Squeeze Play 2008: Price Pressure and Declining R & D Productivity
By Joe Tempio
President and CEO
Pharmaceutical companies are caught in a vise. On the one hand, a confluence of factors, both political and demographic, are pressuring drug prices down while on the other hand, thin pipelines and declining R&D productivity make the prospect of pharmaceutical companies growing their way out of their present difficulties challenging. Squeezed on both sides, many companies in 2008 will likely pursue one or both of two strategies:
Cutting costs, i.e., smaller sales forces, and improving manufacturing efficiency and cost structure
Increasing the pace of innovation and R&D efficiency and effectiveness
These strategies offer unique promises and pitfalls and, more importantly, require specific and difficult-to-master organizational skills. But the sooner pharmaceutical organizations acquire these skills, the more likely they are to escape the double jeopardy of falling prices and stalled innovation.
Pressures on the Price FrontThe pressure on prices will be relentless. Cheaper imports from Canada and elsewhere and patent expirations of blockbuster drugs will continue to cost branded drugs significant market share and push down their sales. Further, with Medicare Part D, the prescription drug program for seniors that went into effect on January 1, 2006, the U.S. government became the largest indirect purchaser of pharmaceuticals in the world. Though near-term improvements in access to drugs will grow overall sales, drug program costs will become a large line item in the US budget. As pressure inevitably builds to change the law to allow Medicare to negotiate drug prices directly, the government may become the industry's largest direct purchaser and use its enormous buying power to exact even lower prices than those that have already been negotiated by the private health plans in the Part D program.
Eventually, this could lead to further price controls perhaps on the European model, which include formularies and "negative lists" of drugs or indications for which the government will not reimburse. Consider the example of the Veterans Administration, which is already permitted to negotiate prices directly with pharmaceutical companies. According to an analysis by Columbia University Professor Frank Lichtenberg, only 38% of the drugs approved by the FDA in the 1990s and 19% of the drugs approved since 2000 are on the VA national formulary.
Declining R&D ProductivityWhile prices have been under attack, R&D productivity has remained flat. According to the Government Accountability Office (GAO), annual R&D spending by the pharmaceutical industry increased 147 percent, to $60 billion, between 1993 and 2004. At the same time, the number of new drug applications to the Food and Drug Administration grew by only 38 percent, and has generally declined since 1999. Moreover, the GAO found that only 32 percent of those NDAs were for potentially innovative new drugs.
The trend appears to be continuing. According to PhRMA, America's pharmaceutical and biotechnology companies set a record for biopharmaceutical research spending in 2006. Nevertheless, through October of 2007, the FDA had approved only 14 NMEs and 1 BLA, compared with 17 and 4, respectively, for the same period in 2006 (Figure 1). The drop in NDA approvals was even steeper, from 83 through October of 2006 to 60 for the same period in 2007.
By some estimates, only one in five INDs for NMEs makes it to an NDA. Further, according to the FDA, new compounds entering Phase I development today have only an 8% chance of reaching the market versus a 14% chance 15 years ago. And the Phase III failure rate has risen to 50% versus 20% just ten years ago. With all of the prior R&D investment in a Phase III drug and clinical trials costing approximately $100 - 150 million, Phase III is an extremely expensive place to fail.
There are of course good reasons for declining R&D productivity, such as the need to increasingly address complex diseases that have high drug failure rates. At the same time, some observers see an increasingly careful, some think risk-averse, FDA, as a result of recent safety issues with some high-profile drugs and the attendant political scrutiny. But for whatever reasons, the fact remains that costs are increasing and innovation is declining. And because it is innovation in branded drugs that eventually supplies the pipeline for generic manufacturers, they too will be adversely affected, likely resulting in widespread consolidation of generics manufacturers in the next several years.
Streamlining ManufacturingMany companies, recognizing the squeeze that these dual pressures will put on profitability, have already embarked on aggressive cost-cutting. They have shrunk their sales forces, reduced headcount in other parts of their organizations, and have begun to make manufacturing more efficient at home or outsource or offshore it to regions with lower labor costs. With manufacturing now eating up an average of 25% of revenues, the savings opportunity is substantial. Companies will pursue those savings more aggressively than ever in 2008.
Successful outsourcing will require skills in vendor oversight, technology transfer, quality assurance of contractors, vendor performance assessment, and maintaining complex communication lines for rapidly recognizing quality issues, counterfeiting, and other problems. Improving manufacturing at home will require a different set of skills: especially the ability to attack inefficiency at its root cause in manufacturing processes.
While we believe that both strategies can work and have helped pharmaceutical companies pursue both paths, we also believe that many companies haven't begun to really tap the full potential for savings that lies in improving current operations. Many industries have gone through convulsions similar to those that are now wracking the pharmaceutical industry. They responded by developing or adopting powerful improvement methodologies like Six Sigma, Lean, Lean-Six Sigma, and other variations that grew out of the work of the great quality pioneers of the last century.
A number of forward-looking pharmaceutical companies have begun to adapt these proven improvement methodologies to the unique needs of pharmaceutical manufacturing. With Lean they have been able to improve process flow, reduce waste, and shrink cycle time. With Six Sigma they have achieved the depth of process understanding that is required for such key milestones as process validation, scale-up, and technology transfer. They have also been able to reduce process variation, find the best operating conditions, design more robust products and processes, uncover root causes of problems, and - most importantly - solve them once and for all. Process understanding and Quality by Design Development form the basis for intelligent deployment of PAT (process analytical technology) and other cost-efficient quality systems.
Improving R&D ProductivityTo improve R&D productivity there are at least three things companies can do in the near term: (1) apply to drug development processes the same proven improvement methodologies that have revolutionized manufacturing, (2) determine the likelihood of a compound's failure as early as possible in development, and (3) make better decisions in the management of drug development portfolios and allocation of R&D resources.
The problems that plague manufacturing processes - variation and waste - also occur in drug development processes from discovery to toxicology, animal studies, submitting an IND application, and clinical trials. In clinical trials, for example, the already high costs that result from their increasingly complex nature and larger enrollments can go even higher as a result of the delays and bottlenecks that result from the myriad inefficiencies commonly found in trial processes. The potential benefits from improving the patient enrollment process alone are worth the effort, given that missed enrollment deadlines are responsible for a significant percentage of lost days in clinical trials. Similar opportunities for improvement can be found in such processes as study start-up, site recruitment, protocol development, document submission, investigator payment, and numerous other processes.
Having drug candidates fail earlier, if they are going to fail, can also dramatically lower R&D costs, improve productivity, and speed time to market by freeing resources to accelerate more promising drug candidates. Sometimes called "fail-fast" programs, such efforts aim at determining as early as possible in the development of a compound what key experiments must be performed to see if the compound really has potential in human therapeutics. Such highly targeted, well-designed and well-executed experiments can avoid or minimize the risk of costly failure in expensive human trials.
Making optimal decisions about drug development strategy, allocation of R&D resources, and portfolio management also yields rich rewards. However, the increasingly complicated nature of drug discovery and development, therapeutic areas, patient populations, and market opportunities has made these decisions more difficult than ever. And because getting these decisions right is so difficult, many organizations simply follow the typical phased development program - the path of least resistance - and lowest return. In a world of declining R&D productivity and price pressure, that approach no longer suffices. Companies that pursue growth through innovation will increasingly need to employ state-of-the-art tools and methodologies for comprehensively and quantitatively evaluating costs, benefits, and risks of complex R&D decisions. These techniques have been successfully employed in other big-bet industries such as oil exploration and semiconductor manufacturing, and they will increasingly distinguish companies that innovate efficiently from those whose productivity continues to lag.
Escaping the ViseGiven a future in which the big winners in pharma are likely to be low-cost producers and companies that innovate, the potential benefits of applying proven improvement methodologies to manufacturing and R&D, instituting fail-fast programs, and improving decision-making are enormous. In manufacturing, reduced deviations and fewer investigations mean improved yields and higher productivity. Additional benefits include more robust and compliant processes, fewer inspections and costly shutdowns, reduced regulatory burden, increased equipment uptime and plant utilization, and higher quality products, processes, and analytical methods. In R&D, the better allocation of resources, more efficient development processes, and improved portfolio management mean getting to market faster with more innovative products. And together, more efficient manufacturing and more productive R&D can provide an unbeatable combination for escaping today's industry vise by simultaneously generating bottom-line cost savings and enabling top-line growth.
About the author: Dr. Joseph S. Tempio is President and CEO of Tunnell Consulting. He has been at Tunnell Consulting since September 1999, directing the Life Sciences practice before being named President and COO in February 2004, and CEO in April 2005. Joe has more than 25 years experience in the pharmaceutical and consumer healthcare industries. Joe has been President of IBAH Pharmaceutical Services (now Omnicare), Director of Scientific Affairs at Lederle Consumer Healthcare (now Wyeth) and Director of Scientific Affairs at SmithKline (now GlaxoSmithKline). His management experience spans leading technical departments in large and small divisions of large corporations, as well as, growing a start-up division of a small clinical research organization, and a new practice in a consulting firm. Joe earned his B.S. in Pharmacy at Duquesne University, and his Master's and Ph.D. in Pharmaceutical Sciences at Rutgers the State University of New Jersey.