The healthcare sector seems to have avoided the same state of lassitude as the rest of the economy, but, as Ian Rhodes, Gregory Berman and Bob Damms argue, it is far from immune from the current events.
Though the economy has been in crisis with companies failing and jobs at risk, people still get sick, and the resulting demand for the products and services of the healthcare sector seems to exhibit a trend-defying resilience led by demographic trends, novel treatment interventions for conditions that were not considered ‘diseases’ in the past, coupled with changing patient expectations. To date, the pharmaceutical industry has apparently been largely insulated from the current crisis, with the largest companies retaining large cash reserves, remaining highly cash-generative and delivering attractive levels of profitability. Perversely, we can even identify an upturn in business performance since 2007. Indeed, this seems to be the case at a macro level across the healthcare sector, including pharmaceuticals, medical devices and diagnostics.
Companies have been making large-scale rationalisations, resulting in headcount reductions, but to a great extent these initiatives were not as a result of the banking-led crisis. Rather, the inability of major pharmaceutical companies to replenish their pipelines from internal R&D efforts, coupled with the desire of payors to reduce their costs of healthcare, were already in the process of revolutionising the industry in the medium and long term.
We believe the economic crisis, or the ‘zombie economy,’ as it has becomes known (because it has left our banks, governments, companies and consumers ceasing to function normally and unable to contribute to expected rates of economic growth) will eventually catch-up with and have a negative impact on the healthcare sector. But given the time taken for restrictions in investment, and the changing development models, it may be indirect and follow on the tail of the current crisis, perhaps several years after the rest of the economy has entered a period of slow but sustained growth.
New growth opportunities?
With the financial environment exacerbating the challenges facing the healthcare sector, which include poor R&D performance and looming patent expirations, the year-on-year, double digit growth in R&D expenditures has come to an end; commentators now suggest that low single digit growth will become the norm.
In the absence of dramatic improvements in R&D performance, or a continuous stream of in-licensing opportunities to strengthen the portfolio, this can only result in reduced performance. However, given the time taken for products to move through the product development process, this may not become apparent for some time. In addition, new products are increasingly being based around combination of technologies; in future, they will include communications devices to collect, analyse and disseminate information about the patient’s status or behaviour.
New products will increasingly be based around data services and management. Opportunities exist, then, to drive future growth by corporate investment in these technologies. However, this doesn’t seem to be something the new clutch of corporate venture funds are looking for, preferring instead to support the existing flawed business model.
But the pressure on the industry is creating opportunities for new models of delivering healthcare, often from new market entrants. Technologies, including systems to ensure compliance and to measure therapeutic outcomes, may be used in combination with low-cost therapies to compete with higher-priced, next generation products, and enable governments to manage treatment costs at the expense of the incumbents. In combination with expensive therapies, such technologies will be used to reject payment when the treatment fails to achieve the desired outcome in the individual patient.
Much of the apparent recent growth has been by defensive M&A by the big players or by in-licensing of products from emerging companies, and we see this trend continuing. However, the current crisis may reduce such activity in the future, as the conveyor belt of product and corporate opportunities breaks down. The current funding environment is already making it difficult for start-ups to raise the early development capital needed to keep this pipeline full, at least in Europe.
Moreover, the industry faces its own challenge in transitioning from the blockbuster model in favour of the ‘niche buster,’ with the move from a reliance on millions of patients taking relatively low-cost, small-molecule drugs, such as statins costing a few hundred dollars a year, to biologics that cost many tens of thousands of dollars per year but are targeted at relatively small indications and thus taken by many fewer patients.
In the near future, while biologics are predicted to make up the four biggest selling drugs by value, they often have a relatively ‘high cost of goods’ compared to small molecules, although the cost of development is similar. The consequence is that it may be increasingly difficult to justify innovation, as governments seek to access lower cost treatments as soon as possible. The smaller the target population, the higher the treatment costs, and the more reticent payors will be to pay.
How to respond to the changes
In addition to revisiting their commercial and product/service strategies, we believe companies should also seek to reshape their operations to deal with the fundamental changes in healthcare, rather than to iterate and evolve around a flawed molecule discovery and development model. This can be achieved with:
- Defensive mergers and strategic in-licensing. These will continue to drive growth, but, in the future, might include new entrants that enable incumbents to wrap additional products and services around existing/proven drug assets, and more importantly, control the data associated with these integrated systems. Control of these additional components to the supply chain will drive value, especially when the payors start to mine and control these data.
- Rationalization and cost-saving initiatives that are comprehensive in their focus. Pharmaceutical companies are improving the efficiency and productivity of discovery and development activities by outsourcing and off-shoring. Device companies are transferring manufacturing to low cost and low tax economies. However, this in itself is not a sustainable or long-term solution when treatments are value, rather than price, based.
- Extension of the breadth and depth of their engagements with external sources of new technologies and potential products. This will include initiatives with external translational resources, in addition to more conventional commercial partners. A key issue will be the management of these interactions on a global basis as development moves to demonstrate safety, efficacy and cost effectiveness in the appropriate population.
- Further diversification, with vaccines, consumer health and emerging markets all experiencing renewed interest and investment. In addition, new entrants, especially in communications, are seeking to blur the distinction between healthcare, wellness and lifestyle propositions.
A healthy outlook?
The effects of the zombie economy layered on top of the existing industry challenges will be most sharply felt by the healthcare sector in two or three years time. As a result, the sector will exhibit further radical change and realignment. Consolidation will mean familiar names disappear and new entrants emerge, and some of these new entrants will come to dominate the sector. Lasting and fundamental change in how the companies in the sector operate and act to engage with their evolving communities of customers is inevitable, and will inject life back into the market. The opportunity is to use the window that we are afforded by this lag to develop appropriate new products to adapt to this new environment.
Bob Damms is a technology expert at PA Consulting Group
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