Why Big Pharma Needs to Become Smaller Pharma


The role of Big Pharma companies is changing.

Each year, it becomes more likely that the new drugs needed to advance curative medicine will come from small start-ups and biotechs.

Those companies will be the ones to discover innovative compounds and demonstrate their proof-of-concept.

Where does that leave the pharmaceutical giants? On a path to becoming smaller.

The Big Pharmas will provide financing to complete the development, guide the new products through registration, and launch them into a market where corporate payers-providers call the shots.

Right now, the Biggies maintain large R&D operations that consume around 15 percent of their sales while selling, marketing and administrative costs burn 30 percent more of revenues. This leads to the question of whether R&D and sales/marketing at current levels remain necessary.

The size and function of Big Pharma's sales operations will have to grow smaller and more specialized when customer decision-making rests with a hundred or so large corporations instead of a few hundred-thousand physicians in small practices. Likewise, the ability of creative marketing to nurture commercially successful products will also become more limited because customers will decide which drugs to use by analyzing large, real-world, patient databases that make it difficult to creatively differentiate brands.

Big Pharmas already outsource the mid- and late-stage parts of drug development to contract research organizations, while their contributions to the early work will increasingly focus on the financier's role. That means if financing the research of small companies is to become Big Pharma's core function, these big companies will need to show they are more adept at it than venture capitalists.

The advantage that Big Pharma can maintain over private-equity firms will consist of its ability to integrate and manage the diverse functions that comprise the pharmaceutical industry. Financing, late-stage clinical development, regulatory affairs, commercial planning, selling and distribution will all remain necessary.

If Big Pharma wants to maintain its place at the head of the table, it must show a unique capability at "orchestrating" a business requiring a series of specialty contractors. To prosper in that role, the size of Big Pharma will have to shrink considerably because returns from legitimately financing high-risk research, and from providing various services, will not generate adequate earnings growth for companies with $160 billion of equity.

The economies of scale that drove numerous mergers/acquisitions in Big Pharma over the last 20 years no longer apply, even as end-to-end capabilities are too costly and unproductive to maintain. This leaves two options.

One possibility is that Big Pharmas can become considerably smaller companies. The advantage there lies in the fact that a product with $200 million net income can propel the earnings per share of a smaller company much further.

The other option is for Big Pharmas to become subsidiaries of large, financial-service conglomerates that maintain industrial holding operations. There are certain advantages in balancing the down times of a cyclical industry, such as pharma, with the other sectors of a well-managed conglomerate. When Jack Welch said he had visions of General Electric one day becoming the world's largest pharma company, his thinking probably went along those lines.

Either option appears plausible, but in both cases Big will mean something smaller.

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