Commentary: Big Pharma Needs a New Prescription for Growth

By Amy Barrett

For an industry accustomed to getting its way in Washington, the summer of '03 is bringing plenty of political heat for drugmakers. As proposals for a Medicare prescription benefit pick up steam, the Senate appears ready to attach an amendment that bars some tactics Big Pharma has used to thwart makers of generics. And while a Medicare drug benefit is likely to boost sales in the near term, industry watchers fear it could seriously depress prices over the long haul.

Political risk is one of many pressures weighing on the industry these days. Drug-company execs are also wrestling with patent expirations on hot drugs, a dearth of new products, and major changes in research science. Making matters worse, years of strong growth in prescription-drug spending is fading. This year, according to the Centers for Medicare & Medicaid Services, the amount Americans spend on prescription drugs will rise just 13.3%, down from a peak of 19.6% in 1999.

Add it all up, and the pharmaceutical industry is in for wrenching change. Through much of the 1980s and 1990s, drugmakers prospered by offering one pricey blockbuster after another, relying heavily on mass marketing to fuel sales, then using the enormous profits they reaped to foot the huge bills for research needed to find the next blockbuster. But, warns Barrie G. James, president of Pharma Strategy Consulting, "you can't ride the old business model into the future -- it is fast falling apart."

This doesn't mean drugmakers are in immediate trouble. Blockbusters aren't going to disappear altogether. In fact, Pfizer (PFE ) Inc.'s $8 billion cholesterol-lowering drug Lipitor got a boost on June 16 when data showed that diabetic patients taking it had fewer heart attacks and strokes.

Moreover, drug stocks, depressed by wan earnings and other setbacks, have been rebounding lately. Analysts say that's partly due to the beating drug stocks had already taken; many were down to unusually cheap levels. At the same time, some investors appear to be betting that a new Medicare drug benefit will boost volumes. Smith Barney analyst Glen Santangelo, for example, figures the benefit could lift drug spending by as much as $5 billion in 2006.

Nevertheless, that boost may be short-lived. however. Industry watchers warn that drugmakers will likely feel pressure to offer big discounts under a federal program, particularly if the cost of the drug-benefit program could soar well beyond the $400 billion Washington has budgeted over 10 years. Prudential Securities analyst Dr. Timothy Anderson wrote recently that the price pressure could eventually more than offset the boost of increased volumes for drugmakers.

If that were not enough, the one-size-fits-all drug market increasingly is giving way to more specialized medicines with smaller markets. But to protect profit margins, pharmaceutical companies will have to bring down their development costs. Right now, it costs some $800 million to bring a drug to market. Drug researchers have plenty of new tools to help cut research-and-development costs. Gene-based tests, for example, may help determine which patients are likely to respond to a drug, meaning clinical studies could be less extensive and, hence, less expensive. But while drugmakers can charge high prices for these medicines, Jon M. Fisher, head of equity research at Fifth Third Bank (FITB ) believes few will become the multi-billion-dollar money machines of the past.

The upshot is that even if the Medicare benefit lifts the industry's fortunes in the short term, it may not be enough to overcome deeper long-term problems. Acknowledging that the old way is no longer working may take time. "Pharmaceutical companies are slow to change," warns Fifth Third Bank's Fisher. But with the ground rules shifting, drugmakers will have to find a new way to play the game.

Barrett covers the pharmaceutical industry from Philadelphia.

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