Coping with market failure

Editor’s note: James E. Heasley II is a principal of Evolution Marketing Research LLC, Blue Bell, Pa.

The pharmaceutical industry is in the throes of an historic downturn. As we entered the recession, overall drug sales in the U.S. grew at their slowest pace since 1961. At the same time, patents on an entire range of top-selling medications began to expire, flooding the market with low-cost versions. In 2008, for the first time ever, the money that pharmaceutical firms spend on advertising actually declined. Pharma companies have, across the board, reduced the size of their global sales forces, laid off thousands of other workers and gone through one or more restructurings.

One key symptom of the current environment that affects marketing researchers in particular: As marketing budgets have been reduced, frozen and eliminated, companies have reduced the number and scope of marketing research projects – when studies are conducted, they tend to be more narrow in focus with an emphasis on value.

What is interesting and, to be honest, scary about this situation is its very uniqueness in our experience. Prior recessions have not impacted pharma like this one has. Many of us thought pharma was recession-proof. After all, patients need their medications regardless of how well the economy is doing. But this may no longer by true. Structural changes in the industry over two decades have left it more vulnerable to the kind of crisis that we currently face.

Three main factors

So how did we get here? Three main factors have been interacting to fuel the industry’s troubles. Any one of them would be cause for concern but the intersection of all three at the same time will have lasting implications for the pharma industry and how we all approach our profession.

Factor No. 1: Big Pharma and its pattern of self-inflicted wounds

The pharma industry has a propensity to inflict damage on itself and its image with the public, both here and abroad. This is not an indictment of the industry but rather an attempt to take a brief and honest look at it so that we can move toward positive change.

As we all know, for decades the presumed path to prosperity has been to search for the Holy Grail: the blockbuster drug. Like most things, the emergence of the blockbuster was not planned and only became apparent retrospectively. However, once it did, most of the industry homed in on the concept as a way to generate tremendous wealth. Wall Street also bears responsibility here (as it does in so many other historical errors) since, given its myopic focus on “the next quarter” and short-term gains, analysts punished those Big Pharma companies that did not move to develop tremendously profitable medications.

As a result, the occasional success in the launch of blockbuster drugs by individual companies inevitably spawned frantic efforts to produce me-too drugs by multiple competitors. What I like to think of as the blockbuster period reached its crescendo in the late 1990s when all major pharma companies had several of these agents in their portfolios. Ultimately, the result was the emergence of crowded drug categories populated by different brands displaying modest clinical differences.

This structural change spawned several unintended consequences. The first was to push Medicare and MCO formulary budgets to new highs. This happened for two reasons. The advent of truly preventative medicine prompted the use of prescription drugs on a massive scale. Second, historically, price was not a major factor for the final consumer of the product. Physicians prescribed the agent, it was usually covered by insurance which was provided by either an employer or the government. The patient was responsible for only a modest co-pay. In political economic terms, this represents what we call a quasi-market failure situation. The true free market only operates when information about all facets of a product exist transparently and the benefits and costs of a product are then easily compared. This, as we know, has never truly been the case in the prescription pharmaceutical marketplace. And, to be honest, this situation has benefited the industry – at least for a while.

The second consequence of this period was the rather myopic focus on the next blockbuster. As companies sought new medications, they often did so by attempting to make small adjustments to the current ones – a mirror isomer here, an active metabolite there. This focus undercut R&D and, ultimately, that lifeblood of the industry, the new drug pipeline. Fewer resources were then dedicated toward identifying unique chemical entities since the “risks” of exploring new areas seemed very large when compared to continuing to expand the franchise into well-known arenas.

The third consequence of the blockbuster period, and perhaps the most apparent consequence to us now, was the uptick in both mergers and acquisitions by Big Pharma. This increase in M&A activity was seen as the best “solution” to the problem of dwindling pipelines. In some cases this worked to expand portfolios and keep companies in new products while in others it led to overleveraged organizations that often were in no better shape after the merger than prior to it. Regardless of evidence to the contrary, however, “bulking up” became the path to perceived prosperity for many Big Pharma organizations.

Ironically, R&D and science staff often suffered collateral damage during these events, which reduced Big Pharma’s ability to innovate. It became more cost-effective for companies to simply buy products rather than develop them internally. This is not, actually, a bad way forward for many companies and it is one of the key recommendations that I will mention later.

Factor No. 2: Big Pharma as a driver of the U.S. health care “crisis”

A key part of the present-day narrative in U.S. politics is that, in its quest for profits, Big Pharma has made drugs unaffordable, rushed unsafe drugs to market and routinely duped physicians and patients alike through deceptive and unethical marketing practices. While the industry recognizes that much of this is truly fantasy on the part of critics, there have been enough shenanigans (e.g., the cover-up of poor safety data, unethical marketing practices, etc.) that the popular perception of the industry is not good. The result is that the bar will be set increasingly high for new drug approvals and the overall process will be slower and much more expensive – resulting in a huge increase in the costs of new drug development. This increase in effort and costs comes at a time when the industry is struggling and can least afford it.

Perhaps the most dire consequence of this political fallout will be the advent of some kind of real price controls on the U.S. prescription pharmaceutical business. Price controls come in many different flavors and one only need look at the patchwork of programs that exist within the E.U. countries. Managed care and Medicare have conspired to put the squeeze on the industry over the past decade. It should be noted that Medicare buys over 60 percent of the drugs on the market, making the U.S. government the single largest payer in the economy. The most obvious examples of future challenges will be the government allowing Medicare to negotiate prices and the possible reimportation of medications from Canada and other countries. The Obama administration and congress have made these two goals key planks in their political platform and one would expect that at least the former will come to pass.

Obviously, the potential for a complete overhaul of the U.S. health care system still exists though it’s sidelined for the moment. Once the economy begins to recover, however, the idea will move back into mainstream discussion and it is considered very likely that some type of reform will pass that contains political ways (as opposed to market-driven ways) to reduce the cost of prescription medications. (For example, a budgetary system such as that employed in Germany would be an extreme form of price control.)

Apart from cost controls, but no less worrisome, is the apparent attempt to more fully politicize the FDA. The appointment of Dr. Sydney Wolfe to a four-year post on the Drug Safety and Risk Management Committee is a prime indicator of tough times to come. Dr. Wolfe was personally involved in campaigns to remove 16 products from the market, many of them considered to be relatively safe when used appropriately. When the political powers-that-be turn their attention more fully back to our industry, we can expect the unexpected – much of which will assuredly pose new and unpleasant challenges.

Factor No. 3: The economic crisis

Among the many consequences of the current economic crisis is frozen credit markets. It’s been extremely difficult for pharma companies to obtain deficit financing for operations and purchases of new products and product lines. Most have also seen their share price plummet along with the markets, thus reducing their ability to raise capital through stock offerings and similar tools.

Further, the previously-held belief that the average person will take their medications even when faced with economic difficulties may be erroneous. Why? It’s a combination of factors, but much has to do with the fact that most medications taken by consumers are actually preventative and/or treat diseases that have no apparent symptoms. When faced with paying a co-pay for their statin or buying food, most people opt for food. When one looks at the market in this context, it is vastly smaller.

Somewhat ironically, the economic crisis is really not the worst problem facing the pharma industry today. It will pass and growth will resume in due course. It may, however, have been the lever that served to exacerbate the existing problems. In normal economic times, companies can work through bad decisions and not overly suffer for their mistakes. In a period of economic downturn, mistakes are magnified and heretofore strong organizations (or at least those with the perception of strength) now find themselves shrinking, looking to buy new products or looking to be bought in order to survive.

Must evolve

The intersection of these three factors is forcing the industry to evolve and so must we as marketing research professionals. In the broader sense, Big Pharma should first move more quickly to balance the portfolio by shifting beyond the low-ROI quest for the next blockbuster. I believe this is already taking place but too many companies are still reliant on their current portfolios and recent M&A activity still suggests that some companies think that big is better, whereas a more nimble organization and portfolio will likely be the best way forward. Many organizations are already moving in this direction with renewed focus on specialty diseases, oncology and a return to vaccines after years of underinvestment.

Second, it should rethink the value of me-toos. Once again, this may already be happening, but it is clear that the apparent low costs of entry for me-toos make them very appealing to some organizations. There need to be real benefits to new medications in the future market or companies are at the very least going to face the prospect of non-approval or non-payment.

Third, move to discover and develop biologics and other sophisticated compounds while deemphasizing easily-copied small molecules. This, in particular, may provide some protection against generic erosion of the market. The complexity of creating biologics makes them far more challenging targets for generic competition in the future. Only the largest and best-funded generic companies will be able to compete, while the U.S. and other governments have yet to put a clear pathway in place for such competition.

Fourth, prepare for price controls. While this is certainly not an easy task, looking to experiences in the E.U. markets offers up some insights. Andrew Witty, CEO of GlaxoSmithKline (GSK), was able to make inroads into these markets by striking agreements that allowed him to raise the prices of GSK products if he could show that they offered the patient a unique benefit compared to other drugs (e.g., they were not or appeared not to be just me-toos).

Fifth, continue to wage the PR battle. Price controls and other restrictions can only succeed if physicians and consumers believe that the pharmaceutical industry is not acting in their best interest. Thus pharma must continue to invest in the creation of value stories for its products that are believable to its customers.

Sixth, it must also continue to invest in R&D, not just M&A. One way to do this is to fund start-up companies that are science-focused, such as biotechs. For relatively small amounts of money it is possible for Big Pharma to seed the development of new products without dramatically expanding internal R&D, which may not be feasible in the present economy. Clearly, a new approach is necessary given that there have been some high-profile drug failures over the past few years that have given Big Pharma R&D a black eye.

Lastly, there needs to be a focus on developing more rational long-term product-focused goals rather than disproportionate adherence to quarter-focused financial goals. As with any public company, there is always the need to please investors, however, there are many examples of very successful companies (such as Apple) that do not bow to the whims of the Street. Only effective long-term planning will keep the industry moving forward.

Adjust our own worldviews

Finally, as MR professionals, we can adjust our own worldviews and ways of doing business so that we too can make the most of this brave new world.

First, we need to be aware of the new realities of the pharma marketplace and the impact on MR budgets. We should not lull ourselves into believing that this is merely a passing storm. I believe that it will lead to some fundamental changes in how the market is structured and how it functions, with lasting implications for us as marketing researchers.

Second, we need to update our assumptions for how new products/indications are evaluated. We need to ask ourselves if we are designing studies that ask the right questions about how a new product will be evaluated in the future versus how it might have been evaluated in the past. This will lead to some adjustment in the criteria and thresholds used for making recommendations to clients (both internally and externally). For example, if it becomes clear that a new product is perceived as very close to a me-too that will not be well-accepted by physicians, patients and, especially payers, we need to make this clear to decision makers.

Third, we need to learn to do more with less, while recognizing that the lowest-cost solutions are not always best. We must strive to develop creative solutions that are cost-effective and which add insight and value for our clients. I know that we believe that we do this now but we will be working with less in the future – less money, less time – and expected to add even more value. Arguably, information will be even more important. With reductions in marketing budgets overall, marketers will be looking to make the best possible decisions to allocate scarce resources most effectively. This will enable us to lead pharma organizations to a renewed appreciation for market research as a means of providing actionable market/product information that will yield improved decision-making.