The two horsemen of pharma's apocalypse

During the past decade, the pharmaceutical industry abandoned most of the distinctive virtues that originally inspired many people in the Delaware Valley to spend their careers working for it.  The main reason for this devolution has been pharma's slavish abandonment of its integrity while catering to Wall Street's short-term, greed über alles dictates.  The industry's whorish posture in that regard is evident from the fact that the CFO's office sets the objectives for all operations (e.g., marketing, R&D, sales, production) while enlisting HR and Purchasing as henchmen to carry out the details.

So for example, pharma has stagnated or cut R&D budgets, despite the fact that the very existence of branded pharmaceutical companies depends upon developing new compounds to improve the standards of medical care.  CFOs readily dismiss this larger rationale.  Their principal mission consists of keeping current management in their positions, a commitment requiring them to appease the vulture funds that demand rapid returns.  When topline revenues fail to grow because the industry cannot develop genuinely improved new products, then finance bolsters earnings simply by cutting expenses.  R&D suffers because, by necessity, it requires substantial spending.  This means CFOs push pharmas into a death spiral: slowing results from R&D cause budget cuts that make improved new products even less likely.

The pernicious control by finance extends across scores of operating areas.  Although no company can be better than the quality of its workforce, such basic logic fails to penetrate management by finance.  During the past five years pharma companies have dismissed thousands of experienced, capable employees over the age of 50 because finance regards workers as interchangeable commodities.  So even if scientists, sales managers, marketers and other professionals at age 50 are at their peak abilities and their replacements possess poorer functional skills, finance believes people beyond that age cost more and they're apt to take four more days of sick leave every year.  Then too, the fact that the loss of these experienced people robs their respective companies of any institutional memory doesn't bother finance managers.  HR receives the order to shove out 50+ workers as the first casualties of every layoff notice.

Detailing the numerous ways finance has caused pharma's degeneration would require several postings. Alternatively, it might be more useful to highlight a second reason behind pharma's difficulties.

A significant source of Big Pharma's problems after the year 2000 started with decisions the companies made in the mid-1990s.  Pharma has always been uneasy about developing long-term, strategic plans and this insecurity has made them perfect suckers for the top-tier consultants.  So it was that approximately 20 years ago, McKinsey and its competing soothsayers decreed to pharma that its road to riches and acclaim consisted of developing mega-blockbuster brands in the primary care categories.  As a means of pushing their brands into this "star" category, they counseled their clients to build up the largest, primary care sales forces they could hire.

McKinsey was the first among equals in this brigade of dubious wise men.  Sources who worked at two or more pharma companies during those years claim that McKinsey actually relied on many of the same slides to spin this Scheherazade's tale to several different clients in the industry.

The problem was that the sages spread their pearls of wisdom just when payers were establishing multi-tier, pharmacy benefit designs.  This trend among benefit managers and payers started the process of turning competing primary brands into commodities and it made the consultants' advice the worst course of action for large pharma companies.

Although McKinsey was the most prominent of the consultancies offering this ill-timed advice, by no means was it the only one.  A major advisor to Zeneca and then AstraZeneca during those years was Anderson Consulting, an arm of the Arthur Anderson accounting firm until 2000.

Pfizer and AstraZeneca were two of the Big Pharmas that followed the consultants' line most closely and neither company has yet fully recovered from its long folly.  Both companies, in fact, slipped into positions that make it extremely difficult for them to ever recover.

It is not difficult to discern the reasons these high-priced consultants offered advice that resulted in pharmas losing sight of their mission, suffering financial distress despite enormous margins, and eventually engaging in ethical lapses and illegal conduct.

The actual analysts and managers who do the work at the top-tier consultancies are ex-Ivy League MBAs with little to no pharmaceutical industry experience.  In fact, they implicitly disdain industry experience.  Their training leads them to believe that analysts and managers can adequately assess all business sectors by using the same techniques and principles.  The approach at the top consultancies exalts the value of willful ignorance and turns analysts there into what academics call "Artistotelians."  Basically, that's a fancy way of saying they become idiot savants who know how to work spreadsheets even as they remain generally unaware of the dynamics and subtleties of a business such as pharma that often operates counterintuitively to other sectors.  The method works to benefit the profit margins of the large consulting firms because it means they can hire young analysts who lack any industry background and, thereby, pay them lower salaries.

The consultants' notion about mega-blockbusters was earlier developed from analyses of other industries and the savants simply borrowed it for pharma.  The idea that most of a sector's revenue comes from a few products or a few customers is older than the proverbial hills, so for analysts lacking a sense of pharma's history and driving factors, it looked appealing and appeared to make sense.

The advice to pursue mega-blockbusters in primary care also reveals the underlying problem with the business research methods used by top consultants.  Absent any real sense and historical context for what works in pharma, McKinsey and its competitors sweep up all the retrospective data they can from financial statements, operating budgets and various company and industry records, even though they lack sufficient experience to place any of it in perspective.  The big consultancies claim they acquire such meaning and detachment by interviewing client personnel and other knowledgeable sources, but the process is as likely to reveal objective reality as asking an overindulgent mother if her son is a good boy.

When the Ivy League nerds advised their pharma clients to develop primary care blockbusters, they were committing the consultant's fatal sin of borrowing a client's watch to tell them the time of day.  Pharma has been notoriously, often deliberately ignorant of the larger health care system outside its own doors.  The consultants merely borrowed the same blind spot.  McKinsey and its competitors weren't required to be futurists 20 years ago.  They merely had to understand their clients' customers and the emerging business environment, yet they failed to do so.

One might think that the poor advice concerning mega-blockbusters caused Big Pharma to lose faith in the major consultancies, but that never happened.  Even though the savants misled the industry, they proceeded to earn many more millions in consulting fees by telling pharma companies how to recover from that bad advice.

The "paradigm" that the top-tier consultancies recommended during the new millennium consisted of developing specialty drugs, preferably biologicals, for less common diseases and conditions.  According to that playbook, specialty meds would enable pharmas to charge higher prices in categories with less competition, thereby making more money while selling fewer pills.

Pharma reached the pinnacle of the specialty drug approach in 2014 when Gilead launched its Sovaldi brand, a huge advancement for treating hepatitis C.  At the time Sovaldi hit the market, it was the only available product able to reduce the hepatitis C virus to undetectable levels among nearly 100% of patients who receive it.  In return for this breakthrough, Gilead was able to charge U.S. payers almost $1,000 a pill or a list price of $84,000 (before dealmaking) per patient for a 12-week course of treatment.  Although Gilead made money by selling the same course of Sovaldi treatment to India and Egypt for $500, they put public and private payers in this country over a barrel with their budget-busting price.

At last it seemed that the consultancies were on to something.  The new playbook called for pharma companies to develop niche products for serious conditions and then use extortionate pricing, despite its potential for sinking the wider U.S. health care system.  In this manner pharmaceutical companies could again generate huge revenues.

Late last year a pair of announcements by GlaxoSmithKline (GSK) made it appear that both marauding horsemen, finance and the consultancies, had descended on pharma at the same time. First GSK announced at the beginning of December a round of layoffs in the U.S. to implement a corporate strategy that became apparent after a deal they struck with Novartis earlier in the year.

In the spring of 2014 it became obvious that GSK would stop trying to develop drugs in some major specialty categories such as oncology.  As an alternative they decided to focus their efforts on consumer health and certain primary care classes such as respiratory illnesses and vaccines.

Then a few weeks after abandoning its oncology commitment and people, GSK announced a "strategic partnering" approach to clinical development that effectively amounts to outsourcing much of its clinical research responsibility to a contract research organization (CRO), Parexel.

Looking at each of these strategic initiatives separately, it is evident that the outsourcing arrangement with a CRO is prevalent across the industry.  In virtually all cases, pharma company finance departments push for the arrangement.  In some cases the companies call in consultancies to rubber stamp finance's wishes.  The reason for outsourcing R&D is that finance abhors carrying the fixed expense of full-time, clinical research employees on its books.  They prefer a situation of variable costs where pharma sponsors maintain no commitment to outsource workers beyond the life of their particular development project.

That accords with finance's short-term view of things.  The major problem with the approach, however, emerged at pharmas that began using CROs in a big way several years ago.  Lilly and Pfizer, for example, both found that over the long-term, it takes them more time to develop new drugs and it also costs them a good deal more.  Although those two companies are still held captive by their finance officers, meaning neither will abandon their "strategic partnering" approach to running clinical trials, a substantial and increasing number of R&D personnel at both companies now recognize the serious impediments this finance-mandated arrangement has created for them.

As for the consultants that urged GSK to drop oncology in favor of developing primary care and consumer products, a glaring contradiction presents itself when they declare pharma's road to riches lies through specialty products while, at the same time, they advise GSK to go in exactly the opposite direction.

The managing partners at the consultancies readily understood that the divergent paths recommended by their spreadsheet savants would leave them open to the charge of consulting out of both corners of their mouths.  Their answer was to make a virtue out of inconsistency by claiming that the specialty and the primary care paths are both subsumed under a higher strategy in which individual drug companies should focus on their "competencies."  Using this piece of sophistry, the consultants advise their clients to forget about pursuing a wide range of therapies and limit themselves to those areas where they possess some special knowledge and a reasonable likelihood of developing new products.  In other words, the consultants started advising Big Pharma clients to behave more like the niche biotech companies they used to swallow whole during merger-and-acquisition phases.

It remains to be seen whether "special competencies" confer worthwhile advantages for developing and marketing new products.  Another question concerns the profits pharmas relinquish from a narrower range of abilities if they fortuitously develop auspicious compounds outside their focus areas.  A company organized to develop and market products in, say, oncology, rheumatology and virology would need to find a partner skilled in primary care if they stumbled upon a compound with blockbuster potential in that area.  The need for such an alliance would require them to divide profits from the new drug.

In GSK's case, the consultant's recommendation to concentrate on primary care and consumer products appears more the result of frustration.  A "strategy" was likely bootlegged in to provide a respectable cover story.  After pouring substantial amounts of money and effort into R&D and failing to produce any worthwhile results in oncology, GSK's management likely believes it would take too much heat from directors and investors if they kept putting more resources into cutting edge research.

GSK's decision to limit itself to "competencies" also avoided the need for remaking R&D once again, after the company recently completed such an overhaul.  Then too, the revenue hit from the expiration of Advair's patent, together with the need to manage a nasty bribery scandal in China, limit management's attentions and place them in a situation that requires profits now rather than four years down the road.  Although a long-range development strategy may well be more beneficial going forward from 2020, management likely doubts that investors would leave them in charge of the company that long.

In other words, although it's too soon to tell, there is reason to suspect the Dirty Harry approach (a company's gotta know its limitations) that the consultants peddled to GSK represents another ill-conceived piece of nonsense that's been tarted up to look like strategy.  It will be interesting to see it it's just a convenient rationale for a beleaguered company or if McKinsey and the others will profitably peddle the idea across the industry.

In either case, finance managers and the high-powered consultants have served pharma poorly, just at the time when dealing with aggressive pharmacy benefits managers and payers requires strategic wisdom.

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