are acquisition targets for the first group: biotech companies with a focus on a

particular drug or specific area of research. Such is the example of Salix – a takeover

target for Allergan. Another, is NPS Pharma, recently bought by Shire.

The criteria to determine whether the company belong to ‘Big Pharma’ have been

excellently summarized by M. Rosen (Rosen, 2005):

‘Sales exceed $2 billion/annum

International exposure to the main 3 markets: U.S., Europe and Japan

R&D in minimum 5 various therapeutic areas

A fully integrated pharmaceutical operations models, that encompasses in-house

R&D, operations, clinical trials, a regulatory department, sales and marketing ’

Only ~30 companies globally are estimated to meet all 4 criteria to qualify as ‘Big

Pharma’ (Rosen, 2005).

Mallinckrodt plc. $14.07B

Data: Yahoo Finance, 02.07.2015

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2. Mergers and acquisitions – does bigger

really mean better?

Over the past year pharmaceutical companies have undertaken M&A deals worth

£300bn (Financier Worldwide Magazine, 2014). The first quarter of 2015 has already

seen deals of £95.2bn, making up 12% of all M&A and accounting for a 70% increase on

the same period from the previous year (Massoudi&Fontanella-Khan, 2015).

Pharma incumbents are adopting several distinct stances in terms of M&A deal-making:

2.1. Acquisition of generic drug manufacturers

One is the acquisition of generic drug manufacturers to, firstly, deliver efficiencies

through cost-cutting. Given potential patent expirations, this path can, furthermore, be

seen as an attempt to retain decreasing revenue streams from off-patent blockbusters.

Another reason for acquiring generics manufacturers is gaining fast exposure to

emerging markets with millions of patients, unable to afford high-price branded

medicines

Such is the £8.05bn deal, where Endo seeks to acquire drug maker Par, careering the

company to top-5 generic drug makers by U.S. sales (Paton, 2015). 5 years ago the

company was heavily reliant on a single blockbuster – Lidoderm, and derived almost

half the revenues from it. Using the M&A strategy Endo successfully adapted and is

valued more than 3 times as much. (Financial Times, 2015).

Another pharma player to acquire a generics drug-maker is Pfizer with its £16.8bn

acquisition of Hospira, the world leader in biosimilars – genetic copies of biotech drugs

(Fortune Magazine, 2015). Ian Read, the company CEO, has justified the deal by claiming

excellent alignment with Pfizer’s business and a strong exposure to growing developing

markets (Pfizer, 2015).

However, modifying the business model to focus more on generics carries inherent

risks.

To increase revenues from low-margin generics, companies have been selling drugs at

different prices in developed and developing markets. This approach has recently

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erupted in a scandal enveloping Gilead, a US company, over the sale of U.S. hepatitis-C

Sovaldi and its generic version Sofosbuvir (Kazmin, 2015) in developing markets at just

1% of the U.S. $1000/pill price. The company, in order to prevent the spillover of the

cheap generic into developed markets (potentially undermining sales), has come under

fire for policing usage, almost demanding that patients return empty bottles before

receiving the next instalment. Selling generic and branded drugs with same outcomes at

divergent prices in different markets is the acid test facing pharma incumbents in

entering the generics playfield.

A further risk lies in the strategic implications of acquiring generic drug-makers.

Unbranded and standardized, such medicines extend a lifeline to millions of patients in

the emerging world. However, future expansion of the middle class is an almost

established fact, representatives of which could increasingly move upmarket,

demanding access to more expensive and branded medicines.

Overall, the overriding rationale behind this strategy appears to be short/medium-term

cost-cutting measures. Following this M&A path will do little to bolster company growth

and deliver solid returns to shareholders in the long-run in the absence of further

measures taken.

2.2. Acquisition of biotech companies

Another M&A strategy is the acquisition of biotech start-ups by Big Pharma and

specialty pharma incumbents to tap the latters’ innovative potential and restock own

drug development pipelines.

The parallel drawn between specialty pharma and ‘Big Pharma’ in section 1.4 is of

importance, as motives behind acquisitions by the two types vary widely.

Big Pharma frequently acquire biotech companies with incomplete research,

transferring development of promising molecules in-house.

However, big specialty pharma players frequently do not have sufficient in-house R&D

resources to successfully fully develop a drug. Thus, they choose to take the safer route

and target biotechs with either successful existing drugs or drugs nearing a successful

launch.

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To prove the point at case, Valeant, a large specialty pharma company, spent just 3% of

sales on R&D last year, as opposed to Big Pharma’s spend of 15% of sales (Crow, 2015) .

According to Ronny Gal, analyst at Bernstein, as cited by David Crow (Crow, 2015)

‘Valeant is a financial construct that happens to be in the pharmaceutical business’.

Nevertheless, such business model as Valeant’s is popular amongst investors and serves

as a model for other companies, albeit with variations.

Circassia, a UK drug developer is aiming to raise £275M to finance two acquisitions

(Ward, 2015a), seeking to not only acquire the drugs, but also retain the commercial

infrastructure of targets to cross-sell own drugs.

In the absence of viable R&D solutions in the pipeline to supplement thinning revenue

streams, both Big and specialty pharma are seeking acquisition targets with promising

drugs or molecules, ruthlessly outbidding each other and ratcheting up targets’

valuations. In a recent deal Alexion agreed to pay ~$8.4bn to acquire Synageva

BioPharma, a biotech company with a single drug in the pipeline, expected to be

launched this year. The offer of cash and stock is reported to represent a 140%

premium over Synageva’s closing price on 05.05 (Pollack, 2015).

Another similar deal is AbbVie’s $21bn acquisition of Pharmacyclics. The deal rationale

is adding a blood cancer drug, Imbruvica, to AbbVie’s shrivelling drug portfolio. Yet,

AbbVie paid ~$900M in excess of runner-up offers from Johnson&Johnson and an

unknown bidder. (Crow & Fontanella-Khan, 2015). $21bn for a company producing but

a single drug raises significant concerns as to the sensibility of such high valuation

premiums for biotechs.

One risk of this strategy is the impending interest rates raise by the Federal Reserve,

making ultra-cheap debt a bygone and further acquisitions prohibitively expensive. The

Actavis-Allergan deal was possible through the mammoth £21bn bond offering, the

Valeant-Salix deal through raising £10.1bn in junk bonds (Fuller, 2015). Should interest

rates rise, attracting such vast sums of money will prove financially difficult, reducing

the scope for high-value investments and threatening the viability of the entire business

model.

Another risk is the diminishing number of potential targets. CEO of Actavis, as cited by

David Crow, even described the ‘pool of targets depleted’ (Crow, 2015). Furthermore

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integration of acquisitions can prove difficult - biotech start-ups can simply be folded in

the existing corporate culture, stifling the entrepreneurial spirit that led to discoveries.

Overall, business models based on this M&A

strategy are currently providing investors

with ample returns (Crow, 2015). However,

the long-term prospects of the strategy

seem rather bleak. As mentioned, a key

factor is cheap leverage. The future

exchange rate raise being an established

fact, reliance on debt-fuelled acquisitions

and no in-house R&D is a costly and risky

path to take.

‘Specialty pharma total shareholder returns’ (Thompson Reuters Datastream as cited by

Crow, 2015)

2.3. Precision M&A and specialty drug development

Precision M&As differ from regular mergers, as they represent not an expansion of the

business, but a focus on streamlining the portfolio (Ward & Fontanella-Khan, 2015).

Utilizing this strategy companies aim to focus on core areas of expertise, where they

have the knowhow and resources to compete internationally, whilst divesting non-core

assets.

Thus, Merck sold its consumer healthcare division, expedited by patens expiration of

key revenue-generating drugs and the pressure to supplement its drug development

pipeline. The decision taken by company management is to focus R&D on select areas,

divest non-core parts of the business and engage in mass cost-cutting (Ward, Hammond

& Vasagar, 2015).

Yet, cutthroat competition means pharma incumbents increasingly spearhead funds to

imitate the strategy described in 2.2., and acquire companies with a specialty drug

portfolio, focusing the business model on specialty segments. This enables to attain

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leadership positions in niche highly specialized segments, effectively creating a

monopoly and a core strength, as biologic specialty drugs are significantly harder to

replicate compared to conventional blockbusters (Amgen, 2014). With the average cost

of a specialty treatment at $35000- $75000 and spending predicted to increase 67% by

2015 (Grom, 2014), potenial margins seem irresistible.

However, a heavy blow has been dealt at the recent IMS Health UK Market Access

Summit. Health secretary, Jeremy Hunt, as cited by Andrew McConaghie, stated that

funding priority until 2020 would be given to primary care and not specialty drugs

(McConaghie, 2015). This means U.K. market conditions for specialty treatments will

become more challenging, potentially causing other countries to follow suit. This could

render the strategies of acquiring specialty treatment biotechs and ‘precision M&A’ with

a focus on specialty drugs unviable, as payers refuse to reimburse high costs of

treatments.

Overall, it is to be concluded that M&A at stratospheric prices bear risks of losing sense

of reality. Buoyed by cheap leverage, it is too easy to overpay or acquire a company so

out of focus with the acquirer’s expertise, that no tangible gains can be generated. When

revenue streams from biotech acquisitions are unable to justify exorbitant price

premiums, sole reliance on the M&A strategy is perilous and dubious to deliver

sustainable long-term success.

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31.70%

22.40%

11.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Pharma Vaccines Consumer healthcare

Operating margins

3. Diversification – supplementing the core

business

An alternative strategy to precision M&A is moving away from the core business into

related products and services, most frequently consumer healthcare.

Bayer followed the diversification route, acquiring Merck’s consumer healthcare

division for £14.2bn. The price was lambasted in the media, being over 20x EBITDA

(Ralph & Livsey, 2015). Nevertheless, Bayer justifies the premium in terms of revenue

gains: cross-selling benefits and introducing Merck’s predominantly US-sold products in

Europe (Bayer AG, 2014).

Another company adopting elements of the diversified business model is

Johnson&Johnson, focusing on three main areas: pharmaceuticals, consumer healthcare,

medical devices and diagnostics, effectively limiting risks of exposure to purely one

category (Johnson & Johnson Innovation LLC, 2014).

GlaxoSmithKline adopts the diversification strategy for future development having

relied on its blockbuster Advair asthma medicine for 14 years. GSK is aiming to defy the

current predominant industry focus on high-price specialty drugs for the developed

world in favour of high-volume, affordably priced products for the growing middle class

in developing countries (Ward, 2015b). This strategy shift led to a 20-billion asset swap

with Novartis, whereby GSK exchanged the high margin cancer business for the lower-

margin vaccines and consumer healthcare

(Ford, 2015). The rationale behind the

swap might seem questionable and even

ludicrous. Indeed, why divest one of the

higher-margin fastest growing businesses

and willingly subject oneself to more

intense competition?

Segment operating margins. GSK annual report, as

cited in the FT (Ward, 2015).

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Yet, GSK is not abandoning the pharma sector: the company has received more drug

approvals in the past 3 years than any other company and invests £3.5 billion/annum in

R&D, matching the industry average at 15% of sales (Ward, 2015b).

This effectively means GSK is strongly investing in in-house R&D expertise, whilst,

simultaneously, hedging the risks with developing high-priced specialty drugs and

limiting its exposure to the high-risk high-reward strategy. As Sir Witty, cited by

A.Ward, aptly remarked ‘we leave open the upside potential to be one of the winners

from innovation… But it can’t be a one-way bet’ (Ward, 2015b).

Overall, the rationale behind this strategy is spreading risk across various segments and

markets. However, successfully keeping distinct parts of the business under one roof

proves a challenge. Reckitt Benckiser has demerged its pharma business, Invidior, into a

separate entity to focus on consumer healthcare, stoking the debate about whether

pharma and consumer healthcare actually belong together.

Undeniably, there are similarities between two sectors regarding R&D, yet, there is

fundamental difference between diverse parts of the business. In consumer healthcare

brand message and product design play a far greater role than molecular drug

improvement - traditionally the focus of Big Pharma. (Ralph & Livsey, 2015).

Furthermore, there are differences in target customer groups: consumer healthcare

buyers are, typically, supermarkets or pharmacies, pharmaceuticals customers in many

countries are public health services that cover the public healthcare bill (Ralph & Livsey,

2015). Hence, the two segments are vastly different, requiring different approaches in

terms of marketing, customer management and overall resource allocation.

The diversification strategy seems a viable alternative for large pharma incumbents

with sufficient funds. However, it carries with it the risks of funds dilution and

misalignment of efforts. If diversification is to be successful, a balance needs to be struck

between retaining core strengths, identifying non-core assets for divestment and areas

for expansion.

Overall, aforementioned measures to innovate and move beyond blockbuster drugs can

yield results in the short run. However, for long-term success in the pharma industry

further modifications to current business models are necessary.

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4. Collaboration: within the sector and beyond

In the future pharmaceutical companies are predicted to generate profits through

collaboration with a large network of institutions: from university partnerships to

smartphone app developers (PricewaterhouseCoopers, 2009). The following social and

economic trends underpin the prediction.

4.1. Industry trends – a case for increasing co-operation

Spiralling healthcare costs and corresponding shift towards outcome-based

reimbursement

Worldwide there is growing public discontent towards pharma charging payers high

prices. The UK’s National Centre for Health and Care Excellence has recently rejected an

ovarian cancer treatment – olaparib, due to the £4200/month price and the rule that no

drug cost more than £30000/annum per additional quality-adjusted life year (Potts,

2015).

China, the world’s second largest pharmaceutical market, aims to cancel its existing

15% hospital drug sales mark-up and give hospitals more remit to negotiate price

rebates with suppliers (Waldmeir, 2015), which, furthermore, strains pharma

incumbents’ profits.

A crucial outcome is the pressure to shift from the pay-per-treatment to the pay-per-

outcome model. In fact, by 2020 most medicines are predicted to be paid for only if they

deliver verifiable results (Pricewaterhousecoopers, 2009).

Measuring outcomes, however, requires access to relevant data, possible through

partnerships between pharma, healthcare payers and providers.

Patient involvement in treatment and drug self-administration

An increasing number of patients nowadays are more actively involved in

understanding their ailments and treatments needed (Grom, 2014). A rise in computer

technologies instigated this trend, with patient blogs and activist groups created to

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encourage experience sharing. Modern day patients demand easy-to-administrate

medicines that obviate regular commutes to health centres. Hence, future success in the

business environment will depend on closer ties with the patient: providing training,

measuring treatment progress and outcomes, encouraging efficient treatment follow-

through to deliver consistent results and, consequently, reinforce the pay-per-outcome

system.

Growth of the middle class in emerging markets

Economic growth in countries such as Indonesia, China, Vietnam, Thailand is attracting

pharmaceutical companies. Yet, to ensure success in the heavily government-regulated

markets, pharma companies must collaborate with existing players to establish a solid

presence in the region. Whereas hitherto M&A was the established route to gain a

foothold, interest rates raise by U.S. Federal Reserve is expected to diminish the gains

generated from a bolt-on acquisition commonly fuelled by cheap leverage. Given

improving legal and investor protection, strategic alliances and joint ventures are a

safer way for long-term success and early entrants are expected to be at an advantage

by selecting the most credible partners.

Emergence of new technologies

There is great scope for cross-industry implementation of cutting-edge technology. The

most recent breakthrough innovation is 3D-printing and its seemingly inexhaustible

potential. A possible application for this technology in pharma is bioprinting.

Bioprinting works by using cultured human cells, chemically turning them into a ‘bio-

ink’ and using a bioprinter to deposit a cell pattern, with the printed tissue then allowed

to grow (Powley, 2015). Partnership with bioprinting companies to produce tissue

analogies can significantly reduce drug-testing expenditure and expedite the drug

development process. Thus, collaboration beyond the healthcare sector can cross-

leverage innovations to achieve a competitive advantage.

Threat of new entrants

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Spurred by increasing patient involvement in health management, the broader

healthcare industry is experiencing a deluge of new entrants: from health management

apps, to wearable healthcare technology.

23andMe, a Google genetics testing company, claims to have amassed the largest

database of human genetics data through providing DNA saliva tests (Ward, 2015c). The

company seeks to determine patterns in aggregate data to develop treatments and has

already partnered with Pfizer and Roche, providing limited access to its database.

Though far from directly competing with incumbents, such entities, backed by

behemoths like Google, are ambitious to enter the healthcare industry and could

potentially disrupt the status quo. Early partnerships can help pharma to supplement

their expertise, allowing leveraging others’ assets and knowhow for implementation

into own value offerings.

4.2. Forms of collaboration

Partnerships can be implemented through following forms of collaboration.

Strategic outsourcing

Capabilities beyond core areas of expertise, (e.g. manufacturing, IT, marketing) can be

outsourced to third parties (Capo, Brunetta & Boccardelli, 2014), enabling better focus

on patient value-adding activities.

This course of action could improve management of funds, deliver a higher ROI and

reduce initial capital expenditures. Pharma companies would then monitor outsourced

capabilities, ensuring seamless and lean operation. Furthermore, non-core knowhow

could be out-licensed, enabling better focus on key areas of expertise, and generating a

stream of royalty payments.

Strategic alliances and joint ventures

Strategic alliances represent a contractual agreement of, as a rule, limited scope,

whereby companies seek to leverage each other’s expertise without extensive resource

commitment.

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Joint ventures are a more long-term legal commitment to mutual collaboration and

entail a creation of a separate, jointly owned company. The newly created entity can

gain access to founders’ expertise, generating synergy cost savings.

These forms of partnership can be implemented at nearly any stage of the business

cycle (New Zealand Ministry of Business, Innovation and Employment, 2015):

Distribution and purchasing collaborations

Manufacturing in new markets

Joint marketing agreements

Transfer of technology

Academia research projects

Strategic alliances are presently widespread through partnerships between Big Pharma

and small biotech companies in certain segments of drug development, where a

successful therapy procedure is hard to establish. Oncology is one such area.

Novartis has recently forged an alliance with Aduro of California to develop Sting – a

way of activating the immune system to destroy cancer cells. Novartis is prepared to

pay $200M to license the technology and a further $500M should it prove successful

(Garde, 2015).

Merck finalized a deal to test a checkpoint inhibitor drug – Keytruda, combined with

another drug developed by a US biotech, Syndax. This draws on the industry-

established fact, that checkpoint inhibitors perform better used in combination with

other treatments (Ward, 2015d).

A more radical technique – adoptive T-cell therapy, involving taking immune cells from

the patient and reengineering them to destroy tumours (Ward, 2015d) has spawned a

further spate of partnerships. Merck Serono has struck a $941M co-development deal

with Intexon and is developing a checkpoint inhibitor with Pfizer (McDermid, 2015)

This drive for collaboration is due to the particulars of this area of medical research.

Oncology is an extremely fast-moving field with over 200 cancer types. Sole-drug

therapies typically put the patient in remission, but to fully eradicate the aftermath and

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prevent the disease from developing anew, a follow-up treatment is necessary. This

creates ample scope for incumbents to secure leadership in treatments for certain types

of the ailment and makes partnerships a viable path to manage risks and build on

diverse expertise.

Collaborative networks

Utilising this model, the pharmaceutical company acts as a ‘hub’, establishing a network

of separate entities: hospitals, suppliers, universities, etc., all sharing common

infrastructure (PricewaterhouseCoopers, 2009). Players in the network are united by a

common goal and rewarded according to defined criteria and input. Common

infrastructure creates interdependence, which, in turn, creates incentives to remain

within the network. This form of collaboration provides an excellent opportunity for

idea cross-fertilisation, whereby pharma incumbents can leverage expertise within and

beyond the industry, creating integrated patient value offerings.

Integrated value chain

This model is an entirely new level of collaboration and involves various

pharmaceutical companies performing different roles within the traditional value chain,

each complementing others’ core strengths and cross-leveraging expertise.

Integrated pharmaceutical supply chain (Capo, Brunetta & Boccardelli, 2014)

The model partially resembles the outsourcing collaborative model, insomuch as certain

parts of the value chain are outsourced to third parties. However, the third parties

would not simply assume a dependent relationship, where one pharma company is the

chief party and coordinator, but would all act as equal partners, leveraging their

collaborative networks to perform parts of the value chain in the most efficient manner.

Selecting an optimal collaboration form and implementation of that decision depends

on a company’s unique requirements, targets and resources. However, as a general

Research Development Manufacturing Marketing & Sales

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trend, pharmaceutical incumbents are expected to adopt a progressive approach to

business model innovation initially (PricewaterhouseCoopers, 2009): starting with

rather short-term collaborations, identifying the most successful ones to extend co-

operation, ultimately, establishing a collaborative network and, subsequently, efficient

links between collaborative networks to implement an integrated value chain.

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5. Key routes for business model innovation

Adapting business models to focus on these key guidelines through collaboration is

expected to deliver the greatest benefits to both pharma incumbents’ bottom-line and

stakeholders.

Development of novel commercial models of drug uptake & implementation of

outcome-based pricing

Understandably, pharma players want to recoup substantial R&D costs by charging high

prices. However, with the pressure to reduce healthcare expenditures, prices can only

be sustained if an outcome measurement system is in place.

Currently, in many markets specialty drugs reach patients through physicians buying

drugs upfront and being reimbursed upon the drugs’ administration. However, the risks

are that reimbursement will not be effected due to the payer’s refusal to cover high

costs of such medicines (Robinson, 2014). Industry incumbents could take the following

steps adapt their business models to the challenge:

Provide support to doctors and physicians with the reimbursement process and

assistance with measuring drug results to substantiate the case for

reimbursement. Angela McFarlane, as cited by Andrew McConaghie mentioned a

novel real-world evidence collection application being developed, which could

be utilized to fund drugs that deliver verifiable positive results for patients.

(McConaghie, 2015).

Consider implementing changes to the billing process, e.g. consenting to

postpone receiving full payment for drugs until positive outcomes have been

empirically verified, effectively providing up-front discounts to physicians. As

partnerships with payers enable access to crucial patient data, implementation

of flexible pricing can ensure that R&D investment is recouped within the drug’s

life cycle. Although this could lead to lower revenues initially, mutual trust can

be established and prices for effective, life-saving drugs justified.

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Provide patients with adherence devices and support to ensure effective

treatment follow-through in order to empirically prove positive drug outcomes.

Delivering integrated product-service packages

As mentioned above, to deliver sustainable value and measurable results, pharma

players need to implement changes to the current focus on providing solely an effective

treatment/drug. There is evidence that medicines deliver better outcomes coupled with

appropriate nutrition and exercise (Gilbert, Henske & Singh, 2003). Thus, a network of

product, patient support mechanisms, wearable technology for progress measurement

and mobile apps will enable better treatment outcomes and patient value offerings.

Delivering patient-tailored solutions

This route is especially viable for pharma companies focusing on specialty drugs. A

great opportunity for innovation lies in linking genetics with conventional treatments

(Grom, 2014). The approach will enable drug manufacturers to predict which patients

will derive benefits from the drug, and which will experience adverse side effects. This

will result in better patient value creation, substantiate the price charged for a

treatment given a verified outcome and an increase in quality-adjusted life years.

Innovation in in-house R&D approach and adaptive clinical trials

Blockbuster drug development in the past entailed juxtapositioning various compounds

with a certain molecular target (Gottlieb, 2011). However, evaluating vast numbers of

chemicals to identify effective ones is a resource-consuming process with decreasing

ROI (Nisen, 2015). This dispersed approach can no longer yield cost-optimal results: a

sprawling R&D department does not translate into

better innovation, as seen from the Pfizer case. The

company built a 2.7M sq.ft of research space, only to

lay off staff after facility investment failed to

translate into more innovation (Caroll, 2015).

Pharmaceutical R&D returns, top 12 spenders (Nisen, 2015)

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To counteract this, alternative R&D approaches must be evaluated. Virtual R&D is one

approach: computer molecule design could, through leveraging existing scientific

knowledge and accumulated data, greatly expedite drug’s structure design and lower

R&D expenditure (PricewaterhouseCoopers, 2008).

Another approach is entirely changing the drug development focus to concentrate on

the particular molecular structure of an ailment and the targeted biological receptor.

This ensures efforts and resources are not wasted, but are spearheaded to find a cure

for a particular ailment, thus avoiding the industry-famous ‘Viagra experience’ (Gilbert,

Henske&Singh, 2003).

If the pharmaceutical company considers its strength to lie not in successful drug

discovery, but in, e.g., an efficient supply chain or marketing, a viable R&D approach

could be to in-licence drugs for future commercialization from smaller players with

potentially lucrative drugs in the portfolio lacking such capabilities.

Adaptive clinical trials could, further, supplement the chosen value creation model

through establishing reactions to the drug from the outset and efficiently modifying the

dosage/patient sample/combination of drugs based on initial results (Brennan, 2013).

Emphasis on prevention

As mentioned above, governments worldwide are seeking to contain healthcare costs.

Detecting ailments at early stages can significantly reduce treatment costs, as well as

ensure better patient cure rates. Pharma incumbents, have largely ignored this area.

Though this strategy may seem counterintuitive at first (indeed, the lifeline of the

business depends on curing ailments, not preventing them), first entrants can gain

favour with government healthcare payers, willing to increase spending on prevention,

whilst decreasing available funds for drug cost reimbursement.

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Conclusion

Pharmaceutical incumbents are moving away from the ‘blockbuster’ business model

through utilising various diverse strategies: from precision M&A to greater

diversification, from focusing on generic low-price high-volume drugs to creating high-

premium specialty treatments.

There is and can be no single recipe for success. The business model changes to be

implemented depend greatly on the company: its culture, vision, resources, ownership

and targets.

What cannot be doubted are the general trends of the changing pharmaceutical

business environment: the shift towards outcome-based drug reimbursement, patient

involvement in treatment, new technological innovations implementable in healthcare.

The key to successfully adapting pharma business models lies in eradicating the current

clash between pharma and healthcare payers, gaining access to patient data in order to

deliver excellent value. This can best be achieved through collaboration within and

beyond the industry by providing integrated product-service solutions, implementing

flexible outcome-based pricing, delivering tailored patient solutions.

Hence, each pharma incumbent must carefully evaluate their current business model,

identify core capabilities and strategic strengths to build on, determining the optimal

route for future development.