Every weekday, some 38,000 Pfizer Inc. (PFE) sales reps fan out around the globe. Armed with briefcases full of free drug samples, reams of clinical data, and lavish expense accounts for wining and dining their quarry, the reps infiltrate doctors' offices and hospitals. Their goal: to persuade medical professionals the world over to make Pfizer drugs the treatment of choice for their patients' aches and pains.
This massive sales force -- roughly the size of three army divisions -- is just the advance guard in Pfizer's quest for world drug domination. Equally important is the drugmaker's $3 billion annual ad budget. A pricey array of prime-time commercials and glossy magazine ads show vibrant people freed from the threats of heart disease, hay fever, and a dismal sex life. Sure, consumers can't just go out and buy this stuff: It has to be prescribed by a doctor. But Pfizer and the industry have learned that stoking demand among consumers puts irresistible pressure on doctors. That's why Pfizer is now the fourth-largest advertiser in the land.
Efforts such as these impose huge fixed costs. Pfizer, for example, now spends twice as much on sales and administrative expenses -- $16.9 billion last year -- as it does on research and development. And it employs 15,000 scientists and support staff in seven major labs around world. As long as those labs are churning out a steady stream of blockbuster drugs for Pfizer's gargantuan sales force to promote, this mass-market approach is extremely profitable. Pfizer, which has more than its share of megasellers, including such familiar names as Lipitor, Viagra, and Zoloft, earned $16 billion last year, not counting discontinued operations and onetime items, on sales of $52 billion.
There's only one problem: The blockbuster model doesn't really work anymore. Pharmaceutical companies, Pfizer being the leader, have sent so many sales reps into the field that they're tripping over one another. The company's once-vaunted labs, along with those of most of the industry, have hit a dry patch, with introductions of promising new treatments slowing alarmingly. Some of Pfizer's recent launches have been duds. (Ever heard of Caduet or Inspra?) The diseases Pfizer and others now chase are harder to defeat with a one-pill, mass-market solution. HMOs and the like are putting the brakes on skyrocketing drug spending.
End of an Era
It could get much worse. As BusinessWeek went to press, the Food & Drug Administration was holding contentious hearings about the fate of some of the biggest-selling and most lavishly promoted drugs -- painkillers that include Pfizer's $3.3 billion Celebrex and $1.3 billion Bextra. Evidence is mounting that all these so-called Cox 2's -- and not just Merck & Co.'s (MRK) withdrawn Vioxx -- may be linked to cardiovascular problems. Critics go further, though, arguing that Pfizer has not aggressively tried to answer that question -- and in at least one case has not publicized important safety data on Celebrex. Even if the drugs survive, they are almost surely irreparably damaged.
Add it up, and it looks an awful lot like the end of an era. Big Pharma's sales are expected to grow by a sluggish 2.2% annual average through 2010, according to Datamonitor PLC. Pfizer's top line over that period will actually decline, by an estimated 1.5% a year. While Pfizer has posted strong earnings growth during Chairman and Chief Executive Officer Henry A. "Hank" McKinnell Jr.'s four-year tenure, much of that has come from cost-cutting in the wake of big acquisitions. That has caused investors to flee the stock, which has dropped 45% since he became CEO. "The pharmaceutical industry is in the process of transformation," says longtime Pfizer board member Stanley O. Ikenberry. "We have to reexamine all the assumptions that pharmaceutical companies have made for as long as I can remember."
That's why Pfizer has quietly circulated a memo telling its employees to brace for a restructuring that analysts expect will slash billions from the company's cost base. That's not to say McKinnell, 62, has accepted the end of the blockbuster era. While he acknowledges that Pfizer is heading into rough times, he also argues that the company is primed for a resurgence. And he has become the public face of an industry that these days seems only one step above the tobacco business in public opinion. That's him on C-SPAN for an hour, trying to soothe callers irate over the high price of drugs. That's him calmly looking into the camera in TV ads as he explains how Pfizer's scientists are pushing for cures for the greatest of human scourges. He simply won't cotton to the notion that his company's go-go years are gone-gone.
Quite the opposite. McKinnell argues that there are a host of untreated diseases that represent huge potential markets. He says Pfizer's internal research is presenting more great opportunities than ever before -- indeed, the company is on track to file 20 new drug applications in the five-year period ending in 2006. And he boasts that a number of those are potential blockbusters.
Size, McKinnell believes, is especially advantageous as clinical trials become more complex and expensive. Who else but Pfizer, McKinnell asks, could afford to wager $2.1 billion on what he thinks is the next megablockbuster, a heart disease-fighting compound that goes by the chemical name torcetrapib? Pfizer is testing the drug in a combo pill with its current cholesterol fighter, Lipitor. And while this product is still three years away from the market, if tests show that it causes major reductions of plaque in arteries of the heart, McKinnell believes it could eventually surpass Lipitor's $11 billion in annual sales. "If it works, it will be the biggest blockbuster ever," says McKinnell. As for those who argue that the blockbuster model is a bust, he has sharp words: "People who advocate that don't understand our business."
Still, the signs are all around him. He has seen the Age of Viagra pass as rivals crowded into the erectile-dysfunction field; sales of that signature Pfizer product slid 11% last year, to $1.7 billion, far below initial projections. Nonetheless, Pfizer and its competitors keep anteing up more advertising dollars. Viagra is the leader, but the companies behind Cialis and Levitra are ceding nothing, making erectile-dysfunction drugs one of the most heavily advertised categories on TV. McKinnell is left scratching his head: "Normally a new entry creates new interest in the market. That doesn't seem to be happening here. We certainly have the Viagra team trying to figure that out."
That's not to say there won't be blockbuster drugs in the future. McKinnell is right that there are some huge opportunities, such as an anti-smoking drug his labs are working on. But by and large, the diseases that remain without satisfactory treatments either represent smaller markets or are so complex that they defy one-size-fits-all solutions. Pfizer has a number of exciting cancer drugs in development, for example. While those may be decent-size products, cancer therapies typically aren't multibillion-dollar products sold by your neighborhood general practitioner. And as medicine moves toward more personalized treatments linked to an individual's genetic makeup, marketing will need to become even more sophisticated. What all this means is that there will be fewer $1 billion-plus sellers that lend themselves to being marketed through the existing blockbuster sales machine that has sustained Big Pharma over the past decade.
This drying up of the pipeline exposes another challenge that drug companies face: They enjoy patent protection only for a limited time -- 10 years typically. After that they face an onslaught of cheap generic competition. Pfizer will see blockbuster drugs worth $14 billion in sales per year lose their patent protection in the next three years. Even with the drug applications McKinnell has in mind, most analysts agree that there's not enough in Pfizer's labs to keep the company growing in the face of those losses. And many of the drugs it's pursuing are the results of partnerships that will ultimately make them less profitable to the company.
The thing about the blockbuster model is that it gives you great leverage. But it cuts both ways. Each of Pfizer's sales reps costs close to $170,000 per year including car, computer, and benefits, estimates Credit Suisse First Boston (CSR) analyst Catherine J. Arnold. That figure doesn't change a lot if the company's sales are soaring or falling. So a big-selling drug can generate fantastic margins as sales ramp up. Pfizer generated an astonishing $45 billion in gross profits last year. That works out to $1.2 million per sales rep. Celebrex, with rich 90% gross margins, according to analysts, contributed some $3 billion of that.
But watch what happens if those blockbusters fizzle. If Celebrex gets yanked from the market, profits per sales rep immediately drop to $1.1 million -- a 7% decline in productivity. If several drugs fall dramatically, which will inevitably happen as patents run out, and if others fail to take off quickly, that massive sales force could quickly become a massive millstone. Even without the unexpected loss of one of the blockbusters, Pfizer's net income is expected to fall nearly 9% this year, to $14.7 billion, as generics begin to launch and big franchises such as the Cox-2 drugs take hits.
Clearly, McKinnell needs to do something. The Stanford University PhD in business, who blows off steam shooting his Sig Sauer handgun as a guest at the FBI firing range in Quantico, Va., will soon take aim at a major restructuring. According to the late-January memo obtained by BusinessWeek, McKinnell has ordered a top-to-bottom review intended to make the drug giant more flexible and less bureaucratic. But don't expect him to make big cuts in his sales machine. Sources say Pfizer's overhaul will entail having salespeople call on fewer doctors and talk about fewer products -- with the goals of cutting down on the repetitive pitches doctors get and making it easier to determine who's most productive. And the sales force will shrink, though largely through attrition and selective cuts. Employees have been told that decisions on cost reductions and the like will be announced to Wall Street around the April analyst meeting. Friedman, Billings, Ramsey & Co. (FBR)analyst David Moskowitz figures McKinnell may slash as much as $3 billion in expenses over the next several years.
Pfizer, though, may require more radical surgery. One smart move would be to inject the sort of bottom-up decision-making into Pfizer that has worked so well at companies such as Johnson & Johnson (JNJ). Decentralization might be a better match for a company that figures to have a more diverse portfolio of products requiring more targeted sales strategies. That would be a huge shift for famously top-down Pfizer. McKinnell says Pfizer has begun using a similar approach for product planning, linking managers from drug discovery through licensing, focused around specific disease categories, such as cardiovascular or metabolic disorders. He says that sort of structure eventually could be pushed across the entire company, in effect creating a series of smaller, more focused businesses. In the memo to employees, Karen L. Katen, president of global drugs, and Chief Financial Officer David L. Shedlarz wrote: "Many of you have expressed frustration with processes that are getting increasingly cumbersome, and with decision-making that seems to be slowing down. We share those frustrations."
Even bolder would be a diversification into other health-care businesses to reduce the reliance on pharmaceuticals. Pfizer was just such a beast not that long ago -- in the early '90s it sold everything from heart valves to perfume. Former Chairman and CEO William C. Steere Jr. divested most of those businesses to focus on the high-growth drug operation. That set the stage for Pfizer's hot run. These days, though, medical devices are a hot growth business. The problem is, if Pfizer bought a device business today, it would pay a stiff price, since many device makers have seen their shares bid up. Buying another big drug company would be tough, too, since it would make Pfizer's revenue base even larger, compounding the challenge it now faces in expanding that top line.
A more likely path is for McKinnell to go shopping for drugs to shore up Pfizer's portfolio. He certainly has the financial muscle -- Pfizer is expected to generate $10 billion in free cash flow in 2005 and may repatriate as much as $38 billion in overseas profits to take advantage of a one-time tax break. That's money McKinnell can put to work licensing drugs or buying up smaller companies.
One way or another, though, Pfizer has to address its dearth of new blockbusters. Like others in the industry, Pfizer has been plagued by declining productivity in its labs. According to SG Cowen Securities Corp. analyst Stephen M. Scala, Pfizer spent about $70 million on each product in its pipeline in 2004, up from $53 million just two years earlier. That is slightly higher than the $65 million average for the companies Scala follows. And a number of the most exciting products in the pipeline were either acquired or licensed -- a sign of the weakness in Pfizer's early-discovery operations. Its last blockbuster that was discovered in its own labs: Viagra, launched in 1998.
That's why investors are so skeptical that McKinnell can get Pfizer back to its teens-plus revenue growth of the 1990s. Says portfolio manager Edwin C. Ciskowski at money-management firm Broadview Advisors: "It's a mature company with modest growth prospects."
Even Pfizer's potential hits won't help as much as you would think. To understand why the company is essentially running in place, look at its huge gamble on torcetrapib. The compound, which is supposed to raise HDL, or "good" cholesterol, is being tested at a cost of $800 million, with Pfizer spending $1.3 billion more to acquire a biotech company that is developing another HDL-raising drug. No product is more critical to Pfizer, since it will take a big hit when Lipitor, which contributes 30% of current earnings, loses patent protection. But even if the new drug is a home run and trials show the combo reduces heart attacks and death, ultimately it is a replacement, not a driver of new growth.
The launch of the pill, expected in 2008, could become a lot more difficult if Pfizer loses a critical patent challenge. If Indian drugmaker Ranbaxy Laboratories Ltd. succeeds in knocking down both Lipitor patents -- which is seen as a long shot -- a generic Lipitor could hit in 2006. If Ranbaxy wins on one of them, which some observers expect, generics could arrive in March, 2010. Either way the loss would make it much tougher to get people to switch from a cheap generic Lipitor to a much more expensive combination of Lipitor and torcetrapib. Credit Suisse's Arnold figures if Pfizer loses on both challenges, the stock, now at $25, would be worth $18. McKinnell says he's confident Pfizer will win on both decisions.
Clearly, all this is hard for McKinnell to swallow. He is, after all, the architect of the bigger-is-better strategy. He played a key role in the acquisition of Warner-Lambert Co. in 2000 and led the Pharmacia Corp. purchase in 2003. McKinnell, widely known as a quick study, has no shortage of confidence in both Pfizer and his own abilities. In a recent interview, he explained how working with an executive coach helped him learn to stop jumping in with an answer before someone has finished talking. "My mind works pretty fast, and I tend to know your question before you ask it," McKinnell says matter-of-factly. He says he now listens to the full question, pauses, and then answers.
McKinnell's faith in the Pfizer way is well known. Anthony H. Wild, former president of Warner-Lambert's drug operation and now head of a small drugmaker called Medpointe Inc., recalls working with McKinnell on the integration of their companies in early 2000. During a dinner in a Paris restaurant, Wild says, McKinnell observed that as he toured and met with Pfizer and Warner managers, he became more convinced that Pfizer managers might be the best choice for key positions in the combined company. Wild says the Warner executives in attendance were stunned, taking the comment as an indication that they had no future with Pfizer. "I saw a few jaws dropping," Wild adds. McKinnell says he doesn't recall the incident. But in the end, most of the Warner managers left or were let go.
That blunt style is well known within Pfizer. Shortly after taking over as CEO in early 2001, McKinnell made clear his concerns about the R&D productivity problem in a meeting in San Juan with Pfizer's top 300 scientists, including R&D chief John L. LaMattina. Known inside Pfizer as the "Houston, we have a problem" speech, McKinnell used that line to make it clear that the labs weren't delivering as they should. He says he meant it as a wake-up call: "They were busy congratulating themselves on opening new buildings."
The group, which had already created a task force to see what it could learn from previous drug-development flops, responded with a system to ensure that when it came to compounds in development, they had a good balance between totally novel approaches and less risky ones. They also came up with a series of tests that might help identify duds earlier.
But that solves only part of the problem. Since many of the drugs that do succeed are apt to be smaller and more targeted, they will force a big shift in the way Pfizer sells those drugs. While the company does have salespeople selling to specialists today, that sales force is dominated by reps who pitch a lot of drugs to a wide swath of practitioners. In the future, Pfizer will need more in the way of small, highly trained SWAT teams to target doctors focused on a particular disease. That approach will undermine a lot of the economies of scale Pfizer has enjoyed in the past.
Wide Sales, More Risk
Even now, Pfizer's mass approach to the market is taking some major hits. For one thing, rivals have caught on. Pfizer was one of the most aggressive drugmakers in building up its army of reps in the 1990s. But with an explosion in numbers across the industry, it's getting harder for any one salesperson to get face time with physicians. The number of U.S. reps grew nearly 8% from 2002 to 2004, according to research firm Verispan LLC.
With so many sales reps on the prowl, doctors have been absolutely besieged -- and they're starting to push back. Dr. Edward L. Langston, a physician in Lafayette, Ind., says his practice had to institute a policy last year to restrict when salespeople could visit and where in the office they could talk to doctors. "We've had multiple times where we'd see three reps from Pfizer in one day," he says. Pfizer's Katen says she hasn't seen a drop in productivity. But Sanford C. Bernstein & Co. analyst Richard T. Evans says: "They are all committing death-by-salesperson."
As Pfizer evolves into a company with a bigger portfolio and a greater number of targeted or niche products, its massive marketing arm could weaken. In 2003, Pfizer shelled out $2.96 billion -- behind only General Motors (GM), Procter & Gamble (PG), and Time Warner (TWX), according to Advertising Age. But many of the new medical advances are in areas such as oncology, ophthalmology, or virology, where treatments vary from patient to patient and don't lend themselves to a cutesy 30-second sales pitch.
The dangers of mixing glib advertising and medicine are now more obvious than ever. Consider Pfizer's Celebrex and Merck's Vioxx, two next-generation painkillers. The much-ballyhooed benefit of the drugs when they were launched in the late '90s was that they were safer on the stomach. But according to a recent paper published in the Archives of Internal Medicine, more than half of the growth in the market for these Cox-2 drugs from 1999 to 2002 was sales to patients who were not at risk for stomach problems and who could have taken older, cheaper drugs safely. No doubt some of that sales growth was driven by the drugmakers' heavy promotion and advertising.
Now it's clear that broadening the market carries with it grave risks -- legal as well as medical. With Vioxx pulled from the market and Celebrex also showing evidence of a link to heart attacks, plaintiffs' lawyers are gunning for Merck and Pfizer. Merck's legal bill could approach $20 billion. Pfizer's liability is less clear. The Justice Dept. and a group of state attorneys general have requested information on the safety and marketing of Celebrex and Bextra. If the evidence suggests that Pfizer knew more about heart risks than the company has admitted, it could lead to hefty penalties. In fact some critics have argued that the company did not publicize an earlier study looking at the use of Celebrex in Alzheimer's disease that showed more cardiovascular problems in patients getting the drug than in those taking a placebo. Pfizer says the data were shared with the FDA and that the higher rates for Celebrex may have been the result of differences in cardiac health between the Celebrex group and the placebo group. Even McKinnell is critical of pharmaceutical ads. "Somehow we created an image that these products are totally safe," he says. "We need to communicate in the advertising that no drug is absolutely safe."
Overly aggressive marketing also has made drug companies easier targets politically. And that pressure will only grow -- particularly after the government starts paying for prescription drugs for seniors in 2006. McKinnell speaks passionately about trying to educate politicians on the cost-effectiveness of drugs. But it's a hard sell. The company invested nearly $20 million in a program in Florida that was intended to show that better utilization of drugs would actually save the state money. It did -- but not enough to deter lawmakers, who are demanding big Medicaid price cuts.
Big Pharma's blockbuster business model may be wobbly, but McKinnell remains defiant, insisting that he will find some way to snap Pfizer out of its malaise. "We are willing to run experiments. Things that don't work, we stop, and things that do work, we press on," he says. "And we are exceptional in execution." Maybe so, but this is one ailing patient whose condition defies a simple cure.
By Amy Barrett