Sunday, December 28, 2014

Three things Pharma can learn from tech

As third-quarter earnings season moves to a close, the general impression on Wall Street is that the period was at best lackluster for Big Cap pharma. Some might claim that a series of uninspiring or even a dreary earnings reports represent a major accomplishment, given that the patent cliff persists and the industry's R&D productivity remains in a trough. But pharma's managements distort all operations, even as they develop strategies and misuse capital for the sake of quarterly earnings, so no one should get enthusiastic after seeing a rouged up glow on the numbers.

Three things Pharma can learn from tech

As third-quarter earnings season moves to a close, the general impression on Wall Street is that the period was at best lackluster for Big Cap pharma.  Some might claim that a series of uninspiring or even a dreary earnings reports represent a major accomplishment, given that the patent cliff persists and the industry's R&D productivity remains in a trough.  But pharma's managements distort all operations, even as they develop strategies and misuse capital for the sake of quarterly earnings, so no one should get enthusiastic after seeing a rouged up glow on the numbers.

As far as improving its fundamental prospects for long-term growth, however, pharma might do well to look at some tech companies for inspiration.  Last week the Wall Street Journal's tech columnist, Farhad Manjoo, suggested a few strategies (see here) that merit strong consideration in pharma's creaky C-suites.

Apple also reported its earnings last week and while the numbers were mixed, the company faces a more important challenge from the corporate activist, Carl Icahn.  Icahn recently acquired enough shares in Apple to gain the receptive ears of the company's other investors.  He wants management to "return" a substantial part of its $147 billion in cash assets to shareholders by means of a stock buyback program.  Big Cap pharmas have been doing precisely that, even borrowing money to repurchase shares and make high dividend payments.

Majoo thinks that's a terrible idea for Apple.  Instead he proposes a few more constructive ways that Apple can invest its cash to enhance the company's long-term growth and sustainability.  This raises the question about which of the alternatives to share buybacks and high yield dividends pharma can apply to the drug business.

The first strategy consists of using capital to vertically integrate.  In the case of Apple, two of those integration initiatives involve competing with Google by building its own search engine and another would have them competing with Verizon and AT&T by building its own cellular network.

Competing with Google on a search engine is an intriguing prospect.  Despite the fact that Google has a presence in myriad software and hardware businesses, revenue from the search engine is what drives the company.  It allows Google to intentionally operate on thin margins or even lose money in some of its operations because these can ultimately feed revenue to the search engine.  So for example, Google bought Motorola's cell phone business which it will use to offer full-featured smartphones at a fraction of the price that Apple and Samsung charge.  Google can afford to lose money on its cell phone business because its goal is to drive down price levels across that industry.  Cheaper cell phones mean more people using them for online activity.  That means more people will do more searches that Google can analyze, track and sell to other companies.

The other vertical integration concerning building or buying a cellular carrier also seems interesting.  As sales in personal computers decline, the cellular business provides Apple, Microsoft and the other tech giants with a growth opportunity.  Although individual consumers decide whether they want to buy a smartphone from Apple, Samsung, HTC or one of the others, the telecom carriers are the real customers of these IT/electronics companies.  For the carriers the phones they buy from Apple are the razors that they sell at a loss.  The unconscionably high monthly bills that every smartphone user pays are the razor blades on which the carriers make their money.  As Microsoft/Nokia and Google/Motorola will start offering state of the art phones for less than $50, the carriers will have to match those prices and demand that Apple and Samsung lower their prices accordingly.  By starting its own carrier, Apple can reduce its need to deal with carriers that crimp its margins.

These integration concepts are examples of how innovative tech managers approach their business.  Of course pharma has periodically tried vertical integration over the past few decades. The decisions by Eli Lilly, Merck and SmithKline during the '90s to acquire PBMs was only one example.  By and large, most of those initiatives failed.  In part that was because the background of pharma managers in a patent-protected, regulated industry was poor preparation for successfully competing in innovative, aggressive markets. 

But pharma also failed in its efforts to enter ancillary businesses because they could not adequately grasp how business units such as PBMs, devices or consumer products might function as razors to drive the sales of its brand drug "blades."

But now it appears the time has passed when even the most highly inventive marketer can kickstart pharma's long-term prospects with a razor/razorblade business model.  Ironically, pharma is now in the same situation as Gillette (now a unit of Procter & Gamble) because even the most high-tech, modestly priced razors cannot lure men into buying more blades when a three- and four-day growth of beard is the norm at many offices.  In pharma's case, no collateral products can induce payers and providers to increase their demand for the industry's me-too, marginally improved, overpriced brands.

Although vertical integration with various health care services remains a possibility for pharma, it seems most likely that the industry's managers are too hidebound, unoriginal and narrow in their thinking to acquire or build such units.

There is another path for cash-heavy companies such as Apple and the Big Pharmas.  Here again, Majoo clarifies the option.  "Just cut prices," he recommends.  "That would effectively return...cash to customers rather than shareholders," he writes, but "in the long run, it's better...to curry favor with customers over investors.  See all that cash?  It comes from customers."

Wall Street, however, considers moves such as price reduction and long-long-term investment as anathema.  Last week, for example, Citigroup analyst Andre Baum reacted to the appointment of a new CFO by AstraZeneca.  Baum claims that many AZ investors are focused on obtaining near-term income from the stock and they fear an increased risk to earnings and dividends in the immediate future because the new exec may push for either more R&D or acquisitions. 

If that's the objective of AZ investors, the bloody stiffs should buy bonds and avoid equities in research-driven industries.

..........................................

Pharma still can't seem to get the knack of transparency.  Researchers at Cooper Medical School of Rowan University published findings in the British Medical Journal (see here) that showed results from 32% of clinical trials funded by pharma remain unpublished five years after completion.  Only 18% of trials that received no pharma funding remain unpublished.

Reduced to basic terms, that means the only published drug studies someone is likely to see are those with favorable results for the test drugs.  The studies where results are unfavorable or show dangerous side effects never see the light of day.  Heads pharma wins, tails everyone else loses.


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Daniel R. Hoffman, Ph.D. President, Pharmaceutical Business Research Associates
About this blog

Check Up covers regional health news and a wide array of healthcare topics from pharmaceutical happenings to patient safety. Read about some of our bloggers here.

Portions of this blog may also be found in the Inquirer's Sunday Health Section.

Michael R. Cohen, R.Ph. President, Institute for Safe Medication Practices
Daniel R. Hoffman, Ph.D. President, Pharmaceutical Business Research Associates
Hooman Noorchashm, M.D., Ph.D. Cardiothoracic surgeon in the Philadelphia area
Amy J. Reed, M.D., Ph.D. Anesthesiologist and Surgical Intensivist in the Philadelphia Area
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