For more than 50 years the me-too element of pharma was an integral part of its business model. The process involves a company developing and launching a compound that produces almost exactly the same clinical results as other products already available in that therapeutic class. In itself this me-too phenomenon is nothing unique because analogs exist in most product markets. The difference lies in the fact that pharma operates as a cartel in which all the competitors in a given class price their brands within a tight range of one another.
For the pharmaceutical industry this has produced the benefit of eliminating price competition as a market factor. A company could introduce the fourth ARB, the fifth beta-blocker, the sixth ACE-inhibitor or the twelfth non-steroidal anti-inflammatory and still make a substantial profit, even by securing only a small market share. Of course, for payers (private insurers, government and employers) and the public, the me-too system has meant drug prices in the U.S. are at least double those of any other country in the world.
Then within the past year, something interesting started happening that may at last curtail pharma's me-too system and, thereby, jeopardize the industry's profitability. In an effort aimed at forcing pharma companies to compete on price, the larger pharmacy benefit managers (PBMs) such as Express Scripts/Medco and Caremark started to substantially restrict their formularies. That means instead of covering each of the five or six products in every therapeutic class, PBMs will increasingly limit coverage to two or three brands per class. Especially for those commodity classes where clinical differences among the competing brands are negligible, formulary inclusion will depend upon favorable pricing.
Although pharma has long tried to justify its approach with the expression, "It takes the me-too's to fund the breakthroughs," policy analysts have seen through that explanation as the phony dodge it is. Now restrictive formularies represent the wolf at the door for pharma's me-too cartel. If a company introduces the third or later brand into a therapeutic class, and fails to demonstrate a substantially superior clinical profile for it, they will either have to cut its price well below those of the older competitors or eat it. If prescribers and/or their patients prefer a brand that's not on formulary, the patient will have to pay the entire, eye-popping, full-freight price for the medication.
So someone might think that this trend of narrowing formularies would greatly increase the urgency among pharmas to develop and launch their various pipeline compounds as the first or second brand within their respective classes. Unfortunately any such urgency has failed to reach the industry's R&D leadership.
During the past ten years pharma has come to outsource a growing percentage of its new drug development to contract research organizations (CROs). That is because while pharma CEOs are massaging investors and burnishing their personal portfolios, most company operations have fallen under the deadly hand of the finance departments. One goal of chief financial officers consists of enriching the compensation of C-suite executives at their companies. Since company directors have linked executive compensation to short-term investor goals such as earnings growth and share price, CFOs try to enhance those metrics by removing fixed costs (e.g., employees and facilities) from the company's books and replacing them with variable costs.
When it comes to the clinical R&D of drug development, this pruning of fixed costs has caused CFOs to make their senior colleagues on the research side dismiss thousands of experienced people in clinical operations and retain CROs to perform that work.
It's often the case in business that outsourcing a function costs more in the long run and takes more time than doing it in-house. So it is with clinical R&D. A Sanford Bernstein study last year found that during the past decade, the median time from starting clinical studies to regulatory filing has increased by one year.
Yet the outsourcing trend shows no sign of relenting. This past June the chief executive of the second largest CRO, Covance's Joe Herring, told an investor group that while it's taken almost thirty years to reach a point where pharma outsources 50% of its drug development, “we think it’ll go to 70% a whole heck of a lot faster."
Doubtless that will be profitable for CROs, but for pharmas that wind up launching the third, fourth or fifth brand in a class and can't even get it on formulary, it's a disaster.
Despite these circumstances that require faster, more efficient drug development, pharmas reject efforts to introduce cost-effective procedures into their clinical operations. Program directors and their bosses shrug, "That's the CRO's job," as patient recruitment starts to fall behind schedule. Yet a number of circumstances at CROs, such as high personnel turnover that approaches 20% annually in some cases, prevent them from attending to the tasks that keep patient recruitment on schedule.
For the past few years, pharma's Washington lobby, the PhRMA, has used the bogus figure that it costs pharma companies $1 billion to develop each new drug. In fact, the actual, out-of-pocket cost is closer to one-tenth that amount, but $100 million is still a lot of money. It would then become a real albatross to a pharma company if revenues from a new product remain negligible for several years because its late entry and parity pricing exclude it from managed care formularies.
Most people working on study teams within pharmas are admonished by their superiors to leave clinical operations to the CRO. At the same time, their trained incapacity to depart from conventional practices remains part of their stigma as career R&D people, so innovation is a more alien concept to them than it is to their business side colleagues.
All of this raises the questions of who works on pharma's R&D side to recognize the existential threat of restricted formularies and who can accept the need for cost-effective recruitment remedies to meet the challenge?
In the past pharma has benefitted from structural conditions that enabled it to avoid genuine market competition and challenges from countervailing powers such as payers and PBMs. For example, when office-based physicians were the industry's principal customers, pharma enjoyed an asymmetry of information that made it the most profitable sector of the economy. In dealing with top-tier PBMs, however, pharma faces an adversary that is smarter, tougher and faster than others the drug company managers have faced in their patent-protected environment.
Some people in pharma think that their headlong rush into specialty drugs will bring back the leafy days by allowing them to charge extraordinarily high prices in small, niche classes where they will face few competitors for formulary spots. Others in the industry privately suggest that pharma's payoffs to elected officials will provide an exemption from economic realities. Both possibilities exist, but meanwhile the wolf's howls get louder all the time.
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