The Global Pharmaceutical Industry - Case Study Example

The Global Pharmaceutical Industry Case overview and analysis– This case “The global pharmaceutical industry” describes the impact of external and internal environment factors which are responsible to change the industry structures and strategies for drug discovery process, research and development, manufacturing and sales and marketing of prescription drugs over a period of time. In the initial phase of the pharmaceutical industry, it was less regulated and relatively stable. Although, the scenario was less competitive but requirement of huge investment in R&D and patent protection rights created high entry barriers for new players in the industry. During the 1960’s the main key drivers of the growth was innovation in the new drugs development while 1970’s, legislation regarding period for patent protection (20 years from the initial filing) resulted in entry of generic drugs into the market and industry becomes much competitive. This had lead to a price war in the industry and scenario became highly competitive and government regulated. The decade of 1980’s was of evolution of biotechnology firms and because of the strong purchaser power, share of blockbuster drugs in bottom line of the companies, intense competition and government interventions made the industry less profitable with unstable future. The case throws a light on the key success factors of the pharmaceutical companies across globe but mainly from US, Europe and Japan. The case covers issues related with global industry environment and driving forces like regulatory and legislative issues, changing demographic scenario of the world, increasing pricing disparities, industry consolidation, mergers and acquisitions, emergence of new potential players like China and India and technology development. Issues related with corporate social responsibility have been discussed too. All these factors created a greater impact. Some of them were become opportunities in the industry whereas rest became threats to the industry. Aging populations and increasing unmet demands of consumers were creating a tremendous opportunity for the future growth scenario in this industry. Countries like India, China, Brazil and other south and East Asian countries were emerging as a potential new market. A lot of MNC were taken a global position from these countries. Opportunities in these markets were the key driver to increase the overall spending on R&D and innovation expenditure for companies across the globe. Overall health care cost for government and consumers were increasing year by year and supporting a growth rate for health care industry which is more than the GDP of the country. This had been created an unstable scenario for this industry. To get a competitive advantage over competition or to go beyond the competition, R&D expenditure was the only source for the company so there was increased in R&D investment for firms. Average cost for a drug development process had been grown up to $1.4bn in 2003 from $ 231mn in 1981. At the same time the average R&D expenditure for global firms went up to $60bn in 2006 but the launch of no. of new drugs in the market had been reduced. It was less than the previous years. Due to decrease in patent protection period, companies were facing problems with recovering R&D costs because of the short patent expiration period. Short patent protection period became a major threat for company’s profit and investment in R&D processes. Generics drugs manufacturers were selling drugs at low prices before the expiration of patent this had given a severe threat to patented drugs. The emergence of new diseases like HIV AIDS increased the corporate social responsibility on pharmaceuticals companies. Although this industry is serving the human mankind from its evolution but spending on awareness camps and free distribution of drugs or at lower price reduced the profitability of the companies. The affect of globalization was such that to compete globally on the basis of cost, quality, differentiation and value for money, companies went for the consolidation and mergers and acquisitions. The rational behind that is the bigger size will give them these advantages like low manufacturing cost and synergy effect in all parts of the business. The number of mergers and acquisitions were increased in the pharmaceutical industry and to get the synergy effect. The issues which are to be solved are the growing disparities in the prices at global level, global level strategies as per the current market scenario, threat of the price wars from generic drug, unstable market across globe, issues of patent expirations, viability of R&D investment etc. Models used for analysis - The environmental analysis can be done by using various models like Porter’s Five force model for industry analysis and PESTEL (Political, Economical, Social, Technological, Environmental and Legal perspectives) for macro economic environmental analysis. 1. Porter’s Five Forces Model – To identify the significant forces prevailing in the industry, it becomes imperative to use this model. It helps us to figure out the environmental and competitive forces which will affect the industry in the near future. These major five forces includes – 1. Threat of the substitute products 2. Threat of the new entrance 3. Bargaining power of buyers 4. Bargaining power of suppliers 5. Competitive rivalry within the industry Implication of these forces is that, strong the impact of these forces makes the industry less attractive, unstable in the near future and the scenario will be highly competitive to get high returns. (Figure 1 and figure 2 at the end of this report includes porter’s five force framework and factors affecting the business environment under this model) 1. Threat of entry – This influences the degree of competition within industry. As the entry barriers are low for new players then it becomes easy to enter into the business which gives rise to the competition. The level of entry and exit barriers decides the degree of rivalry in the industry. High entry and exit barriers give advantages to the existing players in the market. In this case there are certain factors which determine the level of entry and exit barriers to this industry. 1. From the initial phase of this industry, it has some high barriers to entry of new players in this industry. The industry requires huge amount of investment in research and development of new drugs. R&D cost for companies are increasing year by year. As the data given in the case that R&D expenditure went up to $60bn in 2006 from a few millions in 1960’s. R&D cycle time, clinical testing time and lead time has been increased for the drug development questioned the viability of R&D investment. As given in the case that from 26 trials involving 1500 patients in 1980’s, it went up to 65 trials involving over 4000 patients in 1995. This makes the clinical trial system more complex and lengthy. 2. For manufacturing of drug it requires expertise and knowledge base workforce. Requirement of large and expensive work force creates an entry barrier for new players. 3. Requirement of sales force in the form of representatives was high during the initial and emerging phase of this industry. Because of the price wars and changing consumer preferences the scenario of marketing and distribution had been changed, for companies there is a requirement of huge investment in the marketing (Direct to customer - DTC) and large distribution network to get the positive returns. In 2006, the spending on DTC advertising in USA went up to $4.5bn. 4. High emphasis on the role of corporate social responsibility shifted the focus to disease prevention. As mentioned under the evidences given in the case about Merck and GSK. 5. Government interventions, legislations and regulations like price controls, reimbursements, less patent protection time etc. had created high entry barriers to this industry because it takes a lot of time to recover the R&D cost. 6. The prevailing strategy of consolidation and mergers and acquisition will give no space for new players to grow. The existing big players will eat up the new players in order to be a bigger size firm. 2. Threat of substitutes – Substitutes of the products will result in decrease in the demand of the existing product as it will provide the same benefit as of the original products. Rather than creating a new market, substitutes will take its share from the exiting pie and this will result in the competition on the basis of price and quality in the market. There are certain factors pertaining to this case which determines the pie for existing products for existing players in this industry. 1. Introduction of the generic drugs (same active ingredient as the patented drugs) in the pharmaceutical market gave a strong shock to the existing players. Reason being that cost of manufacturing of generic drugs is normally very much less than the cost for patented drugs and the lead time is also short for these drugs. This gives an incentive to sell these drugs at a cheaper cost. Generic drugs created a price war in the market and it captures a huge market share in a small period of time. During 2001 to 2005 sales growth fell from 18% to 8% for patented drugs and generic drugs recorded a growth of 40% by volume whereas patented drugs recorded a decline of 4% by volume. 2. Medicines launched by biotech firm were also became a substitutes for the products. These were successful in the market because of less lead time, less cost and high safety scores. It was contributing the 25% of global sales in 2006. Although in the initial years it made loses to recover cost but soon it will reap benefits. Biotech firms were contributing an increasing share of the industry’s new products via in-licensing deals. 3. Changes in consumer’s preferences and increasing use of alternative remedies and cures gives a demand shock to the existing players. There was a shift from prescription drugs to over the counter drugs. The market of OTC drugs was estimated $16bn with a growth rate of 3%. 4. Companies which are having me-too drugs became successful because they had a competitive advantage over others. Their return on investment was better than the industry average. 3. Bargaining power of buyers – The profit margin for any company depends on the degree of bargaining power it has with it. If this bargaining power shifts to the consumers then profit margins can take a toss. In this case issues related to bargaining power of buyers had been highlighted. 1. Earlier the decision taking power to buy any medicines was into the hands of doctors and consumers were less aware about the products. But due to the rise in consumer’s awareness and introduction of the Over the counter drugs (OTC) and the number of options available with them resulted in high price sensitivity and less brand loyalty among consumers. 2. Price sensitivity of consumers forced doctors to prescribe the cheap generic drugs. 3. Government has become the major purchasers of medicines. Bulk purchasing policy gave the bargaining power in their hands. Government policies like price controls, reimbursement and negotiate pricing resulted in low profit margins for companies. 4. Switching cost for any consumer is very less which gives a disadvantage to the market players. 5. Globalization resulted in pricing disparities among countries; this gave birth to the parallel trade practice. For example Lipitor was $3.20 per pill in USA in 2003, compared with $1.89 per pill in Canada. 6. The awareness among consumer was increased over a period of time, this lead to shift in decision making. 4. Bargaining powers with suppliers - This determines the cost of goods sold to the company, as the bargaining power will be in the hands of suppliers of raw material then the cost of manufacturing will go up for the company. There are relevant issues in this case under this head. 1. Due to the continuous rise in the inflation figure there is continuous rise in the cost of ingredients as a percentage of total cost to the company. 2. This industry requires huge expert and knowledge based work force, which is very expensive for the company. So they need to pay higher amount to their work forces. 3. The cost structure as given in the case includes 12% to 21% for R&D 10% Administration cost 25% sales and marketing cost 25% manufacturing cost and the remaining 19% to 28% as profit margin and other expenses. As the expense on R&D and sales & marketing were going up, and the price wars in the industry had putted all pressure on the manufacturing cost of the drugs which in turns created pressure on bargaining power of the company on suppliers end. 5. Competitive rivalry – As the figure 1 shows that all the above 4 forces create a huge impact on the competitive rivalry among existing players. Be it low barriers for entry and exit, availability of substitutes and low bargaining power with buyers and suppliers, these all result in intense competition among player in the basis of price, quality, differentiation, and value for money etc. In this case also we can find out a number of factors which will help us to judge the intense competition within industry. 1. As practice of consolidation and merger and acquisition is prevailing in the current phase because companies wanted to go for economies of scale and more efficient R&D, leveraging the synergy effect in terms of cost, profit margins, innovation, drug development, sales and marketing force, distribution network etc. 2. A large number of players in this industry created a competitive scenario because for the same pie the number of shareholder is greater. 3. Firms having advantage in terms of R&D cycle time, lead time will have a competitive advantage. 4. Introduction of generic drugs and biotech firms converted this industry into Red Ocean (price war). 5. Emergence of over the counter drugs and direct to customer marketing has changed the industry structure and it become more competitive now. 6. Ageing population, increase in health care spending and potential markets in countries like India, china etc. which is creating opportunities for new companies to come in. 7. Government regulation regarding patent protection, price controls, reimbursements are the reason for declining profit margins and rivalry among players. Conclusion – The above five force model analysis gives us a clear picture about the industry. Although there are ample opportunities of growth in this industry but looking at the government interventions, declining profit margins, intense price competitions, huge investment requirement in production, R&D, larger sales force and distribution network etc. we can say that for new companies it is not an attractive scene to enter in. The current strategies adopted by companies will not work in long run as the industry structure and business model is changing from business to business marketing to direct to customer (DTC) marketing. 2. PESTEL Analysis Political, economic, social, technological, environmental and legal analysis A PESTEL analysis is useful to evaluate the macro-economic environment of the industry. This analysis becomes important when industry is going through globalization phase and key drivers for the industry had undergone a sudden change. There are certain key drivers to this industry which might lead to change in macro economic environment. PESTEL framework gives idea about failure and success of any strategies. PESTEL includes six different perspectives to any strategy which are political, economic, social, technological, environmental and legal aspect. It is imperative to evaluate the future changes in these aspects. PESTEL framework helps us to figure out that which factors should given most priority. In this case also it is vital to evaluate the macro economic perspectives. 1. Political Due to the government interventions, health care systems and spending government had become a bulk purchase for pharmaceutical industry across nations. To control the rising prices and health care spending in the 1980s and 1990s, governments’ regulation had been increased. Globalization created a pressure on industry, for an example free trade policy of European Union for its member countries raised issues like inter-country pricing disparities and parallel trade. Parallel trade will continue to be a significant issue because of the role of governments in setting prices and reimbursement policies, resulting in significant pricing disparities that are likely to remain entrenched. 2. Economic Whole economics round around demand and supply. There were some demand side factors and some supply side factors which determines the strategies for any company. On the demand side earlier consumers had little impact on buying decision about choice and price because the trend was of prescribed medicines. Companies tried to make impact on doctors to make them prescribe their brand. In spite of the inflation consumers were become less price sensitive as insurer will pay the amount. To control the health care cost government imposed some price controls and reimbursement facilities. Emergence of new potential markets and aging population were driving unmet demand for the products. On the supply side global pharmaceutical market only a few company were holding more than 80% of the total market share. Top 10 players were having over 50% of the global sales and Pifzer were having 8.4% market share in year 2005. Spending on R&D has been increased but the number of the launch of new drugs in the market has decreased. The average resource cost for developing a new drug grown up to $1.4bn in 2003 from $ 231mn in 1981 although the average R&D expenditure was $ 60bn in 2006. Investment in R&D shows that companies have future plans in their pipe line and supply will go up. Due to globalization companies were revising their product portfolios. 3. Social - As the awareness level went up the consumers were enable to do the risk benefit analysis before buying any product. The high awareness level resulted in consumer oriented marketing as the market of OTC went up. Companies focused on pull strategy and adopted the new means with information technology developments to provide detailed healthcare information. Demographic scenario was changing and aging population was becoming the key driver for the growth. Emphasis on ethical and issues related to corporate social responsibility had been increased. Pharmaceutical companies were getting benefited from human suffering and companies had patents for the causes people are dying of. Being ethical suggests that companies should not put short term profit ahead of the well being of patients. CSR issues changes the entire industry structure and business model. 4. Technological and environmental forces - Innovation and technological development is the major key driver for this industry. Investment in drug discovery process and success of the drugs made the future of the companies. The case describes that companies are going for mergers and acquisitions to get cost advantages through economies of scale, leveraging synergy effect on R&D facilities, distribution network, knowledge and expertise sharing etc. Facts show that R&D will continue to be an important part of this industry. 5. Legal forces Government intervention changed the strategies of the companies. Government decided the time duration of patent protection. Regulatory controls were in place for reducing cost to the company as well as consumers. Legislative issues like price controls and reimbursement were increasing rapidly. Conclusion – In conclusion we can say that that global competition in pharmaceutical industry has increased. While formulating strategies companies should keep a track of government regulation because it can change the industry structure. Key drivers like changing marketing strategies and distribution network across countries were become more important because of globalization. Implications of the changing business environment on pharmaceutical firms - After having done with industry analysis and macro economic analysis by using porter’s five force and PESTEL analysis models respectively, we can say that the external and internal environment scenario is facing a rapid change, which brings various opportunities like harmonization of regulatory environment and threats like purchasers power pressure, viability of R&D investment. Companies are still investing in R&D and marketing which shows their concern about the long-term viability. Companies wanted to have profitable products in their product portfolios so consolidation of the players will not be a sustainable strategy, only having basket with innovative products and reach of the product across globe to take out positive returns will work. The reason behind this is that companies can charge price premiums only for the differentiation they will offer to the consumers. Although market for generic drugs and other me-too products will keep rising but history suggests that a single product can change the future of the company. As per the market scenario and industry structure is changing, so to cope up with the growth and to beat the competition there are certain business implication should adopt by companies while formulating strategies. 1. Shortening of product life cycle and increase in the drug development process has changed the overall situation. Earlier companies made profits because of the success of the blockbuster drugs. But now in order to remain in market and having a competitive advantage over others companies should invest in R&D and innovation in the business. Continuous Innovation will give a sustainable base to the companies. 2. In order to get the positive sustainable returns from the market companies should reduce their R&D cycle time and work on effective clinical trials. Rather than reactive to any new diseases, companies need to be pro-active with a solution available with them. 3. Globalization has increased the requirement of large sales forces which might be expensive but it is important to maintain top line as well as bottom line. Looking at the prevailing price wars in the industry economies of scale will give a cost advantage to the companies. Mergers and acquisitions will work only it can reap the synergy effect. 4. Transformation of marketing practices is vital as the market fir over the counter drugs has been increased. Direct to customer or consumer oriented marketing will be successful. 5. Relationship marketing will work better in this scenario, keeping good relations with major purchaser will give a long term benefit to the company. 6. Educating the customers about the benefits of taking patented drugs as it reduces the overall hospital cost and provide better safety. 7. Decision regarding product portfolio of companies will be very important. To summarize, we can say that although the pharmaceutical industry is working for a good cause and saving human life but because o the substitute products, R&D costs, government regulation, short product life cycle, problems in product approval, controlling prices and increase in sales and marketing cost were causing decline in profit for companies and they are struggling to survive. Purchasing power of buyers and buying in bulks are reason for extracting huge benefits from the manufacturer’s share. Still market is full of opportunities and unmet demands of consumers. In spite of focusing on Industry consolidation in order to become big in size without having any synergy effect, companies should go for development of new drugs and investment in meaning. Still it is hard to predict the future growth of industry. Figure 1 - Framework of Porter's Five Forces Model Figure 2- Forces affecting pharmaceutical industry under porter's framework Works Cited Gerry Johnson, Kevan Scholes, Richard Whittington. "The Environment ." Exploring corporate strategy . Pearson Education, 07 Dec 2007. 52 - 67. Holland, Sarah. "The Global Pharmaceutical Industry." Gerry Johnson, Kven Scholes, Richard Whittington. Exploring Corporate Strategy 8th edition. Pearson Education, 07 Dec 2007. 608 - 618. Read More