For many years, pharmaceuticals was the top-ranked industry in the annual Fortune 500 industry profitability rankings. Not any more: in 2004, pharmaceuticals were ranked only number 3 in return on sales, number 12 in return on assets, and number 13 in return on equity. And loyal shareholders are in pain: the average total annual return to shareholders between 1999 and 2004 was -1.4%!
The industry's business model, which used to produce superior profits and happy shareholders year after year, consisted of the following key components:
· High fixed sunk costs for discovering, developing, and launching new products
· A regular flow of innovative new products
· Payers willing to pay high prices relative to the low incremental unit product costs
· Patent protection that kept competition out sufficiently long to make the R&D and launch investments profitable
This business model has been coming undone. To begin with, the R&D costs of bringing a new molecule to market have increased significantly over the years. A recent survey estimated the average cost to be $802 million on average, up from $467 million in 1990. At the same time, the flow of new molecules has declined from a peak of 62 in 1996 to 26 in 2002 (FDA approved New Molecular Entities and Biologics), with a rebound to 35/36 in 2003 and 2004 respectively.
The decline in the number of new molecules has been accompanied by a shift in the nature of new molecules, with biotechnology-based large molecules accounting for a growing share of both launched and pipeline molecules. And these biotechnology molecules generally do not come from the R&D labs of big pharma, but from small, specialized biotechnology companies...
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