Monday, August 17, 2009

Big Pharma, Polar Bears, and the Need to Specialize

For at least a decade, biotechs have been perceived by many observers as the likely evolutionary winners in the race for survival and prosperity in the drug industry. The credit crunch has drastically altered the environment in which companies operate and the biotech business model now looks much less likely to supply the fat returns on capital, and the price/earnings ratios, that have historically been associated with companies supplying novel medicines.

So, who will the new winners be, and what strategies must they employ to thrive in these challenging times? Scisive Consulting chairman Robert Easton, partner Catharine Staughton and consultant Matt Young weigh in with a naturalist analogy.

Granted historically lousy P/Es, growth, R&D productivity – pick your measure -- Big Pharma has one thing going for it. The current financial crisis has, at least in the short term, reversed the fortunes for still cash-rich pharmaceutical companies and the biotech upstarts that have been—for oh, about 25 years—inexorably learning to beat pharma at its own game.

The financial collapse seems itself to have been a sort of bailout for Big Pharma. Now they are able to buy novel compounds cheaply from smaller companies who are dying to sell them.

The 20 largest pharmaceutical own a combined war chest of over $100 billion. If current projections hold, their cash and cash equivalents will rise to more than $500 billion by 2014. With these funds on hand, Big Pharma could buy up not only enough candidates to replenish their pipelines, but the majority of the biotechnology industry itself.

On the other hand, according to Burrill & Co, one third of publicly traded biotechs have less than six months’ worth of operating cash.

The outcome of the financial collapse will be that Big Pharma will remain pre-eminent, at least while the capital crunch lasts, albeit with more modest P/E valuations. As a consequence, biotech companies, which had attracted investors with the long-term hope of valuations based on the high P/Es of Big Pharma, are struggling to fund their pipelines and must focus on - and perfect - their business development strategies just to stay viable.

So can Big Pharma do something to make its new lease of life more than temporary?

Superficially, the recipe for evolutionary success seems obvious: the Big Pharma companies use their enormous cash reserves to acquire cash-strapped biotechnology companies. But before launching into the fray with an open checkbook companies need to consider the attractions of the approach, in the light of their own specific situation.

Scisive Consulting has defined drug companies according to six types of animal: those that have adapted to a narrow evolutionary niche, and those that are more flexible inhabitants of their environment.

Consider the polar bear. These beasts are powerful and can move quickly – challenge them at your peril. Nevertheless they must adapt to a shrinking environment, thanks to global warming, in order to survive and flourish. Not a bad analogy, we believe, for Big Pharma.

At the other end of the spectrum, biotechs are rabbits. They eat a lot of green. And their population varies widely according to the availability of food. When rabbits are stressed by predators or lack of resources, they eat their own young. (It’s true, you can look it up!)

Like polar bears, Big Pharma are the top predators in their shrinking world. To stay relevant, however, they need to either figure out how to live in their shrinking environment – or find and adapt to new territories.

In industrial terms, such an imperative translates to the need for a wholesale change in the drug industry’s business model. When this industry began, it was built on a rather simple model. Science created a pill which was manufactured cheaply and marketed by sales forces to a large group of patients. This model led to profit margins that are almost unthinkable today.

The model also allowed all of the Big Pharmas to evolve in very similar looking creatures. For example, AstraZeneca, Novartis, and Bristol-Myers, all operate in the fields of neuroscience, oncology, and cardiovascular health. While some pharmas involve themselves in nutritionals, animal health, infectious disease, and other fields, all of these companies also engage with a mixing pot of therapeutic areas.

The relative strategic uniformity isn’t generally the case with the leading companies in other industries. In the high-tech industry, for example, there is a much higher level of specialization. Google is mainly in the advertising business; Microsoft, software; Research in Motion, in wireless solutions. You aren’t likely to see Facebook manufacturing semiconductors any time soon. (Yes we are aware of Microsoft’s Bing search engine and the new Google Chrome OS, but still.)

It is likely that health care businesses will evolve in a similar fashion. The leaders of the future will be those with unique and complex models which sub-speciate into differentiated forms. Companies will focus nearly all of their efforts on a single therapeutic area, becoming “immunology companies” or “cancer companies”. These companies will also become more integrated across sectors. A cardiology company will sell diagnostics, devices, and therapeutics pertaining to cardiovascular health.

Such a transformation will involve radical changes to their structures. Fortunately, pharmas have a great deal of cash now, which gives them the resources to undergo such a transformation. The winners, ultimately, will be those who recognize this need to adapt, specialize, and develop more complex business models, and subsequently capitalize on their first-mover advantage.

A good example of this can be seen in Astellas’ determination to acquire CV Therapeutics. Although CV’s board rejected the offer numerous times, ultimately fleeing into the arms of Gilead, the attempted acquisition has marked a watershed event in how Japanese companies operate with respect to their American counterparts. Typically Japanese companies have refrained from hostile corporate activity and this fundamental change in Astellas’ strategy shows its willingness to adapt and its understanding of the new reality in the pharmaceutical market.

Secondly, Pharma’s polar bears must acquire the best candidates from their prey, the cash-strapped biotech rabbits of the world. However, there is an issue of timing at play here. Although biotech assets are cheaper than ever before, they have probably not yet hit rock bottom. It is clear that these cash-eating biotechs will get more desperate as this crisis wears on and hence the pickings for the polar bears will get better.

The astute will watch and wait, and the true art will be in knowing when to pounce: before competitors do and the opportunity passes.

For the full article, including the likely fate of the duck-billed platypuses and other animals of the pharmaceutical world, see

1 comment:

Anonymous said...

Interesting analogies however I am concerned the Polar Bears will eat all the most prolific bunnies, not acquire enough fat reserves to get them through cold winter ahead and only leave behind scat containing pieces of undigested fur and bones. Then of course they can go back to cannibalizing each other.