One aspect of the drug companies worth examining concerns the way they're governed.
The value of scrutinizing directors and top managers in pharma consists of learning to distinguish good from bad leadership in a research-driven industry that requires 10 years or more to develop its new products. If setting companies on the wrong course can take most of a decade to correct, it makes sense to find the best ways of starting them right and keeping them that way.
That issue was the topic of a Pennsylvania Bio breakfast meeting last week. Although the focus was on small, startup pharmas, the Big Pharmas also formed a point of reference since all the featured speakers had spent parts of their careers there.
Perhaps the morning's most impressive speaker was Brenda Gavin, a founding partner of the venture capital firm, Quaker Partners. Gavin was previously the president of S.R. One, GlaxoSmithKline's capital investment company. In addition to her obvious experience, she possesses a remarkable candor and perspicacity that nudges other speakers to display those qualities or, at the least, to avoid the platitudes and spin that characterize most senior executives.
A major satisfaction of writing this blog comes from the occasional comments of some people engaged in actually advancing health care. For example, last week's posting discussed the possibility that pharma can rise from its current funk by addressing the needs of accountable care organizations. The two comments below added substantial depth and perspective to that discussion.
The first was from Tom, who works with a major IT supplier to hospital systems. His remarks deserve quoting at length.
I'd make two points here. First, pharma missed the boat and, second, pharma missed the boat so badly that they'll find it very difficult to recover.
The outcomes models you discussed are called value-based purchasing. Payer-provider programs linked to outcomes use performance protocols as a major component of provider compensation. Hospitals are developing performance protocols and they are starting to appear in chronic care sites. As far as I'm aware, no drug company has ever made the effort to get involved in this process.
Daniel R. Hoffman
The current buzzword in health care is "hot spotting." Essentially the underlying concept has been around for some time. Urban police departments applied it successfully during the past 20 years to substantially reduce crime rates. At its heart it derives from the marketing postulate that in most product areas, 20 percent of consumers account for 80 percent of the sales.
A similar process applies in health care where a relatively small number of people are responsible for a disproportionately large amount of the costs in any community. The idea is that if these people receive upfront attention and resources, the long-term health care costs they create for the community, and thereby the total health bill, will decline.
In Camden Jeffrey Brenner demonstrated that this is precisely what happened. Over the last decade, the Kaiser-Permanente system used a hot spotting approach and reduced by 68 percent the incidence of heart attacks among its members that required hospitalization or surgery.
Although the basic idea remains straightforward, it involves a major transformation of medical practice from a reactive system into a proactive one. People at high risk for expensive, chronic illnesses require vigilant monitoring, early treatment and intensive education to adopt healthy behavior and manage their conditions.
The pharmaceutical industry's fundamental problems by now are so well known that even major consultancies have detailed them in splashy sales promotions disguised as reports. Neither the industry's managers nor these slow-witted consultants, however, have devised plausible solutions to pharma's difficulties.
Stated in the simplest terms, pharma remains in large measure unable to deliver precisely what the world's health care systems need from it — therapies to materially advance the standards of care. At the same time, the public and private systems that pay pharma's bill have grown increasingly unwilling to shell out for the molecular manipulations that have long been an integral part of the drug makers' business model. As a result, pharma barely returns the cost of capital it invests in research and development while the sector as a whole underperforms the S&P 500.
If pharma is to remain a worthwhile financial proposition, the necessary action step requires that the industry do something to generate an earnings pattern capable of attracting capital. It's not as if no plausible ideas have emerged. Some were even discussed here, here and here.
Some pharmas have made laudable efforts, but with the exception of a few small and mid-size companies, these have occurred at the margins or in niche markets. There's good reason for that. The people running the major pharmas, as well as the layer beneath them managing operations, lack the experience, imagination and the acumen to make successful ventures into areas outside of prescription drugs.
Never more than five years behind the conventional wisdom, an expensive consultancy last week issued the results of a humdrum survey in which several pharma executives admitted that the industry's business model is broken (see here). Perhaps these savants will next announce that Elvis is dead and horses no longer dive from high platforms in Atlantic City.
Also during the week, Forbes' pharma columnist Matt Herper demonstrated the industry's enormous reliance on price increases over the past decade for maintaining profitability. Price cuts by national health systems outside the U.S. have already doomed this tactic globally and, eventually, price gouging at rates three times higher than cost-of-living increases will taper off here, too.
At the same time, attracting capital has become far more difficult for biotechs and specialty startups (see here). Two principal factors create the problem. First, the collapse of the IPO market prevents the venture capital funds that traditionally backed biotechs and startups from readily cashing out to secure their gains. Second, the trend by regulatory agencies to more rigorously review drug applications increases development time to the point where biopharma companies no longer fit into VCs' mid-stage funding strategy. While these developments cede the role of major funder to the Big pharmas, the biggies will only provide support at the later development stages, and then only on the basis of performance milestones.
As biotechs and startups continue to assume a larger share of the responsibility for fulfilling pharma's historic mission of developing better drugs, an obvious question then emerges. If the current business seems gloomy to the point where it's become tough to attract capital, and abusive price increases can't continue to drive profits, then what business can pharma pursue?
Karen Tibbals worked for many years as a market researcher for some large pharma companies. She recently left pharma and marketing research to enter divinity school. At the same time, she started her own blog. For her first post, Tibbals discussed the need for innovation in marketing research. The second one described how the preferred vendor system in pharma specifically stifles this sort of necessary originality.
With Finance and its henchmen in Purchasing and HR running pharma's operations, intangibles such as insight, veracity and innovation are low priorities when it comes to selecting suppliers. Finance and its minions claim that such qualities, in fact, don't really exist because they are not easily quantifiable or amenable to spreadsheet analysis. Absent such characteristics, marketing research becomes a commodity service that the pharmas can retain on a lowest cost basis. Some companies even go so far as to make supplier candidates compete for retainers by means of negative auctions -- lowest bidder wins. Since it works for hog bellies and soybeans, why not use it for marketing research?
The process isn't confined to staff support services such as marketing research. The preferred vendor system also led to production problems and recalls in every division of Johnson & Johnson: pharmaceuticals, consumer products, devices and diagnostics. Quality assurance and other production people started complaining about requirements to use low bid vendors, yet Finance and Purchasing just shrugged as the recalls started coming every other week. Meanwhile the CEO who looked the other way received $143 million as a goodbye kiss from the board of directors while he moved his chair down the hall from chief executive to chairman.
Pharma's current struggles with patent expirations, unethical and illegal practices, payer cost constraints, and unproductive new product development suggest the need for one basic quality among the businesses that support the industry. People may use different terms to describe it and apply the approach in a thousand separate ways, but essentially it consists of truth telling. The necessary practices all begin with telling the client pharmas how the world is working, together with the fact that their current approaches aren't adequately addressing those realities. Yet that is exactly the sort of professional integrity that the preferred vendors systems eliminate.
Last year, as reauthorizing legislation for the Food and Drug Administration was nearing ratification, the Obama administration urged the agency to speed its approval process for new drug candidates. It appears uncertain whether the administration was buying the pharma line that stringent regulatory review costs jobs or if the White House staff counseled bending over backwards for hostile Republicans by favoring a policy of lax regulation.
Despite the administration's election season posturing, Democrats have traditionally encouraged a rigorous FDA. Democratic congressmen such as Henry Waxman and John Dingell in the House, together with their party colleagues elsewhere in Washington, generally held the FDA's feet to the fire by demanding careful reviews. But Republicans have also come down on both sides of favoring tough versus lenient drug regulation. Charles Grassley, Republican senator from Iowa, remains one of the staunchest legislators in terms of demanding that the FDA not act as the drug industry's pet.
The example of Grassley notwithstanding, conservatives generally favor public policies that emphasize "values." Typically, this means a combination of repressive Victorian morality and a despotic Christian theology. But the term they prefer to use in connection with their animating regulatory principle is "freedom," defined as a lack of government restrictions. In practice, they pursue freedom as it permits wealthy individuals and corporations to exploit advantages in the market.
Sabeel Rahman of Harvard makes the point that over the past 100 years, progressive reformers in the U.S. have also opposed dangers to freedom that come from sources beside arbitrary state power. Powerful private entities such as corporations pose an even more intrusive threat to individual freedom. In this progressive vision, "government is not an obstacle to freedom that must be dismantled; rather it is a vital tool that can help expand individual freedom."
Just this week, another self-proclaimed savant (see here) declared that pharma's historic mission of developing new drugs to advance curative medicine is dead. In this case, the would-be guru runs a tech company with products for enhancing the electronic connectivity of patients and their health care professionals. His previous work involved advising hospitals on information management for a major consultancy and, before that, he spent a dozen years at Microsoft working on health care IT.
Thus, it should come as no surprise that he suggests that pharma quit trying to develop, manufacture and market new drugs. He recommends, instead, that the industry become a service supplier, using its well developed contacts with physicians, pharmacy chains, managed care organizations and other health care stakeholders to underwrite and promote the very tech services this soothsayer-pitchman offers.
In most cases, critiques of thinly disguised self-promotions are not worth the effort, but one or two points here do merit a quick rebuke. To support his recommendation, the guru resurrects a 50-year-old article by a Harvard Business school lecturer. Its decrepitude means that many people may not even be familiar with the putdowns that consigned this classic article to the lumber room (see the 1975 reprint here), so a brief revisit seems in order.
Professor Theodore Levitt recounted a bit of railroad history from the post-World War II era to make his point that business leaders must constantly re-imagine the scope of their respective domains. In 1945, according to Levitt's narrative, the railroad companies maintained substantial interests in the still embryonic airline industry, yet the rail magnates failed to capitalize on their opportunities and sold out their interests. Their failure, according to Levitt, rested on their conception that they were in the railroad business rather than the transportation business. Had they possessed the vision to expand their horizons, Levitt suggests, planes that now say American or United would instead carry the logo of Atchison, Topeka & Santa Fe.
It takes a lot to elicit a defense of Big Pharma from these quarters, but a deceptive attack by the radical right has motivated just such an effort.
It seems that nothing escapes the right's malevolent gaze, even an industry such as pharma that embodies the capitalist demiurge. But as a big business, pharma requires the government and its functions of regulation, infrastructure, public education and an economic safety net. That sets the Right's teeth on edge and leads them to denounce business pragmatism as a sellout of 18th-century principles.
The case at hand is an article last week by Avik Roy that appeared in Forbes, the publication of ur-plutocrat Steve Forbes. Roy is a fellow at a right wing think tank, the Manhattan Institute, and a contributor to the National Review, a publication now too extreme even for the son of its founder, William F. Buckley.
The kernel of Roy's argument is quite simple — too simple, in fact. He contends that Big Pharma and its lobbying organization, the Pharmaceutical Research and Manufacturers of America (PhRMA), diluted legislation that would have "turbocharged" drug development by substantially weakening the FDA review process. Roy sees no contradiction or irony in big drug companies' favoring strict, arduous, expensive requirements for drug approval. He believes that a fast, inexpensive process for meeting lax standards would allow small biotechs and startups to register their compounds by themselves rather than partnering with Big Pharmas. The longer process obliges the small companies to obtain financing and regulatory guidance from the Big Pharmas and Roy claims that allows the latter to "skim ... the cream off of biotech pipelines for their own purposes."
One of the movies that will receive attention and possibly some awards on Oscar night is Moneyball, based on the true story of baseball's Oakland Athletics. Now it appears that some people in pharma are trying to copy what Oakland and other baseball teams did a decade ago. The likely result is that in pharma, as in baseball, not much will change.
The essence of the Moneyball story is that Oakland, as a small-market team, could not compete with teams in New York, Boston, Los Angeles and other major markets by paying exorbitant prices for free agent ballplayers. To help overcome that handicap, their general manager hired three econometricians (reduced to one character for the movie) to develop stochastic models (complex statistical and mathematical formulas) that could identify unappreciated performance indicators. By seeing which ballplayers excelled on these arcane measures, the A's were able to buy their contracts for relatively inexpensive amounts because wealthier teams didn't bid up the cost.
The A's enjoyed remarkable success in 2002, the first season in which they used quantitative modeling. Their results have been far less successful in subsequent years. Over the nine seasons beginning with 2003, the A's made the playoffs twice. In the last five years their mediocre records failed to even qualify them for the playoffs and they are now what used to be called a "second division" team.
In baseball, the A's haven't produced winners in recent years because the big-market teams also started to use the arcane percentages and formulas, but mainly for selecting the role players to round out their rosters. The stars are still chosen by competitive bidding, and in that contest big money is everything. So even as the mathematical models no longer gave Oakland a competitive advantage, perhaps more important, the wealthier teams were also able to acquire two or more players for various team roles. That allowed them to keep winning when the inevitable injuries or slumps occurred.