A tough pill to swallow

The pharmaceutical industry finds itself at a crossroads. Margins are shrinking, growth is slowing, development pipelines are drying up, and regulation, already heavy, is intensifying. The industry has lagged Wall Street expectations several years running and 2006 doesn't look to break the streak, as patent expirations will again take a large cut out of revenues. Significant, even unprecedented challenges face companies in every sector of the industry and in nearly every area of operations.

Sales-force effectiveness and productivity are down, despite a huge expansion in the number of reps on the street over the last decade. Pharmaceutical companies have never spent more on direct-to-consumer advertising—$7.5 billion in 2005—but informed customers have grown skeptical, and physicians are spending less time with reps. The public's low regard of the pharmaceutical industry's trustworthiness could be a huge problem as the industry patterns itself on the consumer packaged goods (CPG) sector.

Other symptoms of the industry's less-than-perfect health:

• High-profile product recalls and lawsuits involving Vioxx and other drugs;
• Corporate reorganizations, like Merck's decision to close five factories and lay off 7,000 workers;
• Controversy over the validity and fairness of clinical testing; and
• Unfavorable reviews of a new prescription drug provision for Medicare recipients.

The ugly headlines seem to go on and on. Counterfeiting costs the industry an estimated $10 billion to $30 billion per year. In response, the U.S. Food and Drug Administration (FDA) released guidelines for RFID adoption, and many states have enacted regulations for product pedigrees that will allow every single drug to be tracked, traced, and verified as it moves from manufacturing plants to customers' hands. The huge investment necessary to comply has prompted some industry observers and executives to wonder if the cure is worse than the disease.

Regulation also is heating up on the manufacturing front, with the FDA pushing adoption of process analytical technology (PAT). This too will require huge investments in a time of belt-tightening, but there is hope that the FDA's collaborative approach on so-called good manufacturing practices (GMP) will improve abysmal rework rates, shorten product development time lines, and even give revenue a much-needed boost. "Shrinking sales growth and a nonproductive new product pipeline are what business executives see as problematic," says Roddy Martin, a VP with Boston-based AMR Research. "But the operational concerns are just as great, and the focus is squarely on quality."

According to a recent AMR survey of pharma executives, operational excellence is the primary business focus for 74 percent of respondents—way ahead of product leadership and customer intimacy. Among the top business initiatives cited were better data utilization and application of lean manufacturing practices.

In this turbulent time, many leaders are embracing a "back-to-basics" approach to operations, and seeking to address many problems long since solved by other manufacturing sectors (See article, page 25).

Technology is a huge part of the equation. Cambridge, Mass.-based Forrester Research reports pharmaceutical makers spent about $10 billion on IT in 2005, but those dollars are being more closely scrutinized than in the past.

From an IT perspective, the industry is being pulled in two directions. On the one hand, regulations are requiring drug makers to embrace the latest, most powerful enabling technologies—particularly in process analytics, RFID, data management, and product life-cycle management (PLM). On the other hand, many companies must look back to address fundamental issues, like the IT complexity wrought by mergers and globalization, and exemplified by nonintegrated ERP systems. And there are plenty of substandard manufacturing execution systems to be replaced.

According to AMR, the pharmaceutical industry is rethinking its approach to IT.

"The industry is emerging from legacy and in-house development—vestiges of a past when vendor products did not meet compliance or business needs," says Martin. "Companies built both large IT staffs and their own technology applications on a global basis."

Now they are turning to vendors like Agile Software in PLM, Edge Dynamics in inventory management, and Rockwell Automation in process control. And longtime industry partners SAP and Oracle are ramping up new offerings as well.

The industry's problems start at the beginning. For years, there has been a dangerous lack of "blockbuster" medicines—e.g., Valium, Viagra, and Prilosec—capable of creating a new category and producing at least $1 billion in annual revenue, or even viable new products in the pipeline. Blockbusters have been the foundation of the industry, but that foundation looks very shaky at the moment.

Pipeline performance is an especially disturbing problem considering the industry's enviable commitment to R&D; pharmas commit a cool $1 billion and typically spend up to 10 years to develop, test, and launch a new drug. It should be noted that consumer groups and generics manufacturers dispute both of these figures, estimating the cost to be between $100 million and $500 million, with academia and taxpayers picking up much of the tab. Further, they claim R&D time lines have shrunk significantly in recent years.

Drug approval rates are trending downward. According to Forrester's Laura Ramos, "The current odds that a clinical candidate will make it through trials and FDA drug approvals are one in 25, which translates to failure rates of 96 percent." And the FDA estimates that less than half the drugs approved during the 1990s represented substantively new or breakthrough therapies.

In product development, pharmaceutical makers have a huge a new competitor in biotechnology companies such as Amgen, Genentech, and hordes of smaller, highly focused providers. Biotechs, or biologics as they're sometimes called, specialize in the development of compounds, or new molecular entities (NMEs) to serve as active ingredients in medications to treat everything from arthritis to AIDS. With 2004 revenues of $44.3 billion, and higher growth rates and greater market capitalization than pharmas, biotechs have clearly hit their stride. Perhaps most impressive is their success in developing new compounds. NMEs have roughly 27 percent of the active pipeline, and may soon secure more FDA product approvals than pharmas for the first time.

The pharma industry's shrinking pipeline is compounded by patent expirations. The industry lost about $15 billion in revenue in 2005, as many popular drugs went off-patent. Since 2000, losses to generics have totaled more than $40 billion.

To stop the bleeding, many big players are looking to drive more revenue from generics, over-the-counter medications, and so-called "me-too" products—like reformulations for time-release dosing or "extra strength" versions of existing drugs. The challenge for pharmas in developing both value-add versions and lower-margin products is that they'll have to achieve much greater operational efficiency.

Manufacturing costs eat up a full 25 percent of revenues—more than R&D, which accounts for between 17 percent to 20 percent. While some of those high costs may be attributed to scientific perfectionism, the larger percentage is attributable to scrap and rework rates that would not be tolerated in other industries. According to AMR, the pharma industry's rework rates are 50 percent, and only about 10 percent of batches come out right the first time. Capacity utilization is only 40 percent to 50 percent—about half the rate of the automotive and semiconductor industries, and well below CPG's 70 percent to 80 percent.

The end result is grindingly slow and hugely expensive manufacturing operations. "It can take anywhere from one to three months to release a single batch," says Martin. Merck's shuttering of plants is generally considered an admission of this long-ignored problem.

The industry's supply chain record isn't much better, wherein it averages about 200 days worth of finished goods in the supply chain, according to AMR. A huge number of wholesalers, distributors, and middlemen means an average of between 20 and 30 transfers are required for goods to move from the plant to consumers' hands. Forrester's Ramos believes that huge counterfeiting is "largely a symptom of suboptimal supply chains."

With FDA guidelines for e-pedigrees and Wal-Mart mandates for RFID adoption, pharmaceutical companies were expected to be among the leaders in the track & trace revolution. It's been slow in coming. The first round of pilots was concluded last year, and while the results were good in terms of read rates and integration with ERP systems, "The soft stuff turned out to be the hard stuff," says Todd Skrinar, a partner in Unisys' life sciences practice, who led the industry's first e-pedigree initiative in a fully functioning supply chain at Purdue Pharma. The project was closely watched. The Wall Street Journal cited Purdue-Unisys' initiative as a potential "national model because it is the first to comply with pending state legislation."

Concerns about ROI have slowed adoption, however. "Prescription drug manufacturers view item-level tagging as a key benefit opportunity, but the payback relies heavily on new ways of collaborating with downstream trading partners," says Skrinar. "As a result, they are generally investing at a lower rate."