2011 Scrip 100: Year to reform the business model

Late on 2 November, John Boehner, the Ohio Republican congressman, stepped up to the podium, basking in his party's convincing US mid-term elections win. After the cheers died down, he delivered an emotional and concise victory speech in which he did not once mention US healthcare reform. For the next Speaker of the House of Representatives, this omission was telling.

The US pharmaceutical market – and to a broader extent the US healthcare industry – has teetered on the scales of uncertainty and certainty for years. Tipping the balance are regulatory pressures, a lack of R&D productivity and growing demands from payers in search of value-for-money products.

Another factor is US healthcare reform. The Affordable Care Act passed into law in March 2010. Republicans hammered it as a symbol of Democrats' and government overreach, if not intrusion, in American life. "Repeal and replace it," they cried.

Yet, as told by Mr Boehner's omission, the election effect on healthcare reform is much overstated. Immediately undoing it is unlikely. Nevertheless, certainty remains elusive: pharmaceutical companies will be left to re-model and re-balance as the tectonic plates of the US market grind and shift underneath them. This remodelling, rather than more healthcare reform, will make 2011 a year to watch.

All eyes should be on two distinctly diverging business models as they compete to define next-generation US drugmakers: the distribution model and the high-risk-reward science model.

And the stakes are even higher as both companies have decided to change their CEOs ahead of the coming year, with Ian Read taking over from Jeff Kindler at Pfizer, and Ken Frazier the new CEO at Merck.

Pfizer is pushing ahead with the former model in a bid to tap all sources of prescription pharmaceuticals and maximise its product offering for as many customers as possible, across the whole spectrum of payer reimbursement scenarios. It will use its size and muscle to bring products of value to market through orthodox and unorthodox channels.

Pfizer's strategy includes building capabilities in generics and biosimilars, alongside an aggressive roll-up M&A posture. It is shifting away from a reliance on all-or-nothing bets, developing new drugs in its own labs. Frankly, Pfizer has not excelled at this in recent history.

Overall, it is a model to position Pfizer as a financial roll-up heavyweight with less volatility. The strategy uses as many levers as possible: financial levers, new science and research-driven R&D and participation in all parts of the product life-cycle value chain.

Describing these efforts to the company's shareholders, Mr Kindler spoke about "producing steady, reliable, adjusted earnings growth over time… returning cash to shareholders through dividends and buybacks… [and] making disciplined internal and external investments in innovative new treatments and cures that produce good returns on your capital".

Mr Kindler added: "The foundation for these results is the dynamic portfolio of businesses, products, geographies and areas of research that balances both our risks and our opportunities."

Pfizer's third-quarter business development actions show the distribution model in action. The company moved to acquire King Pharmaceuticals, known for its pain medications, to add top-line growth to its Primary Care business, which represents one-third of Pfizer's revenues.

Pfizer acquired FoldRx, a privately-held company focused on the orphan diseases market. This will become part of Pfizer's Specialty Care business unit, which accounts for nearly one-quarter of revenues.

The company added an alliance with Biocon, one of India's leading biotech firms, with biosimilars and insulin capabilities. This augments Pfizer's Established Products unit, a business that aims to maximise the sales of big mature on- or off-patent brands, accounting for one-eighth of total revenues.

And Pfizer purchased a 40% stake in Laboratorio Teuto Brasileiro, a private Brazilian manufacturer of 250 branded and unbranded generic pharmaceuticals in 400 presentations. Pfizer can market these products outside of Brazil via both its Emerging Markets and Established Products units.

To be sure, there are company-specific reasons for the shift towards a new model. Insufficient R&D productivity has left Pfizer grasping to find new sources of top-line growth to at least plug holes from expiries and generic competition. Pfizer's aggressive large-scale M&A strategy of the past 10 years has been a double-edged sword. Mega-deals have created some of its over-reliance on giant, single blockbuster products like Lipitor. Pfizer is now trying to deal with the revenue holes that will be left by the US expiry of their patents.

Merck & Co, meanwhile, is a proponent of the high-science model. It clearly takes a more orthodox view of how a pure-play large pharmaceutical company should look, run and deliver. The Merck model seeks to tap the best of emerging science to find new products that can be marketed as premium-value, breakthrough medicines. The core guiding principle is that the best way to gain business leverage with increasingly exacting payers in the US is to discover and offer differentiated, new treatments for disease states that at present are untreated or not treated adequately. The high-risk-reward science model and its growth increasingly depend on proof.

In its third-quarter results presentation, Merck reiterated its belief in this business model. This came in the context of Merck's first big modern-era deal: its acquisition of Schering-Plough in November 2009. The deal brought opportunities, including financial cost synergies, and it filled a crucial hole in Merck's late-stage pipeline that could help it offset growth challenges.

In the words of Dick Clark, chairman of Merck, "Most important is furthering the science that underpins Merck's ability to address many of the world's most serious unmet medical needs… it is Merck's ability to develop and offer these truly differentiated products that will position us to successfully navigate economies, pricing pressures and challenging regulatory environments throughout the world."

Mr Frazier hit the high notes: "While there's a lot of focus on the emerging markets, one shouldn't forget that science and innovation remain at the core of our business in every part of the world. For us to be successful, we have to continue to discover, develop and launch differentiated products with clinical profiles that offer patients and payers proven benefits."

Incorporated into the high-science model is Merck's new approach to follow-on biologics. It has created Merck BioVentures, underlining its thinking that the better science-focused companies will prevail – even in the "generic" biologics space. This fits with the view that only those with expertise, scale and resources will be able to extract the most value throughout the life-cycle continuum of complex biologic therapies whether they are proprietary or external – from biologic to biobetter to biosimilar and vice versa.

Some company-specific forces play a part here, too. Despite the S-P deal, Merck relies on self-imagery as a company that focuses on new science. Even with R&D productivity and ROI questions bedevilling the industry, the high-science model argues that the basic operating theorem of the pharmaceutical business does not need to change.

In 2011, the Pfizer and Merck models will start to hit stride, showing what they can do to counter intense prevailing industry pressures.

The drumbeat of blockbuster patent expiries in the US continues at a harsh pace: the industry is expected to lose $42 billion in US branded sales due to exclusivity losses between 2011 and 2012, according to Datamonitor. In addition, the top 50 companies' US sales are forecast to decline by an average of 2.2% year-on-year between 2010 and 2015.

the big one

In November 2011, one of the most anticipated US patent expiries of all time is set to occur: that of Lipitor, the world's best-selling drug with peak annual sales once nearing $13 billion for Pfizer.

This is emblematic of a tough reality. Blockbusters were once marketed as great advances, broadcast via DTC advertising. But the creators of these medicines must now work against their own powerful creations in generic form.

R&D productivity is an increasingly complex question. Anaemic growth rates have left capital-market experts wondering if the real question for the tightening US market is whether big pharmaceutical R&D today is still worth its ROI.

US payers are increasingly looking for comparative-effectiveness data and other information to help them stratify and limit branded drug usage. For instance, the pharmacy benefit manager Medco has launched a comparative-effectiveness, personalised medicine trial comparing the antiplatelet drugs Plavix and Effient. It uses a genetic test to screen for patients with a mutation that makes them poor metabolisers of prodrugs like Plavix, limiting its efficacy. It could drive targeted Effient use and more use of generic Plavix (clopidogrel) with US expiry in 2012.

Without a doubt, debate will continue on the future of healthcare reform. Picking it apart could be a strategy, with potentially unpopular targets including the mandate to carry health insurance and the Medicare Independent Advisory Board, set to start via funding in October 2011.

But it's a tightrope to avoid backlash. Some elements are popular: no pre-existing condition refusals, more insured, more children insured and a closing of the Medicare Part D donut hole. And a funding standoff, with government shutdown – denying vital services – could backfire.

The pharmaceutical industry should prefer the relative new certainty of the reforms anyway with more insured patients starting in 2014 – and the perception of cooperation in change.

No matter what transpires in Washington, expect to see the two diverging models playing out in 2011 to show if one, the other, or both are the future of big pharma.

Christopher Bowe is a US healthcare analyst.