For several years, the pharmaceutical industry's fundamentals have been in disarray. Large companies have been plagued by patent expirations on key drugs and a spate of late-stage disappointments for drugs in development. As Wall Street demands earnings growth, drugmakers have been turning more than ever to make deals with smaller companies for new product possibilities.
While a more proactive Food & Drug Administration and the recently passed Medicare drug benefit could offer some relief, issues related to productivity will remain vexing, says Kenneth Kaitin, director of the Tufts Center for the Study of Drug Development.
The nonprofit Tufts Center, affiliated with Tufts University, has been analyzing the pharmaceutical industry since 1976. It's famous, or perhaps infamous, for coming up with the figure of $802 million as the average cost - direct and indirect - of bringing one drug to market. From his perspective, Kaitin believes "the topics that were very hot last year are still hot."
On Dec. 23, BusinessWeek Online Reporter Amy Tsao met with Kaitin and three senior research fellows from the Tufts Center in Boston about the major issues facing the pharmaceutical business. Kaitin addressed the broad changes coming in industry dynamics. Christopher-Paul Milne discussed legal and regulatory concerns. And economist Joseph DiMasi defended the center's methodology for determining the cost of drug development. Joshua Cohen, specialist in pricing and reimbursement, talked about how changes to Medicare will affect companies and consumers. Edited excerpts of the conversation follow:
Q: What do you consider the major issues for companies involved in drug development?
Kaitin: Productivity concerns continue to be the most compelling. We're looking at how [lack of] productivity affects the relationship between big pharma and smaller biotech companies. Mergers and acquisitions [between big drug companies] are now being looked at as a possible reason for the productivity issue.
International factors also play a part. Europe is trying to draw some of the research and development back to European companies because of the fear that too much of the burden has shifted to the U.S.
Q: This year, much was made of the notion that the U.S. is bearing too much of the cost of new drugs. Is this true?
Kaitin: We have an FDA commissioner [Mark McLellan] who's very attuned to these things. The economic prowess of the researched-based industry is [critical for] providing new drugs for patients. The fact that McLellan is both an economist and physician gives him the ability to see that you must maintain the vitality of the industry to make new drugs possible.
Germany and France are good examples of major markets [for drugs whose] contribution to R&D worldwide is very small by comparison. There clearly is a disparity.
Milne: Profitability is higher here in the U.S. It's about the only free market left for the industry. In that sense, the money that sustains the industry throughout the world is because of the profits made in the U.S. market.
Q: How worrying is the productivity problem?
DiMasi: In the short run, you can see a productivity decline in the form of [fewer] drug approvals and fewer new-drug applications. What's not clear is if this problem will persist.
Innovation generally comes in waves - some short and some long. I was reviewing hearings from the late '50s. A Senate report noted an [unexplained] research-productivity decline. I had to chuckle at that. We're seeing the same thing 45 years later. Obviously the pharmaceutical industry came back from the productivity problems it had back then.
Q: What about the various discovery tools like gene databases that were supposed to help fill companies' pipelines with more and better drugs?
Kaitin: The industry embraced these new technologies with the hope that they would revitalize dwindling pipelines. There were some very outspoken CEOs -- like former SmithKline Beecham CEO George Poste -- saying this was going to completely change the way drug development was done.
Skip forward and Hank McKinnell, head of Pfizer (PFE), says the reason why we have a productivity problem is we overinvested in discovery technologies. These technologies provided many more leads but few ways to validate them.
Slowly the industry has backed off [from these technologies]. I don't know any major company now that wouldn't say [embracing them] was a mistake. There's a future for this technology, but we're at a turning point. Many companies have said they won't give up on these technologies. GlaxoSmithKline (GSK) is a good example. They still believe that this is going to be the way drug discovery and research occurs.
Q: Have mergers, and thus larger-size companies, hurt productivity?
Milne: The current thought is size has an inverse relationship with creativity. Larger companies are trying to emulate the kind of creativity you get out of biotech companies. There's a feeling that loss of creativity has been one of disadvantages of M&A. Smaller, smarter, more science-driven pharma companies are the wave of the future.
Kaitin: We have had firms of all different sizes trying to do R&D the same way -- pursuing drugs in a lot of different therapeutic areas, keeping a diverse portfolio. What we're seeing now is that few companies can continue that approach.
Pfizer, with a $7.5 billion research budget, can still do this. But all of the medium-size large pharma firms are talking about new strategies and the end of the blockbuster era. Aventis (AVE), Abbott (ABT), Schering AG (SHR) are talking about it, realizing they have to have a strategy that uses their strengths. All of this is leading to a restructuring of the market.
Q: What are the solutions to the industry's productivity problems?
Kaitin: One of the major solutions is the establishment of strategic outsourcing and partnerships. Eli Lilly (LLY) has been doing so well because they've been a leader in partnerships with small biotech companies. That has filled its pipeline and allowed them to keep some of the expensive technologies outside of the company.
I think a lot of companies are seeing that's the way to operate. There will be specialists in various aspects of the entire R&D process. You'll have fewer firms that will try and manage from soup to nuts. This change is long overdue.
Milne: It's part of the evolution of the R&D paradigm. It's being forced by necessity but will make it more productive. The goal is to spread the risk and resource cost.
Even the biotech companies will benefit. They can't keep being companies without profits or products for 15 years. There's going to have to be an incubation period that's dependent on the public sector. But then you'll have a big company come in and take products through trials and bring their resources to bear.
Q: Of course, the Tufts Center is known for coming up with the figure of $802 million as the average cost of bringing one drug to market. Is the cost rising?
DiMasi: If success rates fall, all things being equal, cost would increase.
Q: What about critics who don't agree with the methodology of the development cost study? Have they cast any doubts?
DiMasi: No. We used capitalization, which is a very standard process in economics and finance. You're putting a monetary value on the time cost of drug development. There's a cost to putting money into a 10- to 15-year process before any returns are seen. The methods we used to estimate that time cost are standard. If anything, they were somewhat conservatively applied.
Q: How is the FDA's role changing?
Milne: There are a number of tensions right now that the FDA has to address. They know there are limitations to how much you can evaluate a drug before it reaches the market. They're trying to address that with new post-marketing initiatives and surveillance, which are great.
By the same token, [Commissioner] McLellan has said the industry needs to reduce resources going toward R&D because the $802 million figure isn't sustainable. Still, the FDA also expects companies to expand what they're doing.
Q: What about the strategy of making more switches from prescription to over-the-counter status - like we've seen in the last two years with Claritin and Prilosec? Will there be more switches?
Cohen: What the agency would have to do is first try to assess which would be switchable. Then they would have to incentivize the industry to switch drugs. Statins, asthma drugs, blood pressure drugs, contraceptives are being looked at next. Britain and other countries are switching statins now.
The FDA encouraging switches to OTC status would be a big change for the industry, which generally views switching as hurtful to their businesses. Insurers see prescription-drug growth as a problem that could be alleviated by having more drugs OTC. We will hear a lot more on this issue in 2004.
Q: How will the Medicare drug benefit affect the pharmaceutical industry?
Cohen: The benefit doesn't begin until 2006, but one of the immediate effects of this legislation is discount cards for seniors given out by pharmacy-benefit managers. These will go into effect next year and will reduce out-of-pocket cost for seniors by an average of 25% off retail prices. Obviously it's not generous, but the card offers some savings.
There are a number of things the industry is going to be happy about. The industry is likely to gain volume. Also, the government will not intervene in terms of limiting prices. With [price caps] you could limit investment in R&D down the road. So the industry has gotten a drug benefit it can live with.