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Recipe for Success

Companies with a diversified portfolio are better placed to achieve positive outcomes over the next decade

A selection of mixed powdered spicesIt is not that bad, really it's not. In the same way that the Great Fire of London and the Ice Age had significant future benefits, the current challenges that the pharmaceutical industry is facing will undoubtedly produce casualties, but also significant opportunities and positive outcomes for the well positioned.

The casualties are clear. $1190bn of shareholder value has been lost since the new millennium began. An additional $140bn in sales and 40,000 jobs will be lost over the next five years.

Some companies have developed conscious strategies to focus or diversify; others arrive there by serendipity. Whichever their route, it is likely that those who are diversified will be most able to survive the challenges of the current economic downturn.

Defining diversification
What does diversification look like? Simply, it is different products in different markets. A diversified business might be one that has worldwide presence in ethical pharma spread across primary and secondary care in several therapeutic areas, coupled with consumer and animal health businesses. By contrast, a focused business example might be one that specialises in ethical products for urology in secondary care in Europe. A new competitor or a change in legislation and/or clinical practice could severely damage such a business.

The routes to diversification are either organic or acquisitive. Organic diversification is long term, risky and expensive. Acquisitive diversification may have less inherent risk, particularly if the assets are in late stage development or being marketed and the diligence is thorough. In the past, acquisitions were both expensive and of questionable value (most mergers and acquisitions are value-destroying), however the current climate affords an opportunity to cash-rich (or well debt financed) companies; share prices have been falling and the number of cash-starved biotechs is at an all-time high.

Dangerous cliffs
Recent analysis by Moody's shows that Pfizer, Bristol-Myers Squibb (BMS), Lilly and Merck have almost half of their global revenues in products that are facing imminent patent expiry. With the rate of generic erosion in Europe being 30 per cent in year one and an eye-watering 90 per cent within three months in the US, such challenges leave organisations dangerously exposed. The drive to M&A activity is likely to bolster not only R&D pipelines, but also to diversify the marketed product portfolio and reduce vulnerability to competition. Interestingly, Wyeth (Pfizer's latest acquisition) is less affected by the patent "cliff". In the newly forming Merck/Schering-Plough, no product in its $47bn portfolio will account for more than 10 per cent of sales and the new business will be strong in human health, animal health and consumer. By contrast, AstraZeneca, which is forecast to lose 30 per cent of revenues by 2014, is avoiding M&A and hoping to plug the gap through improving R&D – a strategic move that the FT cites as "clearly risky".

How to diversify
Patent expiry in pharmaceuticals presents the biggest, most extreme impact on a product's lifecycle. Mixing the portfolio to mitigate compounded revenue loss is, therefore, important and can be done from both a temporal and spatial perspective. While there is always a degree of luck in pharma discovery, good development is subject to good planning. A clear set of objectives and the ability to align and prioritise resources to corporate strategy will allow a good CSO/CMO a higher probability of success. It has little to do with chance and much to do with capability. As such, the temporal management of products coming through a pipeline will allow companies to manage revenue declines better in the 10 to 20 year horizon. 

The spatial management of a portfolio is planned management of products in different channels, geographies and segments, which may be subject to different competitive and environmental forces. This type of diversity can exist in both large- and medium-sized businesses (generally not small). Consider Johnson & Johnson (J&J), the world's biggest diversified healthcare company. It operates globally in consumer (with some of the world's best known brands), devices and diagnostics (with over 10 individual businesses) and ethical (across eight therapeutics areas). A company that is this diversified obviously faces operational challenges, but it is also buffered. At the other end of the spectrum, Merz Pharma of Germany is a global business successfully diversified across consumers (with leading brands in Germany, US and Russia), specialist pharma (including biologics), an outlicensed blockbuster and a rapidly growing cosmeceuticals business (which works across both consumer and healthcare professional boundaries and includes POM, GSL and CE products serving public and private sectors). Such diversification is challenging to achieve in the short term, but by offering a  more fragmented target for competition or environmental stresses confers protection.

The old 80/20
Effective segmentation is of critical importance in any business, but is perhaps more challenging to do well in a large, diversified business. Robust marketing is paving the way for successful sales growth as companies profile their customer groups more robustly. Applying the old Pareto Principle to large, apparently homogenous, GP customer bases is no longer viable. Increased competition has driven the need for proper segmentation, resulting in more tailored and appropriate offerings.

Every marketer knows the Pareto Principle and fatefully believes that that is just the way it is. More informed wisdom asserts (very sensibly) that the Pareto Principle is the result of bad segmentation and that approximately 80 per cent of sales come from the customers to whom our message actually has some real resonance. Why not look up the origins of Pareto Principle? You will be surprised at how an utterly banal chance observation from 19th Century Italy has pervaded the business world as an accepted wisdom.

Channels for diversification
Broadly, there are three channels that healthcare operates in: consumer; animal health and human health.

Consumer – most often confined to OTC, the consumer approach of pharmaceutical companies has seen mixed favour in recent years. Roche and BMS both divested their consumer health divisions, but other major players, like GlaxoSmithKline (GSK), Novartis and J&J, have fought to retain or expand theirs. Under increasing cost pressure, global governments most likely will continue to seek pressure valves for healthcare spending and the consumer paying directly – rather than just through taxation – will only trend one way. Although the credit crunch will depress near-term sales, those companies with strength in this channel will benefit with the economic recovery.
Animal health – relatively few pharmaceutical companies operate in this area (Bayer-Schering, Merck/Schering-Plough, Pfizer, Boehringer-Ingelheim and Novartis) and the size of the market is correspondingly small ($20bn).
Human health – worth an estimated $680bn, the human pharmaceutical market is still growing (forecast to break the trillion dollar barrier by 2012, driven by growth in Central/South America and Asia). The market is diverse and heavily segmented with complex licensing options, ie Marketing Authorisation (MA) and Conformité Européene (CE) mark.

The CE mark is a self-assessment marking, which effectively licenses the product for sale in all European Economic Area (EEA) markets. The lead time and costs associated with achieving a CE mark are considerably lower than that of a MA. As such, those products that can be licensed through this route will get to market faster and most cost-effectively.

Prescription only medicines, the conventional bastion of pharma companies worldwide, represent the bulk of current business. But this ethical medicine business is becoming increasingly segmented across primary, secondary and tertiary customer groups, with much focus on the latter groups. This is being driven by the rise of biotech with high technology products aimed at smaller, more discrete and homogenous customer groups.

A good insight into licensing strategies is important if a business is to exploit the human health markets (see the MHRA's A Guide to What is a Medicinal Product) optimally. 

Plan for success
In the past it was sufficient to have an emergent strategy of diversification, but the environment is tougher now and demands that proper thought and time be devoted to building strategies for growth.

Executive teams typically spend less than 15 per cent of their time developing strategies. Those who, over the last decade, have not devoted appropriate levels of senior talent and time to building sustainable strategies are already shuffling uncomfortably. Others have strategies that are clear and easy to execute.

A look at Andrew Witty's first year gives an insight to a more commercially strategic focus than the usual “fill-the-pipeline” call. He has diversified into emerging markets (UCB's portfolio), generics (BMS' Egyptian business) and broadened GSK's skincare portfolio with the acquisition of Stiefel. Acquisition of Allergan would give GSK a presence in ophthalmology and aesthetic medicine (cosmeceuticals) as well. Of note: his one major change in R&D was to cut 850 jobs and push more development risk (cost) toward partners. The aim of this was to generate more than half the company's trial drugs from collaborations. Interestingly, Chris Viehbacher (newly appointed CEO of sanofi-aventis) has also unrolled a diversification strategy with increased focus on non-Rx sales, driving growth from vaccines, animal health, OTC and generics, as well as exploiting emergent markets. His approach with R&D is also to cut risk and improve commercial evaluation.

Time to reflect
Take a moment to reflect on your own organisation. Do you have strong strategic planning and regulatory capabilities? Do you devote enough time to real planning? Is your business diversified or focused? How many channels and segments do you operate in? Where do your most reliable sales come from and where do you seem to lose business more readily to competition. Finally, when was the last time you used the Pareto Principle as a reason for poor sales in 80 per cent of your customers?

The Author
Stuart Rose is managing director of Merz Pharma UK

18th June 2009


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