Once Golden, Drug Firms Under Assault
After years of basking in the glow of huge profits and a sterling public image, the big brand-name drug companies are reeling from attacks by senior citizen groups, AIDS activists and state and federal regulators. The industry is under tremendous pressures that experts say are likely to transform it in the coming decade and perhaps even alter the flow of new drugs to the marketplace.
For companies already vilified as price gougers by politicians, consumer groups and executives at other firms, the recent stream of bad news has been relentless: questionable accounting practices at Merck & Co. and Bristol-Myers Squibb Co.; dire warnings about Wyeth’s hormone replacement therapy; prolonged manufacturing deficiencies at Eli Lilly & Co.; a criminal probe at a Johnson & Johnson plant in Puerto Rico.
All of this comes against a backdrop of eroding sales and earnings as generic drugs steal market share from one blockbuster brand-name drug after another, while Third World countries challenge the worldwide drug patent system in order to get cheaper AIDS medicines.
“Clearly there is a lot of upheaval and uncertainty in the industry right now,” said Merck’s chairman and chief executive, Raymond V. Gilmartin. He suggested that the industry was taking a breather after a period of rapid product roll-outs in the 1990s. The criticisms, he said, should subside if Congress passes a subscription drug plan for the elderly.
But the Senate last week killed legislation to provide Medicare drug benefits, although it passed a bill that would give consumers easier access to cheaper generic drugs, which was immediately denounced by Pharmaceutical Research and Manufacturers of America, the industry’s main trade group.
The association points out that drug makers have faced adversity before and says it will overcome their current challenges. But their two core problems--a dearth of new products in the pipeline and mounting pressure on drug pricing--are widely seen as deep-seated and long-term. And that suggests the $400-billion industry will be in for a lengthy period of turmoil and change.
“On the revenue side, they’re likely to get kicked in the shin. And on the product side, the well has run dry,” said Uwe Reinhardt, a Princeton University professor and expert on health-care economics and policy. “It is not an easy future.”
In a recent conference call with analysts and reporters, Pfizer’s chief executive, Hank McKinnell, expressed amazement at the sudden change affecting the industry, and referred wistfully to “the days when the pharmaceutical companies were considered safe harbors for investors.”
McKinnell blamed “irrational gloom” for the overall stock market losses and general uncertainty about the industry. What the critics have failed to notice, he said, is that “we’re at a turning point for our industry.”
“There has been a well-documented slowdown in the pipeline for new drugs and there have been rapid rises in research and development costs,” McKinnell said.
One key way that drug makers are expected to respond to these challenges is through mergers, such as the $50-billion deal announced last month by Pfizer and Pharmacia.
Concentration of market power always raises the specter of higher prices, but analysts say drug makers will be hard-pressed to put through big increases, given the intense criticisms and scrutiny of the industry’s pricing and marketing practices. Unlike auto and computer manufacturing, the drug industry is still quite fragmented. Even with the Pharmacia acquisition, the market share for Pfizer, already the industry’s largest, will grow to just 11%.
Consolidation, though, could have a substantial influence on the development of new drugs. Pfizer and Pharmacia promoted their merger largely as a way to enhance resources for research and create new medicines. Their combined research and development budget, they said, would amount to $7 billion, about 15% of their annual revenue.
Bigger May Not Be Better
But experts say the Pfizer-Pharmacia merger was more of a short-term bet to bolster earnings. In fact, big drug mergers in the past haven’t led to more success in drug development, and the largest research departments have been criticized for being inefficient and lumbering.
“That’s the unfortunate thing, there’s no evidence that bigger is better when it comes to R&D;,” said Patricia Danzon, a professor in health-care systems at the Wharton School at the University of Pennsylvania.
Some analysts say they expect big drug companies eventually will stop doing research, leaving it to biotech firms from which they could get product licenses.
The industry’s R&D; budget, as a share of its overall revenue, has declined slightly since the late 1990s, when it peaked at 20%, the pharmaceutical association said.
“These big pharmaceuticals are really morphing from research companies into marketing companies,” Reinhardt said. He expects major companies to scale back on research and development.
Regardless of whether that comes to pass, it is apparent that the industry is entering an era of leaner profits.
Analysts point out that leading pharmaceutical companies still are outperforming businesses in many other industries; demand for drugs will grow as the nation’s population ages. But for most brand-name drug makers, the years of double-digit returns and profit growth appear to be over.
Outlook Grim for Year
Drug industry analyst C. Anthony Butler of Lehman Bros. said in a research note to clients last month that the industry is mired in “what may be the worst year-over-year performance in earnings in the past decade” and that “numerous company-specific mishaps have poisoned investor confidence.”
He also noted that only seven new products have been approved for sale this year--with maybe five more to come--compared with 27 drug approvals last year and 26 the year before.
The dimmed outlook has emerged in one company earnings report after another. Merck, the world’s third-biggest drug maker, said it wasn’t likely to show any earnings growth this year. The main reason: Five of its leading drugs will lose their patent protection.
Adding to its problems, Merck has been under fire for accounting for $12 billion in revenue from its pharmacy-benefits subsidiary that it never collected, even though that didn’t affect the bottom line.
Indianapolis-based Lilly said its latest quarterly earnings plunged 20%, then executives surprised analysts by saying they could not provide any financial guidance for next year because of uncertainties of the Food and Drug Administration’s ongoing review of its manufacturing operations, which could delay the launch of several promising drugs.
Sales of one of Lilly’s most famous products, the antidepressant Prozac, have fallen precipitously since its patent expired last August, opening the market to cheaper generic versions.
Today, generic drugs comprise half of U.S. prescription sales, up from less than 20% two decades ago. That share is expected to keep rising as patents on top-selling drugs, such as the cholesterol reducer Zocor and antidepressant Zoloft, expire in the next few years.
Backlash on Patents
In some ways, the drug industry is a victim of its own success. Over the last decade, the industry launched a host of new products, plus a bunch of me-too versions, and drove demand with aggressive marketing. Consumers clamored for the drugs, doctors obliged, and the drug companies reaped hefty margins because in most cases insurers were paying the bills.
But as insurers and others started pushing back against soaring drug prices, the big drug makers hurt themselves more by aggressively trying to extend patents, which caused a huge backlash in the courts and the political arena.
Many states, including California, have filed lawsuits against pharmaceutical companies in the last year, claiming antitrust violations and illegal manipulations of prescription drug prices. One of the biggest is a lawsuit by 29 state attorneys general against Bristol-Myers Squibb that accuses the company of illegally blocking cheaper generic alternatives to its top-selling cancer drug, Taxol.
“Now, more and more pharmaceutical firms are admitting that maybe this was the wrong strategy and that they are going to readjust and put more energy into new drug development,” said Ken Kaitin, director of the Tufts Center for the Study of Drug Development.
The drug industry always has dealt with patents expiring, but much more now than in the past. That has put enormous pressure on manufacturers to refill their pipelines. Last year, 31 new drugs hit the U.S. market, compared with 52 a decade ago, the Center for Medicines Research said.
Development Slowdown
A big part of the slowdown is the science. Researchers have harvested chemical compounds to treat a number of ailments, but now they are taking on more serious diseases such as cancer. And although there are great hopes for the next generation of drugs based on the mapping of the human genome, those undertakings will be more tricky, expensive and time consuming. Analysts say it could be five to 10 years before companies see the fruits of human gene therapy.
The Tufts Center estimates it costs $805 million and takes 10 to 15 years to bring a new drug to market. Yet only three in 10 drugs have recouped that average cost.
Citing such statistics, the pharmaceutical industry has defended the high price of its drugs in the United States. But recent controversies over the pricing of AIDS drugs in Africa, for example, and the huge amounts spent in marketing to doctors and directly to consumers have undermined that argument. That has made the public highly suspicious.
In a recent poll by the Kaiser Family Foundation, excessive profiteering by drug companies was cited most often by consumers when asked about why they thought health-care costs were escalating.Meanwhile, managed-care companies are successfully pushing more generic drugs in the marketplace, prodded by large employers that are trying to keep costs under control. And as consumers are required to pay larger amounts out of pocket for drugs--through more sophisticated multi-tiered prescription plans--they will be making their voices heard, especially the aging baby boomers.
“The pressure to make important drugs economically available is going to become unbearable because the most politically active group will be cruising into territory where they will need them,” said Dr. Peter Kongstvedt, a leader in the health-care consulting practice at Cap Gemini Ernst & Young.
All that should help consumers, at least in the short run. But for the drug companies, it probably means their long, wonderful ride is over.
“They made hay while the sun was shining,” said Reinhardt of Princeton University. “Sooner or later, they were going to run into this.”
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Opening the Market for Generics
In the next five years, 18 major brand-name drugs worth billions of dollars in annual revenue will lose their patent protection, opening them to competition from lower-cost generics.
2000 sales Patent Brand Use (millions) holder Expiration
Prilosec gastro- intestinal $4,102 AstraZeneca Pending
Neurontin epilepsy 1,131 Pfizer 4/02
Axid gastroi- ntestinal 225 Eli Lilly 4/02
Prinivil hypertension 431 Merck 6/02
Zestril hypertension 833 AstraZeneca 6/02
Accutane acne 636 Roche 8/02
Claritin allergy 1,667 Schering-Plough 12/02
Singulair asthma 676 Merck 2/03
Flovent asthma 648 GlaxoSmithKline 11/03
Flonase allergy 619 GlaxoSmithKline 11/03
Cipro infection 1,023 Bayer 12/03
Diflucan infection 386 Pfizer 1/04
Xenical obesity 237 Roche 6/04
Prevacid ulcer 2,832 TAP Pharma. 7/05
Pravachol cholesterol 1,203 Bristol- Myers Squibb 10/05
Zocor cholesterol 2,207 Merck 12/05
Zoloft depression 1,890 Pfizer 12/05
Paxil depression 1,808 GlaxoSmithKline 12/06
Source: Generic Pharmaceutical Assn.
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More Scrutiny
The drug industry is facing increasing pressure, both in the courts and from state and federal regulators. Cases over the last few months:
* AARP joined lawsuits against three drug companies in May, claiming overcharging and antitrust violations in the blocking of comparable generic drugs.
* An Alabama union health plan sued GlaxoSmithKline in June for allegedly trying to block generic competition to its $2-billion-a-year antibiotic Augmentin.
* The IRS sued GlaxoSmithKline for billions of dollars in unpaid taxes in June, accusing the drug giant of hiding U.S. profit.
* The Minnesota attorney general sued Pharmacia in June for allegedly overcharging for cancer treatment.
* California and 28 other states sued Bristol-Myers Squibb in June over allegations that it illegally blocked cheaper generic alternatives to the cancer drug Taxol.
* The AIDS Healthcare Foundation sued GlaxoSmithKline in July for alleged antitrust violations and overcharging for three antiviral drugs.
* Merck was hit with a class-action lawsuit in July alleging company officers overstated company revenue for its pharmacy benefits unit.
* Eli Lilly settled a suit with eight states in July over allegations the company accidentally released e-mail addresses of 600 people taking Prozac.
* The drug industry sued the federal government in July to stop Michigan from requiring pharmaceuticals to give Medicaid patients steep discounts on some expensive medicines.
* In July, the Brazilian government offered to share its generic AIDS drugs with impoverished countries, potentially cutting into pharmaceutical company profits.
* A Food and Drug Administration panel in July said Bristol-Myers Squibb’s high blood pressure drug Vanlev was too risky to sell.
* The Securities and Exchange Commission announced in July that it was investigating Bristol-Myers Squibb for allegedly inflating its 2001 revenue by $1 billion.
* Federal investigators began looking into record-keeping at a Johnson & Johnson plant in Puerto Rico where its controversial drug Eprex is made.
* A New York federal judge is expected to rule this month on whether AstraZeneca can extend its patent on the best-selling Prilosec ulcer medication. * Researched and compiled by staff librarian JOHN JACKSON
