Drugmakers Need to Break Their Blockbuster Addiction

The industry would be wise to diversfy its revenue streams. Otherwise, the pressures on it to ease up on prices will only intensify

By David Shook

It has been a tough year for the pharmaceutical industry. Never mind the stock market, where drug shares are outperforming any other sector. Just look at the beating the industry is taking in the court of public opinion.

Perhaps it started with the AIDS crisis in Africa, where even the industry seemed a little sheepish about zealously guarding the patents on expensive treatments while thousands of impoverished Africans suffered horrible deaths. Or maybe it was lawmakers on Capitol Hill launching a crusade to lower the cost of Medicare prescription drugs, egged on by legions of aging Baby Boomers.

Then there was the patent threat: About a dozen of the biggest prescription drugs are all losing their patent protection at roughly the same time. The pharmaceuticals don't want to lose these cash cows, so they're fighting to keep these drugs from generic competition as long as possible. What's more, a recent push to reclassify popular allergy medications as over-the-counter drugs has companies up in arms -- and patient groups and insurance companies are ready for a fight.


  It isn't clear how the surging public ire toward drug prices will shake out. But it looks like the escalating cost of medicine -- now three times the rate of inflation -- isn't sustainable over the long term.

That means Big Pharma will have to make a decision: Scrap the current business model, which relies on getting the lion's share of revenue from just a few megasellers, or stay the course and risk doing damage to the industry's reputation -- or worse, its stock prices. If the industry is smart, it'll take its medicine and diversify. Companies can no longer rely on two or three drugs for a majority of sales.

Consider a few recent developments that illustrate how the industry seems to be flailing to protect drugs whose patents are expiring. The most recent involves Schering-Plough's Claritin, which accounts for about a third of company sales and has been one of the best-selling drugs on the planet, thanks largely to the most expensive marketing campaign in pharmaceutical history. Last year, Schering (SGP ) spent $120 million promoting Claritin, according to IMS Health in Westport, Conn. That direct-to-consumer effort has made it a $3 billion-a-year drug.


  Claritin has been such a hit that HMOs recently asked the U.S. Food & Drug Administration to consider shifting the antihistimine, along with Aventis' (AVE ) Allegra and Pfizer's (PFE ) Zyrtec, from prescription to over-the-counter status. An FDA panel has concurred in a preliminary ruling. But the move would effectively kill Schering's ability to charge prescription prices before its patents on the drug expire. (Several patents cover Claritin, and they expire in different years -- in 2002, 2004, and in later years.)

In a way, the company has fallen prey to its own success. The drug's widespread use has highlighted its impeccable safety record -- which is why HMOs argue that it should be sold over-the-counter. "These drugs actually are safer than the current over-the-counter antihistamines," says Terry Leach of Horizon Blue Cross Blue Shield of New Jersey. But Schering wants to keep Claritin's status intact. "We believe that prescription status of these medications is necessary to protect and optimize public health," Schering Chief Medical Officer Robert Spiegal told an FDA panel on May 11.

It's not as if drugmakers are disadvantaged in the battles over pricing, prescription status, and patents -- after all, it's a rich industry. But more than ever, these battles are getting intense public scrutiny. On May 15, attorneys general from 15 states announced a lawsuit against French drugmaker Aventis and Fort Lauderdale generic-drug company Andrx (ADRX ) for an agreement they reached on the timing of a generic version of Cardizem, the popular cardiovascular drug. The states say the agreement amounted to collusion that delayed a generic equivalent from the market. The companies insist they've done nothing wrong.


 At the same time, Andrx is at odds with a different big drugmaker, AstraZeneca (AZN ) -- this time over the right to sell a generic version of Prilosec. That heartburn medication has been the top-selling pharmaceutical worldwide for several years. In 2000 it had $4.2 billion in U.S. sales.

Prilosec's primary patent on the drug expired on Apr. 5, but generic competition could still be a year away. That's because AstraZeneca has been suing generic drugmakers over separate patents that cover the formulation of the drug, rather than the molecule itself. By tying up Andrx in court, Prilosec users might have to wait another year before a cheaper version hits the market.

AstraZeneca says it's simply protecting technology it developed after the drug's introduction 20 years ago. But others see the lawsuits as nothing more than stalling tactics. "Delay, delay, delay...that's their strategy," says Dr. Elliot F. Hahn, president of Andrx. Hahn accuses AstraZeneca of using "the court system to raise technical issues and include what we believe are irrelevant patents to stall our push to introduce a generic Prilosec."


  Analysts agree. "Games are being played," says Merrill Lynch's Gregg Gilbert. "The branded companies do whatever they can to extend their positions of these drugs. Remember, Prilosec is the biggest drug in the world." So another year without generic competition could mean several billion dollars in additional revenues, Gilbert says.

Certainly, the industry has a valid point when it argues that billions of dollars in profits are needed to plow enough resources back into the lab for R&D. "It comes down to making sure people who need these medicines have access to them, and it's going to require a lot of different solutions," says Rachel Bloom-Baglin, spokeswoman for the London-based AstraZeneca. "But price controls or drastic changes to the patent system are not the answers. If that happens, innovation will cease."

Still, as more older Americans move from employer-funded insurance to Medicare and supplemental drug coverage, the industry's high prices are going to come under assault. Already, financial analysts are assigning higher risks to drug stocks, as the sentiment grows in Congress for price controls in the form of a Medicare drug benefit.


  Congress also is considering amendments to the Hatch-Waxman Act. The 17-year-old law was supposed to create easy access to generic drugs once patents expire on branded medicine, but consumer groups say Big Pharma is using loopholes in the law to give monopoly drugs a longer run.

What to do? First, the industry giants, which generally rely on a couple of blockbuster drugs for more than half of their profits, might be better served by shifting their focus to seven or eight highly profitable drugs in different categories. With more products to rely on for growth, prices on commonly prescribed drugs could come down. "Management often is torn between putting resources behind a blockbuster vs. diversifying its risks. That's a tough medium to strike," says Joseph Zammit-Lucia, president of Cambridge Pharma Consultancy.

But without a change in strategy, the drug industry could lose its huge lead in profit margins. Consider pharmaceutical bellwether Merck (MRK ), which earned $7 billion last year on sales of $40 billion, while IBM (IBM ) -- arguably the leading tech weathervane -- earned $8 billion on $88 billion in revenues. Merck is squeezing nearly twice as much profit from its sales as IBM. This is typical for the drug industry.

Certainly, Big Pharma has the resources to maintain its profit margins. But it must face facts: The growing assault on drug prices isn't going away soon. Either the industry relieves the pressure on its bottom line by itself, or it will be hounded by regulators, patients, doctors, and governments worldwide.

Shook covers biotechnology issues for BusinessWeek Online. Follow The Biotech Beat every week, only on BW Online

Edited by Douglas Harbrecht

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