Creative Destruction And The Pharmaceutical Industry

by: Ron Sommer

The pharmaceutical industry is in the nascent stages of transition. Until now, the companies that develop and market new drugs have relied upon monopoly or near monopoly protection from patents in order to succeed.

Companies invest billions in research and development to pursue a limited number of potential blockbuster products and/or acquire other companies with product pipelines with potential.

This model worked for many years. The 1990's is remembered for the introduction of many new blockbuster drugs which brought investors tremendous rewards. Even today, the pharmaceutical companies are viewed favorably for their high dividend payouts and high profits.

However, three forces began converging in the last decade. First, the number of new drugs brought to market, or at least blockbuster drugs, slowed. Secondly, many companies faced patent cliffs on products previously brought to market. Thirdly, as the patents expired, the generic drug manufacturers were standing by with the generic versions ready to take market share.

One reason for the decline in new drug introductions may be the increasing complexity of developing an effective drug. If, in the past, drug development relied upon identifying a chemical compound or cocktail of compounds that effectively and safely treat a disease, today the technology is more complex. The drug companies are utilizing new technology at the molecular level and are learning as they go along.

The dearth of new products increased the demand for mergers, acquisitions and partnerships. All this has done is delay the day of reckoning and the emergence of a new paradigm.

The drug companies cling to the old business model. In the January 7, 2013 issue, Barron's Magazine reports the big companies have an "alluring" pipeline this year. The article goes on to describe five of the most promising, still in development drugs.

Even if the pipeline drugs gain regulatory approval, and it is far from certain that any will, it maintains the dependence of the drug companies on a small number of products. The allure of the blockbuster drug has devolved to the generic manufacturers also. For example, Teva Pharmaceutical Industries (NYSE:TEVA) got hooked on one branded drug, Copaxone, which now accounts for 20% of the company's revenue even as the patent races to expiration. In an article that recently appeared on Seeking Alpha I described how Jeremy Levin is re-positioning the company to be less dependent on branded drugs.

If the old business model is decaying, what replaces it? Creative destruction is a term often used when something new emerges from a prior generation of business truths. In the case of drug companies, the change will come when the companies embrace customized drug treatments.

Worldwide, the population is both growing and aging. This actually creates an unprecedented opportunity to the drug companies but also makes for huge obstacles. The technology is now emerging to tailor-fit a drug to an individual patient. The drug would be customized to address the specific genetic makeup of the individual and also of the specific disease.

In the future, tissue-derived molecular information might be combined with an individual's personal medical history, family history, and data from imaging, and other laboratory tests to develop more effective treatments for a wider variety of conditions.

Pharmacogenetics (also termed pharmacogenomics) is the field of study that examines the impact of genetic variation on the response to medications. This approach is aimed at tailoring drug therapy at a dosage that is most appropriate for an individual patient, with the potential benefits of increasing the efficacy and safety of medications. Gene-centered research may also speed the development of novel therapeutics.

The key task is to find proteins, activated proteins, genes and gene variations that play a role in a disease. The first step is to associate the occurrence of a particular protein or gene variant with the incidence of a particular disease or disease predisposition - an association that can vary from one individual to another depending on many factors, including environmental circumstances. The outcome is the development of biomarkers which are stable and predictive.

The infrastructure necessary includes molecular information - biological specimens derived from tissue, cells, or blood - provided on the basis of informed donor consent and suitably annotated. Clinical information is also necessary based on patient medical records or clinical trial data.

A very high level of collaboration involving scientists and specialists from varying disciplines is required to integrate and make sense of all this information.

The R&D paradigm is changing. The focus is moving to characterizing disease at the molecular level. As bioinformatics becomes more prevalent, patient molecular information will be more accessible.

Personalized drug therapies are likely to increase the effectiveness of treatment. It should also reduce the time to market cycle and the cost of drug development.

Despite the disruptive nature of personalized medicine, the pharmaceutical industry is emerging as a driving force in this field. The list of early personalized medicine adopters includes some industry giants: Roche (OTCQX:RHHBY), Pfizer (NYSE:PFE), Novartis (NYSE:NVS), and Lilly (NYSE:LLY). The field is also populated with upstart companies such as Genomic Health (NASDAQ:GHDX), XDx, and Prometheus Labs that offer specialized approaches to segmenting disease, as well as the recognized pioneers in personal genomics: 23andMe, deCODE Genetics, and DNA Direct. In adopting personalized medicine, they are all embracing a new healthcare model that emphasizes segmentation of patients, and decisions and practices tailored to individuals or small groups. Although this approach might lead to smaller revenue pools for pharmaceutical producers, personalized medicine can actually improve their profits. A business model based on differentiated products can reduce the system-wide costs and complications of one-size-fits-all medications, provide new opportunities for marketing, and establish new efficiencies in production and distribution.

Disclosure: I am long LLY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.