Pharma's 2014 outlook and Merck's changing culture

Citigroup recently issued its 2014 outlook for European and US pharmaceutical companies.  While their outlook is generally bullish, the positive signs they emphasize for the industry are more notable for what they omit than for what they tout. 

For example, some of their up-indicators include a more permissive reimbursement environment in the U.S. due to Obamacare, the FDA's increasing laxity and speed of approval, the eagerness of pharmas to prop up stock prices by share buybacks and high dividends, wildly increasing biotech valuations and, that moldy evergreen, the growth of emerging markets.

These reasons behind Citigroup's optimism are at least debatable.  For example, equity prices in biopharma are indeed approaching bubble status, but certainly part of that high valuation comes from investors in a no-inflation environment who are desperately seeking any sort of positive return.  This desperation plus a perception of pharma's "stability" (a favorable spin on the industry's snailpaced mobility) has led investors to bid up stock prices.  The relatively high dividends pharmas pay, together with their ambitious share buyback programs, make their equities the functional equivalent of bonds.  Of course, when inflation and interest rates return to historic levels, bond values tend to sink accordingly. 

The bloom has also faded on emerging global markets over the past year or two, given that countries such as China and India have made plain their refusal to pay anything remotely comparable to pharma's prices in the west.  It has also become apparent that emerging countries want to grow their domestic pharmas at the expense of western multinationals.

But most of these issues are arguable and, in any case, it will likely take a few years before their their stories play out.  What's more interesting right now is that the only new, breakthrough product area highlighted by the Citigroup analysts was the oncology immunotherapies.  While these clearly do seem promising, pharma's business plan for them involves making more money (+/- $80,000 per patient per year) from fewer pills or injections.  This approach creates some serious risks.  Insurers are not likely to sit still while routinely paying roughly $100,000 for a few weeks of therapy on a growing number of patients.  The fact that payers and their PBMs (e.g., Express Scrips/Medco) are insisting that patients share the risk and burden of this pharma strategy means that many people will face the dilemma of paying $20,000-$50,000 out of their own pockets to keep a family member alive.  That's a crisis waiting to happen and pharma makes an inviting target for politicians looking for ways to resolve it.



Right after Christmas Merck spokespeople told the Wall Street Journal (see here) that they intend to reorganize their R&D by creating designated "hubs" around the world to identify and work on auspicious research approaches.  These hubs will be located in or near the cities of Boston, the San Francisco, London and Shanghai.  By getting its researchers closely involved with their outside counterparts around the world, the hubs would presumably put Merck in an advantageous position to license or acquire the mechanisms and compounds that grab their attention. 

This shift in Merck's approach to research generated a fair amount of discussion around the industry, including some predictable comments about why or why not such a move can succeed.  Most of those thumbs up or thumbs down reviews mention well known dynamics, such as the fact that progress in breakthrough drug discovery will remain slow, whether pharmas do their research in-house or through proxies, because scientists lack an understanding of the human biology that must provide a precursor to major therapeutic advances.  Other discussions essentially just trot out the well known problems inherent in drug research (see here).  The discussion comes down to a question of whether outsourcing drug discovery and development (i.e., search and develop or S&D) is better than R&D.

At least in its current format, the issue is not a new one.  Perhaps a dozen years ago Daniel Vasella, then CEO at Novartis, launched his company on the same sort of development strategy, albeit in a less formalized manner and with lower funding.  An astute observer at the time said he didn't think it would make a major difference whether Vasella placed all his chips at one roulette wheel or decided to lay smaller numbers of them at several gambling tables around the casino floor.

What's notable in the Merck announcement is that Merck has historically been the most egregious of the Big Pharmas in its dysfunctionally arrogant dismissal of not-invented-here efforts.  For that reason the announcement provides another indicator that new R&D head Roger Perlmutter intends to make good on his promise to break up the Merck culture.

Only last week Perlmutter spoke to investors and told them that R&D executives at Merck can now pursue deals on their own to buy or in-license products for the company.  Instead of deferring to a CFO who caters to Wall Street's short-term demands for earnings and share price über alles, R&D will just instruct finance to handle the details of deals, merely to "speed up the process." (See here.) 

It remains to be seen whether this proper redistrbution of corporate authority actually occurs, but the fact that an executive in Perlmutter's position even sends this message to investors is inspiring.

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