Healthy Skepticism Library item: 1561

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Publication type: Journal Article

Gottlieb S.
Big Pharma's New Funk
Forbes.com 2005 May 6;

Full text:

Merck’s surprise ouster of its longtime Chairman and Chief Executive Raymond Gilmartin almost a full year before the executive was scheduled to retire may reveal as much about Merck’s current woes as it does about the funk in which the entire pharmaceutical industry now finds itself mired.

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Merck (nyse: MRK – news – people ), the third-largest American drugmaker, named an insider, Richard Clark, its current head of manufacturing, as the company’s new chief executive. Merck said the chairman’s position would remain vacant for at least a year.

Clark has no experience in drug marketing or research, which are the two areas that are generally considered the most crucial to drugmakers. He is neither a physician nor a scientist and lacks experience in sales. Instead, Clark’s experience and expertise is in manufacturing, drug benefit management and controlling costs.

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But this expertise, more than the other, may provide the appropriate prescription for Merck’s ailments and for its future. Granted, it will be a much different Merck than the one most knew just five years ago.

Without the internal research productivity, cost cutting is going to become more crucial, as some of the biggest drug companies, like Pfizer (nyse: PFE – news – people ), GlaxoSmithKline (nyse: GSK – news – people ) and Novartis (nyse: NVS – news – people ), also begin to face a market where the prices of their products are likely to fall.

For one thing, consumers are increasingly footing more of the bills for their drug choices, whether it’s through higher co-pays or stricter formularies that require them to pay out-of-pocket for expensive branded primary care drugs like cholesterol-lowering statins or high blood pressure pills.

In addition, drug-pricing authorities abroad continue to extract lower prices for new medicines from the major pharmaceutical companies. Companies appear to have little power to stop this practice so long as our own trade authorities sit on the sidelines.

Add to that the United State’s own drug purchasing programs inside Medicare, Medicaid and the Veterans Administration, which may all begin to flex more muscle when it comes to extracting for themselves lower prices on new drugs.

In this kind of a world, having a serious cost-cutter in the executive suite begins to make more sense, especially one who understands the arcane nuances of drug manufacturing—an area long ignored—and harbors some significant savings from much needed technological and management upgrades. Merck’s own stock price has fallen more than 60% from its peak in 2000, and the company has introduced only a handful of new drugs in the past five years. If it cannot make new drug candidates, it needs to cut its costs and buy some.

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This is also one way to view the recent obsession inside the big pharmaceutical companies to upgrade manufacturing processes. It is true that there are many reasons why companies have turned attention to improvements in manufacturing. One reason is that these facilities had long been ignored and become woefully out-of-date. Another is that the Food and Drug Administration has finally become openminded to the kinds of manufacturing process improvements likely to enable significant upgrades and efficiencies.

Finally, in recent years, manufacturing violations have cost the industries millions in delays, injunctions and fines, and companies were forced to confront their creaky factories.

But there is also a big reason why companies had been able to ignore cost-saving improvements in their manufacturing facilities, and why they can no longer do so. In a market where drug prices are more tightly controlled and margins slim, companies can no longer afford to ignore simple efficiencies to be gained from improving things as rudimentary as punching out pills.

This is where the industry is likely to focus more of its attention, and in selecting Clark, Merck is signaling that is where more of the focus will be inside its own management ranks. This is what happens when a wickedly profitable industry becomes a so-so business. Companies can find lots of ways to remain profitable and it need not be from dumping outrageous sums into new research. It can squeeze costs to the bone and, eventually, get into other lines of business such as lifestyle medicines or cosmetic pharmaceuticals.

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In a world where prices on new drugs are likely to be much lower—or even regulated—drug companies are going to continue to focus more of their attention on wringing savings from tasks such as selling and manufacturing and focus less on research and development. They will license more new medicines and then try to aggressively manage their development and production costs within narrow bands of spending in order to achieve predictable, instead of blowout, returns.

It will be an acceptable prescription to some shareholders, who care more about dividends than public health. Indeed, drug companies today are the darlings of value investors who have been snapping them up for their relatively high yielding dividends. But this may not be acceptable to tomorrow’s patients who need new cures to come along today. As Congress searches for creative ways to bolster the industry’s once-rampant growth, nobody seems to be thinking about what diseases we might have cured if our industry devoted excess money for new research and highly-paid scientists. Now, even the once-mighty Merck can no longer afford the luxury of this indulgence.

This is one way to view Clark’s ascendancy as Merck chief. The company is not preparing for a future filled with its own breakthrough research but, instead, for life as a regulated utility. It is a future where profits are increasingly set by price controls and cutting costs has become the best way to squeeze out extra income.