The Analysis: Pfizer Needs a New Approach

Indeed, with the company spending billions of dollars to bring just a handful of drugs to market, it is wise to reorganize R&D

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With the cost of drug development steadily increasing, Pfizer's decision to look to a biotech model for research is probably a good one, says Frank R. Lichtenberg, Courtney C. Brown professor of business at Columbia Business School, who teaches a course on the economics of health care and pharmaceuticals. As the FDA has required larger clinical trials, the cost of getting a new drug approved has climbed to $1 billion. However, Pfizer's spending appears to have been even higher. Pfizer sunk nearly $35 billion into research and development from 2004 through 2007, during which time it introduced four major new drugs. "The recent record suggests that they really do need to try a different approach," Lichtenberg says.

Shifting toward a biotech model in research could be a shrewd move. Big pharmaceutical companies have increasingly relied on small biotech companies for drug discoveries because the startups appear to have a comparative advantage. "Rather than outsourcing all of the research and development, Pfizer is trying to do research internally, using an organizational form that has proven to be less expensive and more efficient," says Lichtenberg. "I think that's appropriate."

Conducting such research in-house could also enable Pfizer to develop drugs more attuned to market opportunities. Outsourcing research and development is risky because other companies may not pay close attention to a drug's market potential. If that's the case, Pfizer could end up with drugs that are technologically successful but not economically successful.

If Pfizer carries out its shake-up wisely, the company has an opportunity to marry the best biotech practices with its own comparative advantages in drug approval and marketing. Pfizer has proven itself to be better than biotechs at getting new drugs accepted by insurance companies, Medicare, and Medicaid at prices that make a drug's development worthwhile.

While the plan sounds sensible enough, it will be unclear for years whether or not the company has succeeded. Moreover, Pfizer just added yet another potential layer of complexity to its experiment by buying Wyeth. Past promises of pharmaceutical mergers delivering economies of scale in research have rarely panned out, in large part because they pose significant integration problems. After GlaxoWellcome merged with SmithKline Beecham in 2000 to form the world's second-largest pharmaceutical company, GlaxoSmithKline, "the rate of drug approval was lower than the years leading up to the merger," Lichtenberg points out.

Nevertheless, Lichtenberg believes Pfizer's restructuring of research is necessary. "Trying to conduct research in smaller, leaner organizations is probably a good idea," he says.

Thornton is a senior writer for BusinessWeek.