Forecast 2007: At Sea

January 1, 2007

Pharmaceutical Executive

Volume 0, Issue 0

Pharma's next big challenge is simple: Rebuild its broken business model. But between expiring patents and dry pipelines, pricing wars and safety woes, a beleaguered FDA, a bloodthirsty OIG, and Dems on parade, many companies are just trying to steer clear of icebergs.

The new year started early for pharma—and with a bang. Hard on the Democratic win in the midterm elections came the industry leader's week from hell.

On November 30, Pfizer CEO Jeffrey Kindler enticed Wall Street to the company's sleek research labs for a pipeline preview-cum-sales pitch. A distinguished lineup of suits and lab coats talked up Pfizer's top-30 R&D programs, doing their best to persuade skeptical analysts that their "robust and diversified product pipeline" will control the bleeding when the company's $12.9 billion cash cow, Lipitor, goes off patent in 2011.

The all-day affair served as a calculated display of the fact that Pfizer was under new management. Former CEO Hank McKinnell had been widely viewed as pharma's Ahab, obsessively pursuing blockbusters and mega-mergers as his company's stock value tanked. Kindler, in the top job a mere four months, wanted Wall Street to see change.

Only two days earlier, he had made a stunning leadership debut, announcing that Pfizer would cut its storied 11,000-strong sales force by 20 percent. That single stroke demonstrated that Kindler could make not only the tough decisions but the right ones—and drew praise for restoring sanity to the mindless escalation of the "arms race."

As Kindler took the mike to introduce Pfizer's crown-jewel—torcetrapib, the breakthrough anti-cholesterol drug that promised to outsell Lipitor—he surely savored the moment. What a coup for a new CEO: to follow up a dramatic cost-cutting move with a flashy display of R&D. All confidence, he revealed that the company would be speeding up torcetrapib's ETA at the FDA to 2007. "This drug," Kindler said, "is one of the important developments in medicine in our generation."

And then, two days later, it wasn't.

The press played the abrupt reversal for all it was worth: "Pfizer's Bitter Pill" (BusinessWeek), "A Catastrophe for Pfizer" (Forbes), "When Big Pharma Gets Too Big" (Fortune). Although no one rushed to pen Pfizer's or Kindler's obituary—and some lauded the company for pulling torcetrapib the day it got word that the drug appeared to cause heart attacks—there was an unmistakable sense industrywide that something momentous had taken place. The writing was on the wall: The Blockbuster Model, R.I.P.

"Big pharma has been put on notice," says Arjun Bedi, a managing partner at Accenture who has watched the industry for 28 years. "It has only a small window of opportunity to make the changes necessary to get to a new model." Bedi sees 2007 as do-or-die, a year of serious soul-searching. "The companies will not only be doing battle with one another. Each one will be struggling with itself and its own capacity to change."

Call it pharma's perfect storm. "Growth is shifting from mature markets to emerging ones," says Murray Aitken, a senior vice president at IMS Health. "New product adoption is not keeping pace with the loss of patent protection. Specialty and niche products are playing a larger role. And regulators, payers, and consumers are more carefully weighing the risk–benefit factors of pharmaceuticals."

Each of these developments is, like a force of nature, largely beyond industry control. And combined, they are far greater than the sum of their parts. In weather like this, companies must figure out how to do much more with much less. "Either you have to downsize or you have to build the pipeline," says Andy Bender, the president of Polaris Management Partners. "Most have to do both."

And as Pfizer's case shows, the bigger you are, the harder the job. "For companies built on blockbusters, it takes a lot more success to sustain success," says Lehman Brothers vice chairman Frederick Frank, pointing out that while 94 percent of industry R&D investment originates from pharma, but when it comes to approved drugs, biotech is credited with nearly 70 percent.

Carolyn Buck Luce, a partner in the Global Accounts Group at Ernst & Young, conducted roundtables with pharma CEOs this fall and returned with this report: "Everyone felt that the promises that the industry stands behind—safety, ethics, transparency—have gotten stronger. But with so many sweeping changes shaping the new landscape for pharma, no one knows what the model is going to look like in five years that would deliver on those promises." (See "Connecting the Dots,", for more on what industry insiders think.)

OLD PATENTS, NEW DRUGS

Such dire warnings make it easy to forget that the drug industry remains the nation's fifth most profitable. But 2007 sales will continue to slow. According to IMS, both domestic and global sales grew at an underwhelming six to seven percent in 2006, and market expansion this year will slow to four to five percent here at home.

A bigger spurt is expected in the developing world, notably Brazil, Turkey, and India. And China, the proverbial sleeping giant, is waking up to pharmaceuticals at a rate of 15 to 16 percent. Although local generics still dominate, Buck Luce says, "the branded market potential in China is growing by 30 million people a year. That's [twice] the size of the entire market in France."

In the real France, however, as throughout Europe, price controls, sharper cost–benefit drug decisions, and a jump in generics have slowed growth to three to four percent. To those who say trends like price controls can't happen here, Frederick Frank laughs. "It's already happening," he says.

In recent years, hard times have been defined by loss of patents on blockbusters and few new products to fill the revenue gap. This year is no exception. Compounding Pfizer's woes will be the loss of its allergy med Zyrtec ($1.4 billion in annual sales) and its anti-hypertensive Norvasc ($4.7 billion), though Novartis will keep it company when its own anti-hypertensive, Lotrel ($1.3 billion), goes generic. Sanofi-Aventis will lose sleep over Ambien's patent pop ($1.8 billion), and Imitrex's unbranding will give Glaxo a mighty migraine ($1.1 billion). The only silver lining is that the year's $16 billion in patent losses will be a mere two-thirds of the 2006 hit.

New product launches will probably exceed last year's total of 30, but they won't churn out turbo profits any time soon. Still, this year's crop is rich in the fruits of targeted drug design, marking significant treatment advances that will burnish pharma's bona fides with patients. Merck's Januvia and Novartis' Galvus are the first in a new class of diabetes drugs. Tykerb marks a breakthrough for Glaxo in breast cancer. Wyeth's desvenlafaxine offers a new option in the antidepressant category. AstraZeneca's Symbicort will make a bid for the big asthma market.

And, of course, all eyes will be on Sanofi's weight-loss (and diabetes, and smoking, and who-knows-what-else) drug, Acomplia, as it fights to fulfill its "miracle pill" billing—though first it has to survive its long-delayed date with FDA.

GENERICS AT THE TIPPING POINT

The global war between generics and brands got bloody in 2004, when the number of prescriptions for generics outnumbered brands' for the first time. And in 2007, "Generics will come out in a big way—not just more products, but more companies and more influence," says Albert Wertheimer, director of Temple University's Health Services Resource Center.

With IMS projecting 13 to 14 percent growth in the generic market, established companies are kicking their operations into high gear. "Generics are poised to ship the day the patent expires," Wertheimer says. "The rate at which generics drive down the price of brands is growing exponentially." And new manufacturers are popping up like mushrooms.

Meantime, generic giants continue to bankroll platoons of lawyers to overturn blockbuster patents. Bristol-Myers Squibb's disastrous pay-for-delay deal with Apotex not only cost CEO Peter Dolan his job and the company its goldmine drug, but "may have a chilling effect" on future reverse-payment agreements, according to Gregory Glass, principal with consulting firm Gregory Glass Associates.

On another front, health plans are increasingly launching their own raid on brands. In an effort to control runaway costs, they're not only bargaining hard for formulary position, says Frederick Frank: "Third-party payers are pushing more and more subscribers to switch to generics"—for example, with timely "reminders" to consumers whose brands are going off patent that a cheaper alternative is available for a smaller copay.

"The most powerful force rebalancing growth in the worldwide market is pressure from public and private payers to limit their expenditures on drugs," says Murray Aitken. "Their influence is offsetting much of the growth that stems from rising demand and innovation. Manufacturers increasingly must strengthen the evidence that their therapies deliver 'value for the money' based on direct health outcomes."

To defend their brands, companies are shifting focus from the courtroom to the lab in hopes of squeezing every penny out of their prized molecules. Lifecycle management is emerging as a key R&D requirement. According to Datamonitor, 39 percent of new products from the 50 top manufacturers between 2002 and 2005 were reformulations. That trend will travel, the group says.

Experts expect to see a big jump in head-to-head studies, as companies vie to demonstrate that their own brand is best in class. But even the most carefully designed study can be a scientific crapshoot, so a safer strategy is to go head-to-head with generics by marketing brands as knockoffs. Novartis pioneered this approach, and Pfizer is test-driving it with Zoloft this year before buying it for Lipitor.

THE DEMOCRATS ARE COMING!

Based on the post-election headlines—and more than a few industry insiders—you'd think that House Speaker Nancy Pelosi (D-CA) were a larger-than-life harpy poised to unleash a swarm of legislative, regulatory, and investigative furies on the industry.

The truth is that even before the Democrats announced their "first 100 hours" agenda, the 2007 congressional calendar was a Pandora's Box of pharma legislation, most notably FDA reform, drug safety, and the Prescription Drug User Fee Act (PDUFA) reauthorization.

Following a huddle of industry execs in Washington, DC, a week after the Dems' sweep, PhRMA head Billy Tauzin gave a refreshingly sober assessment of the group's 2007 outlook: "We all recognize that we can't just say no to every new proposal or regulation anymore. If we want to start being seen as part of the solution—rather than the problem—we need to be proactive."

The Dems haven't ruled over both houses since 1994, and no one denies that the shift in power may be seismic. But while pharma saw its profits soar over the past 12 years, it also saw its reputation tank. The pro-business Republicans didn't exactly serve pharma's best interests by encouraging its worst instincts. Whether pharma ends up playing rope-a-dope to a Beltway slapdown this year will likely depend as much on the industry's own actions as on campaign politics.

The hottest-button issue is pricing. Industry leaders like Tauzin can be expected to fly the banner of "consumer freedom of choice," but that may be a mistake, according to Lehman's Frederick Frank. "With the Democrats taking aim at drug prices, pharma is finally going to have to explain itself," says Frank."Pharma complains a lot about how it is held to a higher standard than other industries. Well, it should be held to a higher standard because what it produces is unique"—uniquely beneficial and uniquely dangerous. Instead of whining about it, he says, "pharma should make the case that being held to a higher standard is precisely why it deserves higher profits."

Frank also advocates talking up the fact that drug costs, while making up only 10 percent of total healthcare spending, are the most cost-effective part of the system. By contrast, a 2006 Harris Poll found that six in 10 Americans believe that the cost of prescription drugs is somewhere between 40 and 80 percent of total healthcare spending. That represents an education gap just begging to be filled.

Jane Sarasohn-Kahn, head of the Think Health consultancy, adds that the sooner pharma gets out in front of its current pricing issue, the sooner it can start laying the groundwork for dealing with is next pricing problem. "Industry needs to get the message out that we have hit the end of innovation based on the old model," she says. "The new model of personalized medicine will mean smaller markets—and higher prices—for specialty drugs. Pharma will have to work even harder to prove the value of these innovations to health plans and patients."

DOUGHNUT HOLES AND DO-SOMETHING POLS

Central to the pricing debate, of course, will be Medicare Part D. Part D has received high grades from the 22.5 million seniors who enrolled in the first year. Fewer than one in five seniors landed in the doughnut hole—a stat that may help account for the plan's 80 percent satisfaction rate. That may persuade Pelosi and other Dems who campaigned on Medicare reform to back off: Why fix what ain't broke?

But the number of plans has risen by a third to 1,850 nationwide, and with a growing number cutting their product menu, many seniors are shopping around again. Consumer unrest may give traction to Medicare reform and even drug importation.

A bipartisan Senate bill repealing Medicare's ban on direct government price negotiation with pharma companies is ready for prime time as soon as the new session convenes. And though leading Dems agree that price deals won't fill the doughnut hole, the party may risk messing with success to score a scalp from pharma for the 2008 campaign.

Still, Part D wasn't going to be a bed of roses for pharma this year, reform or not. "In 2007 we're going to see Part D in its true colors—the good, the bad and the ugly," says Mason Tenaglia, managing director of the Amundsen Group. "And the good—induced demand—is pretty much over. The bad—increased price pressure—is getting worse. And the ugly—the fact that interpreting performance in Part D is nearly impossible—you don't even want to go there."

The windfall pharma got last year from the initial uptake of enrollments was a one-off. What's ahead are the consequences of the doughnut hole and, more important, of the shift from defined benefits to defined contributions, placing the burden of healthcare costs squarely on the consumer. And because of the system's built-in price transparencies, public and private payers, wholesalers, and consumers will be demanding better deals, even as they move to cheaper generics.

"Now that the government has said it will subsidize the first $2,500 prescription spend, employers will follow suit," Tenaglia says, pointing to Ford's recent announcement that it would deep-six its health coverage for Medicare-eligible white-collar retirees in favor of a flat $1,800 toward their Part D premiums. More and more of pharma's most attractive customers will find themselves paying out-of-pocket for brand drugs or going generic. "No one saw this coming," Tenaglia says. "It was touted as a great new entitlement. But it may have ended a fundamental obligation that the government organizations and employers have traditionally had to people"—and put the big squeeze on pharma.

Medicare will also be great for grandstanders. The elevated level of argument will likely include, from the left, Rep. Pete Stark (D-CA), chair of the House subcommittee on Medicare: "In the current program, there are no protections for beneficiaries that aren't exceeded 10 times over by benefits to the pharmaceutical industry." And from the right, Sen. Charles Grassley (R-IA), in other contexts, Pharma Enemy No. 1: "I don't think seniors want the government in their medicine cabinets." TiVo the bloviators.

SAFETY, PDUFA, AND FDA

Ernst & Young's Buck Luce predicts that congressional debates on drug safety will monopolize the September PDUFA reauthorization. "It's possible that PDUFA will become the 'Drug Safety Act,'" she says. "Since it's a must-pass, there's the potential for overregulation, with the outcome going way beyond the initial intent of the renewal."

"All sorts of regulations aimed at the industry will be attached," says Jack Angel, executive director of the Coalition for Healthcare Communication Foundation, "from manipulating DTC ads to permitting drug imports to ending tax deductions."

Longtime Democratic critics of FDA–industry coziness, including Sen. Edward Kennedy (D-MA), Rep. Jon Dingell (D-MI), and Rep. Henry Waxman (D-CA), will head key oversight committees, stepping up efforts to create "a 21st-century FDA." Two bipartisan bills—dubbed Kennedy-Enzi and Dodd-Grassley—are vying to lead this sweeping reform.

"The only bill that counts is Kennedy-Enzi," says Peter Pitts, director of the Center for Medicines in the Public Interest, "because it at least begins to understand that you can't separate safety and risk." Dodd-Grassley, which proposes a separate office of drug safety inside FDA is, Pitts says, "dead in the water."

Although it's more sensitive toward the safety–risk calculus at the heart of the pharmaceutical enterprise, Kennedy-Enzi will give FDA the clout to make pharma finally fulfill its commitment to post-approval surveillance. Congressional debates over whether to mandate the most controversial of the Institute of Medicine's recent high-profile recommendation—the use of a black-triangle icon on prescription labels for two years after drug approval—promise at least to offer comic relief.

The true innovations and regulations necessary to create a 21st-century FDA have little to do, of course, with scary symbols on product packaging. IOM proposes a "lifecycle approach" to "evaluate risks in the context of benefits" for all marketed meds, correcting what it views as the system's favoring of speed over safety and tight pre-approval studies over lax Phase IV surveillance. FDA's Critical Path Initiative goes even further, blue-printing personalized medicine via technological and structural reforms for cheaper clinical trials and faster drug approval in targeted populations followed by expanded approval based on post-market monitoring.

The December confirmation of Andrew von Eschenbach as FDA commissioner provides much-needed leadership. Whatever his failings—buckling to pressure on Plan B, for example, or "stonewalling" (as Grassley put it) in congressional investigations—the former National Cancer Institute chief and three-time cancer survivor is known as a strong agency advocate. "He is focused on 'smart safety'—rather than unwanted additional 'authority'—and on innovations like Critical Path," says Peter Pitts, a former associate FDA commissioner under Mark McClellan. "He will also lobby Congress for more funding to hire more staff to stop drug approvals from languishing."

And with many senior FDA staff nearing retirement, Pitts says, the agency will be looking to invest in long-overdue information technology to attract quality employees dedicated to a 21st-century FDA.

DEATH BY A THOUSAND STATE REGS

Industry execs may be having Nancy Pelosi nightmares, but state legislators are likely to be the ones making their days miserable.

More and more states and counties will be playing follow the money with drug companies, requiring them to account for their promotional spending, especially to doctors. Regulators will be sniffing around consulting fees and CME, and parsing off-label prescribing and clinical trials for signs of payola. Meanwhile, the federal Deficit Reduction Act will offer financial incentives to states to pursue false-claims actions via state-level whistleblower laws.

Although pharma has been cleaning up its act, Polaris' Andy Bender warns that Schering-Plough's $435 million guilty plea for Medicare fraud last year may not be the last big black eye. "The industry environment has become a lot stricter since the late '90s," he says, "but with the lag effect, we still haven't seen a peak in cases."

Compliance with dozens of different, often contradictory, state standards will take a bigger bite out of every company's bottom line. "It's death by a thousand cuts," says Buck Luce. "The challenge is for each company to maximize both its compliance and its innovation"—despite the fact that the two goals pull in opposite directions.

But Bender sees an upside in all the red tape. "With pharma finally recognizing that it needs to control its marketing costs, it will be looking for ways to measure performance and productivity," he says. "The information required for compliance can also be used to answer many of these questions." This means knowing, for example, not just how many annual medical meetings your company bankrolls, but also how many more prescriptions for your drugs these freshly baked docs are writing.

Yet it's precisely this information that states will be angling to deny pharma. Following New Hampshire's lead, a growing number of states will vote on legislation preventing the industry from purchasing prescriber data. "This is going to be a bear to fight nationwide," says Jack Angel. Although the New Hampshire law's constitutionality is being challenged in court, that hasn't stopped congressmen Peter Stark and Frank Pallone (D-NJ) from pushing a similar bill in the House.

DOWNSIZING, UPLOADING, OUTSOURCING

Pharma's merger spree of the last decade has yielded to more measured acquisitiveness. Now, in addition to running marathons to develop first-in-class blockbusters, big pharmas, long on cash but short on pipeline, are increasingly racing to snatch up high-on-innovation-but-low-on-investment biotechs. With a global forest of 5,000 biotechs, the trick is tapping the right tree.

Last year the large firms ponied up some $17 billion for more than 250 biotech deals, up from 150 in 2003, according to life sciences merchant bank Burrill & Co. Oncology and infectious diseases are likely to get even hotter. While most mini-mergers are still made at the discovery phase, drugmakers are increasingly reducing risk by delaying the deal until more data are available.

With the necessity of cutting billions from budgets next year, big pharmas are finally grasping the fundamental principle that "you are in business not to own assets but to use assets," says Bill Trombetta, a professor of pharmaceutical marketing at St. Joseph's University. He sees a growing trend to outsource more and more—whether manufacturing in Ireland or Singapore, conducting clinical trails in South Asia or Eastern Europe, or even moving R&D to India or China.

Peter Young, president of Young & Partners, agrees—up to a point. "There will be more outsourcing but not to the extent that it was predicted. No drug company will be crazy enough to move its important R&D out of house."

But such old-school notions may obscure the path to new business models, according to Accenture's Arjun Bedi. Now that the fat times are gone, even—especially?—the big pharmas are forced to "focus on their core competencies and do as many other functions as feasible out of house," he says. That may mean skewering some sacred cows. "R&D practice has traditionally been viewed as an art form, but the truth is, 80 percent can be systematized—and outsourced—leaving that 20 percent that is creative genius at home to run wild," Bedi says.

WORKS IN PROGRESS

This year, innovation begins at the end of a knife, whether stabbing sacred cows or slashing sales forces. The sad sight of thousands of bright young things getting their pink slips will be a constant as drug companies follow Pfizer's lead in cutting their sales forces. Nor will R&D be spared the blade. Of course, with some 100,000 US reps and only 300,000 docs to call on, the situation had long ago taken on a certain "Stop the Madness!" aspect.

"If we yelled, 'Freeze!' on a Tuesday morning, there would be a rep in every office waiting room and a couple outside a group practice," Mason Tenaglia says. "Every CEO knows something has to give but no one wants to unilaterally disarm. With the Pfizer announcement, this might have finally changed. But they still have no idea how much bang they're getting for their buck."

He expects 2007 to be a year of reckoning—and the beginning of the end of the one-size-fits-all national sales force. Companies will have to do some fancy formulary footwork, getting up to speed on which of their brands are in which plans and which states, in order to deploy downsized sales forces in more flexible, efficient ways.

Jerome Kassirer, MD, a professor at Tufts University School of Medicine and the former editor of The New England Journal of Medicine, sees "a trend toward using doctors to promote drugs—in the development of education materials, in medical meetings, and doctor lectures. And with doctors' incomes suffering, pharma will find a willing group of potential employees."

Many small but significant changes are also in the works, from marketing to information technology to study designs. Pharma is showing an uncharacteristically bold penchant for experimenting with both new media and new messages, according to Jane Sarasohn-Kahn. "There's finally a move toward the Internet—not just as an advertising channel but direct-to-patient education and interactive marketing," she says, pointing to a Vodaphone instant-message program that proved very successful in helping diabetic teens improve their med compliance.

Offering consumers support, information, and even incentives for daily med adherence for chronic conditions seems a no-brainer—and a valuable way to deepen brand loyalty in the age of generics.

And however adversarial their current arrangements, health plans, doctors, and companies will increasingly find common cause in developing and testing drugs. The info that plans have about patient genotypes, for instance, can help pharma preselect patients for targeted treatments of the Critical Path type. And speaking of obsolete models, Peter Pitts says that the double-blind, placebo-controlled (and slow, and expensive, and...) clinical trial is on its last legs. "As gene testing becomes routine in the next decade, we will be able to define what is the right drug for the right patient at the right time."

A QUESTION OF LEADERSHIP

In times of crisis, it's harder than ever to take the long view. The healing arts may be as old as humankind, but the business of pharma is still in its infancy. "The bottom line is, the drug industry hasn't even scratched the surface of what chemicals can do to help people," says Albert Wertheimer. "We still only control infections and take care of symptoms. But over the next generation, we'll see the discovery of more and more small molecules and synthetic chemicals that actually cure diseases." High hopes for the future are in order.

Less certain is whether the great drug firms that tower over the industry today will pave the way to these awesome advances. The failure of character and competence at the top of corporate America in recent years has not been entirely absent from pharma. Merck, BMS, and Pfizer have all been damaged by CEOs who departed under a cloud. Given the immense challenges the industry faces, it would be less than shocking to see more heads roll in 2007.

For years, with Wall Street breathing down their necks, CEOs tended to make decisions based on the next quarter's growth. More than a few mergers and acquisitions were short-term tactical solutions that may have been at odds with a company's long-term goals.

"Pharma was punished—harshly—by Wall Street for all the negative news about safety and pricing," says Peter Young. "But the stock market will be treating the industry better now that the industry is behaving better." That may give CEOs like Pfizer's Jeffrey Kindler the boost he needs to get his R&D house in order.

But there may be a deeper problem. "The real question for pharma is, How are you going to grow? Not, How are you going to make money?" Bill Trombetta says. "As companies are forced to come up with more and more winning drugs with fewer resources and a tougher market, they have to focus on where their true internal growth is."

Focusing on the internal growth of an operating model that is no longer self-sustaining takes more than an annual series of new acquisitions, no matter how smart. "Big companies have to be able to embrace change, and change can be painful," Arjun Bedi says. "It's not a question of which strategies will work—people understand that. It's getting that into the hearts and minds of everyone in the company. And that takes a bold, courageous leader."

Trombetta agrees. "A generation of scientists and MBAs is what got pharma here, so maybe it's time for an outsider," he says. "Someone who is going to stop noodling around with the blockbuster model and start breaking the rules."