BusinessWeek: January 11, 1993

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 Industry Outlook: HIGH TECHNOLOGY

SWALLOWING A BITTER PILL

The high-flying pharmaceutical industry may get its wings clipped this year. U.S. drug companies still lead the world in research and development and rule its largest drug market. But they'll feel pressure on profits, as several major drugs lose patent protection. Prices could get pinched, too, as President-elect Clinton starts his drive against soaring health-care costs. Analysts figure the industry's aftertax margins could drop to 13%--one percentage point below last year's level and down six points from 1991--even as sales rise 10%, to about $82.5 billion.

Normally, drug companies feel a squeeze on profits because of new-drug marketing expenses or a bulge in development costs. But this year, there's more than that at work. Congress may again consider canceling tax breaks for drugs produced in Puerto Rico. There's also talk in Washington of requiring more drug price discounts for big buyers. Drugmakers argue that their products account for just 5 of the health-care dollar, but they're moving anyway to avoid regulation. Seven major companies that together produce a third of all U.S.-made pharmaceuticals--including Merck & Co. and Pfizer Inc.--say they'll voluntarily restrain price increases to the overall inflation rate.

FULL PIPE. The problem is that drug manufacturers need a strong cash flow to support R&D--which will cost $12 billion this year. And healthy prices have always been the key. If prices are constrained, companies without a broad product line or a flow of winners could be in trouble. One is Warner-Lambert Co., whose Lopid, an anticholesterol drug, drops off patent this month. Finding a way to make up for the $500 million-plus Lopid has been contributing to sales each year will be tough--and expensive. Most analysts now figure that the average cost of developing and launching a new drug is nearly $275 million. And only 3 of every 10 drugs that get to market recover the investment that companies have made in them.

Overall, the industry's crisis may not be as severe as that sounds. The FDA has a full pipeline of applications right now: Some 35 new drug entities could be O.K.'d this year. After that, legislation signed by President Bush in October should get drugs to market faster. Starting in 1994, the FDA is due to use higher application fees to add reviewers and update its information systems. This should shorten the time needed to test a drug's effectiveness and safety from 32 months now to 12 months by 1997. For drugs that battle aids and cancer, approval time will be halved, to six months.

These changes could add some $65 million in earnings per drug: Faster approval means a product will be on the market for more of its 17 years under patent. Still, this may not offset all the price squeeze. So, even Merck has set up a generic-drug unit, West Point Pharma, to sell clones of its brand-name products as they lose patent protection. Early this year, Dolobid, which treats arthritis, should become the first Merck drug to go that route.

'WORRISOME.' Drugmakers are trying other strategies as well. Bristol-Myers Squibb Co. is one of several companies selling off low-profit, nondrug operations. American Cyanamid Co. is buying into a biotech startup. In December, it said it will acquire 54% of Immunex Corp. in Seattle for $740 million in cash. Cyanamid will merge the cancer-drug operations of its Lederle Laboratories into Immunex, whose key product is a white-blood-cell stimulant called Leukine. The deal will make Cyanamid the No.2 U.S. maker of cancer drugs, behind Bristol-Myers.

As they ponder leaner times, drugmakers also are cutting costs. This year, Bristol-Myers will cut its work force by 6%, or 2,200 employees. In late 1992, Syntex Corp. issued furloughs, its first in a decade. So far, most such moves involve administrative and marketing employees. But "it looks as if downsizing will be the name of the game," says PaineWebber Inc. analyst Ronald Nordman. "Head counts will have to be reduced." Marketing alliances may also multiply, to save money and boost efficiency: Merck has such deals with DuPont, Johnson & Johnson, and Connaught Laboratories. Even the industry's sacrosanct research is coming under scrutiny. If that gets cut too much, drug development could suffer. But most executives think the cost-cutting has been done prudently--so far.

"Some worrisome things are on the horizon," says Hal D. Eastman, associate dean of the Graduate School of Management at Rutgers University in New Jersey. Still, an analysis he has just completed for the state of New Jersey, where 25% of all U.S.-made drugs are produced, leaves him optimistic. By mid-decade, he believes, drugmakers will have adjusted to lower prices and gotten margins moving up once more. If he's right, pharmaceuticals may soon again become the most vibrant of U.S. industries.

Jane H. Cutaia in New York, with bureau reports
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