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Pharmaceuticals Out of Balance: Reaching the tipping point

Wed, 01/06/2010 - 4:21am
It is no secret that the pharmaceutical industry is facing significant challenges - the regulatory environment is getting harsher, pipelines are underperforming and the marketplace is getting tougher. Even as healthcare budgets are rising, drug sales in most developed markets are forecast to be flat. The existing sales model does not seem to be working. Spending on sales and marketing in the United States, for example, has increased 13% a year over the past eight years, while return on that investment has dropped by 15%.1 Attempts to improve efficiencies have had limited success, and companies are having to resort to cost-cutting. While there have been waves of consolidation, these have resulted in concentrating, rather than solving the problem.” Unsurprisingly, shareholder returns are plummeting.

The industry's future looks just as bleak. Pricing pressures are increasing globally; even the safe haven of the US has become a challenging market. While President Obama's plans for universal coverage may give a short-term boost to revenues, the proposed cost control measures will mean longer-term price challenges. We believe these problems are symptoms of a shift in the nature of healthcare systems. The fortunes of the pharmaceutical industry are driven by the healthcare systems it serves-and virtually every healthcare system is restructuring. 2

The successful pharmaceutical companies of the future will focus on addressing real world issues, show system value created rather than marginal efficacy improvements and serve global mass markets at lower costs. To compete in this harsher environment the most successful pharmaceutical companies will shift from being R&D-driven to become market driven, and this will require a complete rewiring of their organizations and in particular the way the supply chain is managed.

Tipping Points
Global healthcare reform is having a major impact on the pharmaceutical industry. The increasing problems are a sign that the industry is approaching a time of rapid change. We believe the pharmaceutical industry is at a tipping point and that it will emerge in a much different form. These tipping points relate to what the industry sells, to whom, and to how it should organize itself.

Tipping Point 1: From Therapies to Service Models
This changing healthcare landscape is seeing the role of the customer and primary decision maker changing. While the clinicians still makes the ultimate prescribing decision, they are increasingly constrained by payers, regulators and political pressure.

While the doctor-patient relationship across markets is relatively similar, the payer landscape is exceedingly complex. Healthcare priorities vary by country, locality and even ethnic group. In each country there are multiple stakeholders- clinicians, advisory bodies, regulators, charities, special interest groups-that influence how diseases are treated. The traditional pharmaceutical sales model, which focuses primarily on doctors, needs to change to survive in this market. Companies will need to build the capability to understand and influence the entire therapeutic system. It also challenges the nature of what pharmaceutical companies sell and how they price their products.

Payers are changing the assumption that selling a drug more cheaply does not result in more volume, as most doctors do not consider price when prescribing. The focus is shifting toward the perceived value and clinical cost-effectiveness. Organizations such as the UK's National Institute for Clinical Excellence (NICE) now authorize expensive drugs as second-, third- or even fourth-line treatments after less-expensive drugs have been used.

However, the way payers perceive value is quite different from the way pharmaceutical companies demonstrate it. Rarely are drugs the only intervention used to treat a disease. For example in 2002, the overall cost to treat schizophrenia in the US was about $63 billion, of which only $5 billion was for pharmaceuticals.3

For payers seeking to address complex diseases such as diabetes, the availability of a marginally more clinically effective-but much more expensive- therapy is far from compelling. Payers are more interested in the effectiveness of the treatment pathway than the clinical effectiveness of a particular drug in a randomized control trial (RCT). A service model that enables improved compliance and can prove to reduce the number of unplanned admissions and complications can significantly outweigh the cost of drugs and provide a compelling case for the payer.

Positioning a therapy in this context dramatically increases its value. Drugs account for only 15% of most health budgets, yet their proper use could dramatically reduce total healthcare costs. As pharmaceutical companies focus on payer needs, the source of competitive advantage and value will shift to the service model in which their drugs are used. Whether directly or indirectly, pharmaceutical companies will need to become involved in service design and delivery to ensure that real value is delivered by their products.

Tipping Point 2: From Rich Niches to Global Mass Markets
Traditionally the US has dominated the pharmaceutical industry - more than half of all drug sales and R&D spend is focused on therapy areas important in the US market. Drug prices are based on the US market, despite the impact on revenues in other countries. For example Lipitor, the world's best selling drug, is not actively commercialized in Germany (the world's third largest economy). But the US healthcare system is failing and under President Obama will undergo significant reforms towards a more European style low-cost system which will see US Pharmaceutical revenues decline.

Meanwhile, healthcare demand is shifting rapidly toward the developing world, where 96% of global population growth is expected in the next 50 years. More important, it is estimated that by 2020, there will be 742 million people in China's middle class (those earning more than $10,000 annually) and 124 million in India's-they will have Western-style healthcare needs and expectations. However, as state funding of health tends to lag growth in healthcare demand, developing markets are seeing the significant growth in self-pay health markets, with dynamics more similar to fast moving goods than pharmaceuticals.

With the increasing pricing pressures faced in the US, these developing markets become too attractive to ignore, volume at a lower cost will become an increasingly attractive option. Thus, pharmaceutical companies will need to drop their obsession with high-priced solutions focused on the U.S. market and instead establish prices in a way that will maximize revenue over a drug's entire life cycle and across global markets. However, products in these markets will need to be considerably cheaper than those currently achieved in developed markets.

Pharmaceutical companies need to view emerging markets in a new light. While the market today is focused on niche markets that can afford Western prices, low-cost, mass-market and state-funded solutions will be required on a monumental scale. If the global pharmaceutical industry does not respond to these challenges, then local companies surely will. In a world desperately short of funds, with governments caught between unprecedented debt and the need to provide better healthcare, it is naïve to believe that high prices can be maintained when far cheaper, clinically effective solutions are available elsewhere.

Tipping Point 3: From single to multiple supply chains
Many large pharma companies have evolved their supply chains to serve the needs of high priced prescriptions medicines (Rx) where cost of goods sold (COGS) is less than 20% of selling price. Supply chains incorporate gold standard levels of quality assurance, very frequent deliveries, and high levels of stock. The steady nature of sales means that forecasting systems are simple, and have allowed the development of a manufacturing model based on long lead times and large batch sizes.

However, the reality is that companies are rapidly diversifying to de-risk their businesses and to respond to the market tipping points, challenging the traditional pharmaceutical supply chain model.

Supply chain models are already becoming more complex with the industry's portfolio shift to biologicals. The temperature sensitive nature of the products means that a complex cold chain distribution network has been grafted onto the existing distribution networks. Manufacturing of these products can be challenging, leading to even larger batch sizes to increase consistency and a legacy of dedicated manufacturing units. Growth is periodically supply constrained.

The lack of pipeline is rapidly making mature products an increasingly important part of the business. Tail products that in the past may have been allowed to whither or might have been disposed of are being re-invigorated but nevertheless face challenging pricing environment. GSK's star product for emerging markets has been a twenty-year old antibiotic, Augmentin. Mature product supply chains need to be far more flexible and low cost. As products shift to "over the counter", they behave increasingly like consumer products. Branding, product facings and promotions increase demand variability as do market conditions. For example an unseasonably hot summer may produce demand significantly above forecast for allergy products. With a 3- month lead time the summer is over before the products make it to the market, meaning excess inventory levels and shelf life challenges not to mention the loss of revenue. Pharmaceutical companies should move more towards the consumer goods model of late stage customization for local markets with smaller batch sizes and lead times of days or weeks rather than the 2-3 months which are currently the norm.

As well as supporting a mature product and OTC portfolio, many companies are acquiring generics businesses. While there are still markets where generics achieve high margins, the trend is toward low cost markets such as the UK and USA, and a "low cost producer" model is essential. Manufacturing is typically outsourced and produced in places like India and China. The quality overhead of big pharma is unaffordable, and the focus is on establishing processes which are "good enough" - though the recent case of Ranbaxy is a demonstration that this must not be taken too far. The compromises necessary to be cost competitive in generics are of particular concern to the major pharma companies, where failures in a generics subsidiary could easily damage the core brand.

Finally … distribution, for long a passive element of the supply chain, will also undergo significant change and getting the supply chain right is increasingly becoming a source of competitive advantage.

In developed markets there has already been a shift from the traditional wholesaler model to direct-to-pharmacy, and in the future we anticipate a move to direct-to-patient delivery as therapies are combined with other services to increase compliance. For developing markets, the consumer orientation means that distribution coverage and services such as vendor managed inventory and local packaging will be key determinants of sales success.

The inevitable conclusion is that the very idea that there is a single supply chain and manufacturing model is increasingly invalid. Supply chains must operate to different levels of flexibility, cost and quality assurance depending on the market segment and technology.

All this does not imply a series of "silo" solutions. There is a good deal of common ground between the different supply chains which should be leveraged and managed centrally including management of external contracts and freight forwarders, import/export functions, treasury, reporting and physical distribution assets such as the warehouse network. However pharmaceutical companies will need to develop additional competencies before they are capable of operating to different supply chain models for different products at different stages of the product life cycle. The management of the contractual relationships with multiple internal and external providers will become a core competence of the truly connected pharmaceutical supply chain operation-and a major driver of profitability.

This complexity will inevitably bring challenges. Products might be OTC in one country and prescription-only in another. Prescription and generic drugs might be delivered together within a single service model. Means of assuring appropriate levels of service, quality control and even allocation of overheads will need to be developed as the one-size-fits-all model disappears.

Starting the Transformation
Creating the truly connected pharmaceutical company is a daunting transformation from today's reality.

Commercially and strategically companies will need to significantly strengthen their decision-support capabilities to make difficult trade-off decisions on price, investment, make or buy, therapy and geographic focus-and thus optimize portfolio value. Companies will increasingly abandon the U.S.- centric model and adopt a more global view. Some will increasingly go for volume over the profitability of niche markets.

Supply chain operations need to consider five action areas:
1. Assess the current supply chain model against the product portfolio and identify areas where the adoption of a different model may bring competitive advantage. Identify the areas of commonality and build competencies within the organization to manage the areas where there are gaps.

2. Get ready for a lower cost model by redesigning the manufacturing and distribution footprint, looking for manufacturing and distribution partners, and preparing for mass production. In particular look at means of building physical distribution capabilities in emerging markets.

3. As the electronics industry recognised long ago, accept that externalisation is part of a cost-effective global supply chain. Take a strategic approach to supplier management and build processes to allow closer integration of 3rd parties with internal supply chains to ensure seamless end-to-end performance.

4. Adopt practices from the fast moving consumer goods industry to improve responsiveness and flexibility, reducing inventory and delivering superior customer solutions. Specifically, investigate the opportunities for using late stage customization to reduce the batch sizes and the lead times to customers.

5. Broaden the definition of success for the supply chain, transforming the mind-set from produce to plan and quality, to end-to-end cost, responsiveness and flexibility. This will require changes to measures, competencies, processes and organisation. In this new world, supply chain leaders need to have a sound grasp of the commercial value that the supply chain can bring. Demonstrated site leadership skills will no longer be sufficient.

In Bill Gates' words, "We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don't let yourself be lulled into inaction."

Authors:
Jonathan Anscombe, Mike Wise, Carol Cruickshank, David Hanfland, Michael Thomas, Omar Sawaya, Rebecca Drinkwater

Jonathan Anscombe is a partner and co-head of the firm's pharmaceutical and healthcare practice in Europe. He is based in London and can be reached at jonathan.anscombe@atkearney.com.

Mike Wise is a partner of the firms' pharmaceutical and healthcare practice in North America. He is based in Cambridge and can be reached at mike.wise@atkearney.com.

Carol Cruickshank is a partner of the firms' pharmaceutical and healthcare practice in North America. She is based in Toronto and can be reached at carol.cruickshank@atkearney.com.

David Hanfland is a partner of the firms' pharmaceutical and healthcare practice in North America. He is based in Chicago and can be reached at david.hanfland@atkearney.com.

Michael Thomas is a principal in the global pharmaceuticals and healthcare practice. He is based in London and can be reached at michael.thomas@atkearney.com.

Dr. Omar Sawaya is a principal in the global pharmaceuticals and healthcare practice based in Dubai. He can be reached at omar.sawaya@atkearney.com.

Rebecca Drinkwater is an associate in the global pharmaceuticals and healthcare practice based in London. She can be reached at becky.drinkwater@atkearney.com.

A. T. Kearney's full report “Pharmaceuticals Out Of Balance - Reaching the tipping point” is available for download at: www.atkearney.com/index.php/Publications/pharmaceuticals-out-of-balance.html
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