Pharma's Denial and Rationalization Working Overtime

Evidence emerges almost every day that pharma's managers recognize the existence of serious problems threatening their industry, while at the same time most of them refuse to acknowledge the causes of this situation.

Last week, for example, a provider of online marketing research released the results of a survey with 500 people in the industry (see here). Almost three-quarters of them (72.4%) agreed with the statement that profitability levels in industry are "changing dramatically as a result of the current global economic climate." Almost one-third (31.7%) expect staffing at their respective companies will decline, while more than 50% "were worried that their role may be made redundant in the next 12 months."

These numbers amply suggest that pharma personnel know the wolf is at the industry's door. So what factor or factors do they mention as the reasons behind these circumstances? Almost 64% said that stricter regulatory procedures are putting a choke hold on growth. Of the many dozen excuses that pharma's apologists could muster for their problems, this reflexive tendency to blame the referees is probably the least persuasive and the one most indicative of a refusal to accept reality.

This denial of the true factors behind pharma's difficulties means the situation will only get worse before it can ever get better. For example, in Sunday's Inquirer, Robert Calandra interviewed Joel Ario, a former Pennsylvania insurance commissioner (see here) about the insurance exchanges that will be available starting October 1. Ario's concluding remark about the new insurance plans was, " 'People are going to say, there is more cost-sharing than they thought.' " That is another way of highlighting the trend among insurers to move away from defined benefit plans toward co-insurance, a situation that will turn the screws on pharma even tighter.

Under a co-insurance plan, instead of a consumer making a co-payment of, say, $10 to $25, the patient would be on the hook for 20-40% of whatever it costs to fill that prescription. So if someone has MS and requires a medication costing $50,000 a year, a figure that is typical for that condition, she would have to pay between $10,000 and $20,000 every year.

This coming change to insurance plans will also strike people between the eyes if they are among the scores of millions who take chronic medications for conditions such as controlling their cholesterol, blood pressure or blood sugar. The annual cost for each of those medications is approximately $2,500 per patient. Instead of extracting $180 per year from their wallets as co-payment, a patient's annual per patient cost for the same medication will rise to $500-$1,000.

A fundamental tenet of the Affordable Care Act (aka Obamacare) is that all parties in the health care system should "have some skin in the game," meaning they should share in the risks and benefits associated with costs and outcomes. If that causes the out-of-pocket costs patients pay for new, more expensive medications to substantially rise, then the Republican think tank ideologues who inspired this health care plan believe that's all to the good. But their notion of the omniscient, ultimately benevolent market as life's best regulator also means those patients will turn their anger at high drug prices against the pharma companies.

A mounting wave of public resentment will have far more dire consequences for pharma than the unfocused disdain usually directed at the industry. Pharma is able to blunt the effects of their industry's poor image through massive lobbying and public relations. Under a co-insurance model, however, the direct effects on individual patients will be a lot more severe. The knowledge that one faces a choice between ponying up $20,000 a year for drugs or dying tends to concentrate the mind.

The blowbacks from a co-insurance system represent only one of the mounting hazards that pharma must face. The industry's trough of innovation and the collapse of its business model create others.

Previous posts in this space have suggested that until R&D can create scientific breakthroughs that enormously advance the standards of care, pharma should look to other areas of health care for generating returns on capital. The finance people who run all industry operations and possess final say on capital ventures have disparaged such counsel. Since few if any legal areas of business generate the net operating margins of branded pharmaceuticals, the finance people are loathe to allow such departures. Recently, however, a top-tier device company has shown the pharma dinosaurs that innovative business ventures can be preferable to extinction.

Medtronic is a leading medical device company with annual sales approaching $17 billion. A few days ago it purchased Cardiocom, a closely held disease management company. Medtronic's devices for congestive heart failure and other conditions have encountered obstacles to sales penetration as a result of cuts to Medicare reimbursement and the poor economy which causes patients to defer procedures. For that reason Medtronic believes this acquisition will open new market opportunities for them in areas such as heart failure and diabetes -- and not necessarily as a foot in the door to sell their devices. They believe they can sell the disease management service to hospitals that are frantically trying to reduce the penalty costs associated with readmissions, as well as to payers that want to reduce short- and mid-term costs. Medtronic's disease management services can help such customers achieve precisely those results.

In the immediate future Medtronic's new venture into health care services will account for just a small portion of its total sales, but the point is that it represents a smart diversification into an area of growing opportunity. Medtronic, it appears, takes a broader view of the health care arena than most pharmas do and their scan shows them that payers such as Aetna are looking beyond their traditional businesses to address growing service needs.

Pharma would do well to take note of these initiatives by leaders in other health care sectors. 

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