Pharm Exec's 11th Annual Industry Audit

Aug 31, 2012

Success for today's biopharma enterprise requires continuous education around a lesson plan guided by a simple choice: Grow your core, or die in place. Putting it more bluntly: sink or swim. The standard business model of frequent product introductions propelled by huge investments in promotion to plump up prescription volume is no longer delivering the rich returns expected by management and shareholders. Quite simply, the industry must adjust to a new era of lower margins. That makes strong organic growth—fueled by internal drivers like superior administration and a focused strategy to be recognized as a full partner in healthcare—more important than ever in maintaining a place at the top of the league charts. It's the signal message in our 11th annual Industry Audit of the highs and lows of performance among 24 of the largest publicly traded companies prepared by Professor Bill Trombetta of the St. Joseph University Haub School of Business.


Audit Data Sources & Key
The objective of the Industry Audit is to furnish a snapshot of how well companies are doing in advancing shareholder value. This measure is open to interpretation, particularly because there is no other standard accepted reference point we can cite that looks at performance from this perspective. Our approach is idiosyncratic, but it does reveal the importance of metrics that often escape the attention of the major investor rating institutions. One example is the return on assets against profits, which allow for the valuation of intangibles like patent holdings. Shareholder value is also a good indicator of long-term success because of its association with stability: when the investment community is happy, there is less pressure for changes in the c suite and management has some leverage to place riskier bets on investments that may play out only over time.

A historical attribute of the industry—revenue growth rates high enough to paper over a multitude of sins, such as tolerance for bloated sales and administrative expenses—has faded in the face of the patent cliff. Since 2007, the last year of the good times cycle for Big Pharma, growth across the industry has slowed. Although the R&D productivity lag and genericization of major brands are a factor, structural changes in the way companies must do business are arguably more important as drivers of lower growth. Chief among these changes is a radical transformation in the customer base, led by a vastly more heterogenous community of stakeholders and the dominance of payers over clinicians in determining treatment options for patients. The reality is that accelerating growth today requires a different mindset, with strategies geared to smaller, more differentiated revenue targets often requiring up-front commitments that impose high short term costs that eat into margins.

Many high performing companies are pursuing that model, which is reflected in our survey group. Even in the midst of poor economic conditions, the 24 were still able to outperform the drugs sector as a whole on sales growth, posting an average 7.3 percent compared to a global expansion of 3 to 4 percent. Yet pressures on pricing are evident too, with a group-wide drop of 1.4 percent on gross margins as the "proof of value" trend spreads to oncologics and other specialty segments.

Given the trend, what this year's survey shows is the importance of efficient cost management. Reducing overhead through the productive deployment of assets, capital, and resources is crucial to ensuring that lower growth does not corrode competitive advantage—where the winner is the company able to squeeze more and sweeter lemonade, from fewer lemons.

Methodology: eight benchmarks


Annual Sales
The survey relies on 2011 data to compare performance against 2010. As in years past, we use eight metrics to assess performance: sales growth; enterprise value growth; enterprise value to sales; gross margins; earnings before interest, taxes, depreciation, and amortization [EBITDA] to sales (an indicator of profit margin); sales to assets (or asset turnover); EBITDA to assets (a measure of the profitability of individual assets); and sales to employees (a ratio to assess productivity). Each metric is weighted, with the highest score of three given to enterprise value growth; enterprise value to sales; and EBITDA (profit) to assets. All the others are scored at two. The higher a firm places on the list, the higher its score relative to the 23 other companies. A company with the highest ranking on any metric would be ranked at 24, while a company performing at the lowest level would come in at one. Weights attach accordingly, so if a company came in at 21 on a metric with a rate of two, then its total points on that metric would be 42, for a standing of fifth best out of the 24 companies—this is in contrast to the scoring for golf, where a low score reflects high performance. If a company comes in next to last on a metric with a weight of two, then its place in the rankings would be second, with total points of two times two equaling four points, on that metric.

From a macro perspective, the best way to evaluate the results is in comparison to trends in the economy overall. Generally speaking, a company should perform at least as well as the real growth rate in GDP and in range of the performance of other healthcare sectors. US GDP expanded by 1.7 percent in 2011, while the CPI rate averaged about 2 percent. Economic growth outside the United States clocked in at slightly more than 3 percent. Other relevant macro metrics are the Dow Jones Industrial Average, which grew 5.5 percent in 2011; NASDAQ, which contracted by minus 1.8 percent; and the Standard & Poor healthcare index, which shows comparisons against other health providers and ran up 10.2 percent. Together, these parameters are the minimum hurdle for companies to be perceived as successful enterprises. In that regard, 14 of the 24 outperformed the S&P benchmark, a ratio roughly the same as last year, where 11 of the 23 companies profiled did better. On average, the group posted a gain of roughly 12 percent, or nearly six times US GDP growth.