Gilding Lilly

November 1, 2008
Pharmaceutical Executive

Volume 0, Issue 0

Some say it's just another pharma facing its patent cliff. But others say this company's got it worse. With new CEO John Lechleiter in charge, can Lilly find its way back from the edge?

Pharma mergers are important—but they aren't often sexy. Sure, back in 1998 there was the riveting tale of SmithKline Beacham abandoning American Home Products (now Wyeth) at the altar for a merger with Glaxo Wellcome—only to have the mega-deal collapse. But that was a decade ago. More recently, Roche's courtship of Genentech has had a bit of heavy-fisted drama, but for real soap opera appeal, nothing in the recent past compares with ImClone. There's the New York biotech's sordid past—with jail time for Martha Stewart and then-CEO Sam Waksal—the ongoing relationship between ImClone and its marketing partner Bristol-Myers Squibb, the BMS offer, chairman Carl Icahn's withering rejection, and at the last moment, a brief but intense interest from a mystery bidder ... finally revealed as Eli Lilly.»

It's not the kind of thing we've come to expect from Lilly. But as one of the first actions of a new CEO with new ideas, it has observers reading the tea leaves to figure out what the merger—style and all—portends for the 132-year-old pharma.

Fat and Profitable

For the last decade, Lilly was governed by CEO and chairman Sidney Taurel, a 37-year Lilly veteran who came out of the international marketing unit. A Spaniard born in Morocco and schooled in France, Taurel had a distinctive, formal style that his years living in the Midwest did little to soften. Some called him bureaucratic; others complained that he just didn't mix in with employees. Nonetheless, on Taurel's watch Lilly grew fat and profitable. There were dark times, of course—none darker than the earlier-than-expected loss of Prozac revenues to generics. But Taurel pumped money into R&D and launched nine new drugs, including the megabrands that account for a significant share of Lilly's current annual sales of more than $18 billion. When Taurel tapped his COO, John Lechleiter, as CEO in March, he passed along a company with stellar, double-digit growth.

Behind that growth lies a problem, though: Lilly is fighting for its life. "Eli Lilly's patent expiration profile starting in 2011 is probably the worst in the entire pharmaceutical industry," explains Seamus Fernandez, an analyst at Leerink Swann. By the time Lechleiter took the reins, Lilly hadn't launched a new drug in three years, and seemed at risk of stalling out from the lack of innovation. Without new products to replace Zyprexa, Cymbalta, Cialis, and others, Lilly's revenue could drop by 60 percent by 2014. (By comparison, in the dark post-Prozac days of 2001, sales dipped only 7 percent.)

And that's the best-case scenario. Also on the horizon: continuing sales declines of Byetta due to side effects and a possible thumbs down from FDA of its long-acting form, the threat of biosimilars (which would affect Lilly's biotech-heavy portfolio), patent challenges surrounding cancer drug Gemzar, and a potential $1 billion liability settlement over Zyprexa.

So it's no surprise that Lechleiter has been moving quickly in his new position. Since taking the top spot, Lechleiter has:

» Initiated the purchase of ImClone, Lilly's largest acquisition ever

» Orchestrated the most advanced outsourcing deal in the pharmaceutical industry to reshape the R&D model and drive down costs

» Implemented a new management structure to streamline the organization and improve accountability.

Admittedly, these are not innovative moves. Like other companies, Lilly is looking to a familiar litany of strategies: diversifying into biotech, outsourcing to create a leaner, more nimble organizational structure, and buying any good drug that the company can get its hands on. "It's clear enough what we need to do—there's no magic or tricks to this," says Lechleiter. "The question is which company is going to effectively do it?"

But there's more to Lechleiter's approach than business discipline, reorganization, or even science. In his early months on the job, he's come across as a man self-consciously fashioning himself into a leader, not just for his own company but for an industry that, for many reasons, has gone astray.

His watchword—and it's not always a popular one in the industry—is transparency. "He's been interviewed more by CNBC in the past year than Taurel was in his whole tenure," says Clifford Kalb, who heads the consultancy C. Kalb and Associates. "He wants to make Lilly a higher profile company."

Certainly, Lechleiter has built a type of momentum, with news, and some potentially sensitive data, flowing out of Lilly at an unprecedented pace. At a time when Lilly has to make all the right moves to survive its looming "patent cliff," it has yet to be seen whether Lechleiter is a surgeon reconstructing Lilly—or a pathologist, detailing its ills, but too late to cure them.

Change Maker

John Lechleiter has the manner of a man from the middle of America: friendly, plain-spoken, salt-of-the-earth. Born into a Catholic family back in the 50s, when the "Catholic" in "Catholic family" meant big, he was the oldest of nine children and shared the attic with his four brothers at their modest house in Louisville. As far back as he can remember, Lechleiter wanted to be a scientist. In college, during a summer internship at the University of Minnesota, he fell in love with organic chemistry, which he went on to study at Harvard. From graduate school, John joined Lilly in 1979 as a senior organic chemist in process research and development—and has worked for Lilly ever since.

Though trained as a scientist, Lechleiter says his most formative experiences at Lilly came when he was put at the intersection of people and structures. For example, in 1991, as head of product development, he was charged with undoing the bottleneck of molecules coming out of research. He found that by organizing scientists to work together in new ways, he could dramatically speed the flow of projects.

"I saw I could make a difference at an organizational level and have that kind of an impact, change something for the better, move people from one point of view to another," says Lechleiter. "Good leaders can show a group of people that there's something they can accomplish that they never thought they could."

The experience came in handy in 1998, when as senior vice president of pharmaceutical products, he and his team re-engineered the hand-off between development and manufacturing, which had grown so dysfunctional that development occasionally planned drugs that were impossible to make.

The older and more established the organization—or leader of that organization, for that matter—the more difficult it is to change. And with Lechleiter's background, you'd expect him to be a pretty traditional guy—bound to the industry's past and ultimately conservative in approach, not the guy you'd pick to shake things up. But that's not what you hear from those who know him.

"He is a very rare mix of scientist-leader," says Jim Hall, director at the consulting firm Oliver Wyman. "You don't see that very often, someone who has come up through the organization and who is willing to flip it upside down. Fred Hassan did that at Schering-Plough, but he came from the outside and didn't have any connections. John has a much more difficult challenge and he's willing to take it on."

Looking for Lifeboats

Lilly needs drugs, and Lechleiter is trying to get them, fast. The quick fix—he hopes—is ImClone. The deal gives Lilly rights to 29 percent of the sales of Erbitux, a blockbuster drug with more good years ahead of it. But even more important, Lilly gains ImClone's broad oncology pipeline, including Erbitux successor IMC-11F8; the anti-angiogenesis drug IMC-1121B for breast, skin, kidney, and liver cancer; and the human monoclonal antibody IMC-A12 for solid tumors. All are in Phase III or could be by next year, which should make them ripe for harvest during Lilly's most vulnerable time.

Get Ready for the Roller Coaster

Judging by the way Lilly's stock plunged on news of the acquisition, investors feel it is too risky. Cancer drugs are coming under significantly more pricing pressure, which means that even if the drugs are approved, their commercial success is uncertain. And there's some question as to whether BMS has a claim to US marketing rights for IMC-11F8, one of ImClone's crown jewels. But for all the wear and tear on the company, ImClone has a viable upside. Besides, in a world of less-than-perfect deals, Lilly needed to do something. (See "Lilly's Patent Cliff".)

"Lilly probably saw themselves falling into a similar situation as Pfizer," says Michael Latwis, an analyst with Decision Resources "They have this huge patent cliff and they are doing a lot of deals, but it is all too early stage to make a difference. With ImClone, they were trying to get late-stage products, and they saw an opportunity."

Investors wanted the company to snag a sure-fire molecule that could bring in revenue quickly—the way Lilly did when it partnered on MBP8298, BioMS Medical's lead multiple sclerosis drug. "But perhaps the whole pursuit of ImClone is just a commentary on what's available," says Latwis. "You can only get what's out there, and there's a lot of competition."

Lilly says it has the flexibility to finance the deal with a mixture of cash and debt—but if the $1 billion federal settlement over Zyprexa goes through, it would surely compromise cash flow for future deals.

And by the looks of the pipeline, that might be a problem. After all, analysts have been ratcheting down expectations of Lilly's lead candidate, the anti-clotting drug prasugrel. Although it was granted priority review, there have been several rounds of delay, and it now seems FDA will decide prasugrel's fate no earlier than March 2009. Early hopes for the drug were sky-high; Moody said it accounted for 40 percent of the value of Lilly's pipeline, while analysts saw it as a solution to the loss of Zyprexa. The results of a 13,000-patient study were convincing: In a head-to-head trial with Plavix (clopidogrel), prasugrel reduced the chance of cardiovascular death, heart attack, and stroke by 20 percent .

But it also significantly increased the risk of bleeding, and more cancer was discovered in the prasugrel than in the Plavix study arm. Lilly maintains that it understands which patients would receive benefits from the drug that would outweigh the risks, but if prasugrel is approved at all, it's likely to come with a battery of FDA-imposed risk management programs. As a result, most analysts see it as a niche drug, targeted at about 15 percent of Plavix patients—perhaps even fewer when Plavix goes generic.

Add that to the pipeline setbacks Lilly has encountered in recent years (inhaled insulin, anyone?), and the company's late-stage pipeline comes up short. That means the Lilly is in for a roller coaster ride. Through 2010, the revenue will continue to rise, fueled by the present product mix. But without a robust Phase III pipeline to sustain that revenue, the company will see a Zyprexa-sized drop in sales by 2014. (See "Lilly's Roller Coaster Ride," page 80.) But the early to mid-stage pipeline is more promising: The company says it has 44 drugs in development; by the end of 2011, it expects six new product launches and at least 10 new molecules in Phase III.

This scenario hinges on speeding drug development. Like many senior execs, Lechleiter thinks it's time for pharma to create a new model for R&D. And in sports-crazed Indianapolis, maybe he can be forgiven for couching his ideas in football terms.

Remaking R&D

"We have a football coach here, Tony Dungy, who knows what it takes to win games," says Lechleiter. "You don't need trick plays. You don't need to go outside your core of expertise. If you do the fundamentals, you win games. It's the same philosophy I'm preaching at Lilly."

By "fundamentals," Lechleiter means several things, prominent among them is cost control. Continuing with the football talk, Lechleiter describes the Colts' new stadium. With a retractable roof and room for 70,000 fans, it cost almost $800 million to build—about the price of two Phase III studies. And perhaps here is where Lechleiter's approach differs from that of his favorite football team: When he looks at the stadium, he sees a huge, inflexible, fixed-cost asset —the kind of asset he's no longer willing to pay for.

The concept, as Lechleiter sees it, is simple: Use outsourcing to move non-core fixed assets to flexible resources, saving money and time, and working with partners to help speed innovative drugs to market. Lechleiter calls this model the "fully integrated pharmaceutical network"—akin to the "fully integrated pharmaceutical company."

Certainly, the whole industry has been paying lip service to cost-cutting—but Lechleiter has taken Lilly the furthest, says Michael Latwis. Worldwide, Lilly has shed more than 5,500 jobs since 2004, and the company plans to shift up to half the cost of its R&D to outside partners by 2010. Lechleiter says Lilly will continue to get smaller as it outsources more functions to third parties.

Most recently, Lilly created an unprecedented partnership with Covance to help transform Lilly's R&D model. The 10-year, $1.6 billion commitment will shift early drug development duties to Covance. In return, the provider picks up some underutilized infrastructure from Lilly: namely, its 450-acre Greenfield, IN, drug development campus.

"The transaction is the broadest and largest in pharma R&D outsourcing history," says Joe Herring, Covance CEO.

But outsourcing and cutting jobs is easier said than done, particularly for a company like Lilly, which was run by the family of founder Colonel Eli Lilly for three generations, and has long maintained a paternalistic attitude toward its employees. Even during the Great Depression, the company refused to let employees go, and, as the only Big Pharma aside from Merck that hasn't been involved in a large merger, it hasn't had to contend with M&A-related layoffs.

But those days are apparently gone. Outside of R&D, Lilly has outsourced at least 40 percent of its IT; 20 percent of manufacturing, including plant closings in Hamburg and Brussels; shifted nearly 20 percent of its US sales force to contract sales organizations (and hired its first group of fixed duration employees); and outsourced the bulk of employee services such as cafeteria workers, janitors, and security guards.

"This is not a one-off to the business model," says Ron Wooten, president of NovaQuest, the managed partnership division of Quintiles, which has worked closely with Lilly. "It's clearly the way that John wants to do business."

But will outsourcing get Lechleiter where he wants to go?

"They're one of the companies that's been better at reducing head count," says Leerink Swann's Fernandez. "But they have crept up in SG&A spending, which takes out the leverage people thought they had in the model."

Others are more optimistic, noting that Lilly has done the hard part—reducing infrastructure and off-loading risk to partners, a skill refined through its legendary alliance management capabilities. Take, for example, the recent three-way deal with NovaQuest and its partner, the private equity group TPG-Axon Capital, for the Phase III development of two Alzheimer's drugs (a gamma-secretase inhibitor and an A-beta antibody). In this innovative model, TPG-Axon Capital and NovaQuest kick in funding and services to receive milestones and royalties based on the molecules' success.

"On behalf of our shareholders, we're hedging our bets in a very risky disease area," says Lechleiter. "We have no real proof of concept other than biomarkers for these two drugs because of the difficulty of getting an efficacy signal in the smaller Phase II studies."

The company has also created risk-sharing agreements with Jubilant Organosys, Suven, and Nicholas Piramal, which gives it access to Indian markets and talent, early-stage research capabilities, and presumably some generic capability, says Les Fundleyter, healthcare strategist at Miller Tabak.

In all these deals the mantra of moving from fixed to flexible remains the guiding philosophy. "Most interactions are not shifting work for lower cost," says Lechleiter. "We're taking advantage of the intellectual capital in China and India without putting up Lilly brick-and-mortar institutions. You can expect to see a Lilly that is more willing to move into new areas if the opportunity is there."

Taking a Stand

After stepping up as CEO, Lechleiter invited all his employees to an open house in Lilly's plush executive suites. As it turns out, it was a last look of sorts. He soon tore them down and remodeled the space to make them less austere, more inviting—but not so comfortable that the people in charge stayed there.

Lechleiter, according to people who know him, is happiest rolling up his sleeves and walking the factory floors or visiting labs. When shown plans for a big capital project, he wants to put on a hard hat and inspect the site. He challenges employees to e-mail him their questions about Lilly or the pharmaceutical industry, and then answers them in regular updates to the company's blog.

"Lechleiter is a man of the people, who sits in the cafeteria, and can talk with the janitor," says Clifford Kalb.

Lechleiter sees that as an important part of his job. "Part of it is the way I learn," he says. "But part of it is that I think leaders need to be visible, especially in challenging times. Leaders need to communicate directly with people. It's important to have a sense of the character of this guy or gal. Not just what he says in press releases or what precepts have come down from on high, but what's he like? Does he know what he's doing? Does he care about us? Can we trust him?"

Lechleiter also tackles the trust issue on an industry level. Lilly was the first company to commit to publicly disclosing its clinical trials, CME grants, and other educational contributions. Recently, Lechleiter announced it would also disclose payments to physicians in a public registry beginning in 2009, in advance of the passage of the Physician Payments Sunshine Act. The registry will initially list speakers and advisors to the company. By 2011, it will reflect the gifts or payments to physicians.

When asked what it's been like to stick his neck out on these issues, while peers have remained quiet, Lechleiter admits it's "a little scary." But, he says, "It's an important part of restoring trust in our industry. People want to know that this is all out in the open, and that physicians make choices that are best for the patients, not because Lilly is paying them. We're going to get mystery cleared away because we have nothing to hide."

The next issue to tackle is patient safety—but don't look for simple solutions. "We don't have a magic formula for addressing this," says Lechleiter. "I do think that as we get more sophisticated in postmarketing surveillance, including using some of the big databases to get real-time feedback on how our medicines are being used, I see a world in which the knowledge base around any marketed product will continue to grow. But we've got to make that intelligible and accessible for physicians and consumers. That will put people more at ease, because they'll know we're not hiding anything and they can feel assured in taking this medicine; that it is the right thing for them, and that their physician clearly understands what Lilly knows about this drug."

Some say all this public positioning on industry topics is just a distraction from what should be the company's main focus: finding and making drugs. But it's hard to ignore the growing importance of the interplay today between politics, broadly conceived, and pharma.

"At the end of the day," says Oliver Wyman's Jim Hall, "If I'm an investor, I'd have a different view of Lilly with his leadership and long-term vision than [with] someone else who is making short term change."

Of course, Lechleiter's reputation is not without its blemishes. A 2003 e-mail disclosed as part of ongoing litigation over Zyprexa makes it appear that Lechleiter encouraged promotion of Zyprexa for an unapproved use. (A company spokesperson told reporters that he was simply encouraging the company to respond to physician inquiries.) Still, his background in science and ability to bring people along seem to have outweighed any role he might have taken in the case—at least in the court of public opinion.

"He reminds me of Roy Vagelos, who also came out of R&D" says Kalb. "That was a time in Merck's history when people felt aligned with and closer to the company."

Others say his grasp of the new paradigm of customer-focused pharma is what's truly impressive. "He could be the next [Procter & Gamble CEO and chairman] A.G. Lafley," says Jean-Claude Larreche, a professor at the international business school INSEAD and author of The Momentum Effect: How to Ignite Exceptional Growth. "If you look at his speeches, you see a CEO that talks about the customer with some meat."

Kind words are all well and good, but is Lechleiter's grand plan grand enough? "Lilly would have been well served if it started to move down this path earlier, or even last year," says Fernandez. "In my opinion, he is more of an evolutionary thinker, and Lilly's strategic challenges require revolutionary action. It may be, unfortunately, a little too late."

Still, for some, the risks Lechleiter is taking are even bigger than Lilly's—and when he steps up to chairman in December, he has the potential to go, perhaps, even further. "Pharma has really struggled with the new generation of leaders," says Hall. "After Fred Hassan and Christine Poon, who will emerge and take the lead on redesigning the industry? I believe John is one of those people. He has a very clear vision; he's a scientist so he is going to experiment with a few things and some will work and some won't. But his idea is that some things really need to change, and he is going to provide leadership beyond Lilly if he does it right."