Pharmaceutical Business Model
The business model of companies in pharmaceutical industry for almost two decades is blockbuster model. The blockbusters (drugs that have sales over $ 1 billion per year) have turned out to be a significant factor that driven the pharmaceutical industry from 1990s. There were 65 blockbusters in 2002 increased from only 7 blockbusters in 1990 (Deutsche Bank, 2003 cited in Froud et al, 2006: 169) but, by 2006, the number was raised to 114 (La Merie Business Intelligence, 2007). Exhibit 1 shown that the sales of top ten blockbuster companies from blockbuster drugs alone were accounted larger than one-fourth of world pharmaceutical market in 2006. This blockbuster model was adopted in order to maximize revenue because it was seemed to be possible approach to satisfy high growth expectation of financial community (Business Insight 2003: 10). To conclude, the blockbuster business model was underpinned big pharmaceutical companies’ success over the past decade. This model is embedded in pharmaceutical industry.
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â€¢ Exhibit 1 Top 10 Blockbuster companies, 2006
Sales of Blockbuster
Number of Blockbuster
As % of World Pharmaceutical Market
Johnson & Johnson
Merck & Co.
Source: La Merie Business Intelligence, 2007
Challenges of Big Pharmaceutical model
To begin with, the big pharmaceutical companies such as Pfizer and GSK are over-reliance on the sales of blockbuster drugs. In other words, the companies are generated their main revenue from small number of drugs from their product lines. For example, in 2006, Pfizer had 9 blockbuster drugs which generated almost 60 % of total sales. GSK had 12 blockbuster drugs that contributed 56 % of total sales. Another example, in 2007, we can see that 12 blockbuster drugs of GSK accounted for almost 60 percent of company’s total drug sales (see Exhibit 2). Therefore, companies are exposed to high insecurity if they cannot find replacement of products which have equivalent financial size.
â€¢ Exhibit 2 GSK’s contribution of blockbuster to total drugs sales, 2007
As % of total drugs sales
Source: Company annual report, 2008
Next, the less productive of R&D pipeline and increasing cost of R&D. There is a downward trend of the number of New Molecular Entities (NMEs) and Biologics License Applications (BLAs). In 1996, there are almost 40 approvals of NMEs and BLAs but, by 2007, the figure was decreased to 18 (Riley 2008). In addition, the cost to develop a drug is ten-fold increase from $138 million in 1975 to $ 1.318 billion in 2006 (PhRMA 2009) (see Exhibit 3). Hence, from the opposite direction of R&D cost and R&D productivity, we can conclude that the overall efficiency of R&D in industry is lower than in the past.
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Finally, the expiry of patent and the impact of generics. For example, the best selling drug of GSK “Seretide/Advair” which generated US$ 7,653 million or 17 % of total turnover in 2008 will be expired in 2010 in the US and in 2013 in the EU. In this case, there is a possibility that GSK’s turnover might drop sharply after the expiry of Seretide if the company cannot develop product or new source of income to make up for the loss of Seretide/Advair sales. In addition, the increasing in number of patent expiries of blockbusters has a positive impact to the growth in generic market. As exhibit 4 shows, the compound annual growth rate (CAGR) of the global generic market was 16.4% during 2004 to 2007. In contrast, growth rate of overall pharmaceutical industry was at a CAGR of 8.3% in the same span. Another factor driven the growth of generic drugs is the greater attentiveness of payors as a result of current economic recession such as tightened healthcare budget of governments or private payors. It is likely that the price of drugs will be pushed down by the greater bargaining power. For instance, Japan had cut the price of drugs on the National Health Insurance (NHI) in 2008 by average 5.2% (Business Insight 2008). All in all, economic and stakeholders in the demanding side of the industry are now shaping the new form of the pharmaceutical market.
â€¢ Exhibit 3 Cost of developing new drug, 1975 – 2006
Source: PhRMA, 2009
â€¢ Exhibit 4 Global Generics Market, 2004 – 2007
Source: Business Insight, 2008
The Strategic priorities of GlaxoSmithKline PLC
In 2008, Andrew Witty was selected to be a CEO of GSK. After two months of being a CEO, he announced new strategy to steer GSK in global pharmaceutical market. There are three new strategic priorities; grow a diversified global business, deliver more products of value and simplify the operating model. This section will discuss how these new strategic a response to problem pharmaceutical business model problem.
Grow a Diversified Global Business
In this strategic, the company is trying to lessen its risk by widening and balancing its products across all geographic boundaries. In other words, company tries to reduce reliance on blockbuster drugs for company’s growth as Witty said “The biggest thing I’m trying to change is to go from saying it’s okay to have a blockbuster once every five years to a situation where we are delivering several new products every year” (Goodman 2008). As a recession in the USA, it had a huge impact in the US sales which is a main market for company that accounted for 40% of total revenue in 2008. The sales in the US decreased by 4.2% in 2008 compare to 2007 while Europe market and rest of the world market sales were increased by 16.3% and 16.6% respectively (GlaxoSmithKline 2009). Therefore, at this moment, the US market is saturated; company is now focusing on the market which has high growth such as Africa, China and India but also not ignore the US market. It shows that company is adapted to the current market situation. There are many actions that have been taken by the company that response to the business model problems. First, company is focusing on vaccine, biopharma and consumer healthcare which have high potential growth which in turn might create revenue to make up the loss of sales from expired patent blockbusters. Second, fulfill the potential of emerging markets and Japan market. Japan, alone, accounted for 10% of global pharmaceutical market (Medicines Australia 2009) which is the second largest from the US. It is a big market and a high growth market with market value of US$ 68.6 billion in 2008 and sales growth of 17.2% over 2007 (Business Insight 2009). In emerging markets, particularly, the seven “pharmerging” market including China, Brazil, Mexico, South Korea, India, Turkey and Russia seem to be the major driven of growth in the global pharmaceutical industry (see Exhibit 5). Better approach to generic is driven this growth. It is likely that GSK is now more concentrated on generic drugs, for example, company acquired branded generics from both Bristol-Myers Squibb and UCB as well as formed alliance with South Africa’s Aspen Pharmacare and Dr Reddy’s of India (Hirsler, 2009). To conclude, this strategic priority seems to be positive reaction of the company regarding the over-reliance on blockbusters, market decline in the US and the impact of generics as Johnson et al. (2008) suggested that diversification is suitable when current markets saturated while need for more rapid growth.
â€¢ Exhibit 5 Sales in 7MM and pharmerging markets ($m), 2003 – 2007
7MM = USA, Japan, France, Italy, Spain, Germany, UK
Pharmerging markets = China, Brazil, Mexico, South Korea, India, Turkey and Russia
Source: Riley, 2008
Deliver More Products of Value
GSK is lack of therapy area diversification and technology concentration. We can see that there are only 6% of biopharma in GSK’s pipeline. Moreover, oncology area represented only 1% of GSK’s Sales in 2007 while this area had global market growth of 3%. In order to maintain growth in the long term, GSK need to adjust its R&D issues (Riley 2008). Therefore, company announced plan as follow. First, company will focused on eight areas of therapy. Second, externalize R&D as its take a long time to create and develop by in-house. Third, GSK will create new biopharma and oncology R&D unit in China that have lower cost than established in developed countries which in turn help company to control R&D budget. Finally, divided R&D units into small group and financed dependent upon its performance which in turn will stimulate innovation. To conclude, GSK redefined its R&D pipeline and structure is reacted directly to the problems of R&D as mentioned previously as well as problem of over-reliance on blockbusters.
Simplify the Operating Model
GSK is trying to reduce cost in running business. First, develop commercial model; for example, integrate the back office finance system into one system across organization. Second, reduce cost in manufacturing. Company has a plan to cut two-third waste in production by 2015 (Jack, 2009a). As a result, company will be able to redeploy the money from cost reduction into investment. Overall, this strategy is not related directly to the problems of business model, however, the amount of reduction in working capital can be put to R&D or other investments which might turn to be in form of company growth (Bender and Ward 2009).
In conclusion, it is obvious that new strategy of Andrew Witty is reflected directly to the problems of business model which are heavily reliant on blockbusters, R&D problem and impact of generic drugs. However, company is likely to put their focus on small molecules which is the core heritage of the company and the existing products as well as diversify its portfolios and adapted itself into recent market environment.
Will new strategy succeed?
The new strategy of GSK is likely to lead the company to succeed in the future as it is reflected straightforwardly to the problems of business model. Additionally, it is not simple to point out or evaluate the firm’s performance as Rosenzweig (2007) argued that the success or performance is not totally forced by internal factors; in contrast, it is relative to a company itself and environment as a whole. Therefore, successful of strategy in this paper will be defined as if company can increase its shareholder values in the long term. In addition, how will company succeed will evaluate by if the new strategy will increase value of its shareholder. Rappaport (1998) pointed out that shareholder value can be driven by seven factors; raise sales growth, boost operating profit margin, lessen cash tax rate, reduce incremental investment in capital spending, reduce investment in working capital, increase time period of competitive advantage, and reduce cost of capital.
Regarding company’s diversified global business strategy; there are many significant improvements as a result of applying this strategy. First, there is sales growth compared with quarter in previous year in every quarter from third quarter of 2008, after announcement of new strategy, in British pound term. Furthermore, GSK had an increasing in third quarter 2009 of sales 19% in Japan, 25% in emerging market, and 8% in consumer products (Jack, 2009b). In first quarter of 2009, company experienced decline in US market by 22% company Overall, this strategy reflects directly with sales volume which leads to growth in sales. Therefore, company increases its shareholder value as it can raise its sales growth.
Deliver more products of value; from this strategy, company should be able to create more revenue from its value added activities. From the company financial data comparing nine month of 2008 and 2009, we can see that GSK had an increasing in gross profit and operating profit 16% and 8% respectively (see Exhibit 6). However, gross margin and operating margin were decreased slightly by 0.4% and 2.39% to 74.05% and 29.48% respectively. Therefore, company unable to raise its shareholder value by this strategy as it was failed to increase operating margin. Moreover, company has less efficiency as its return on capital employed (ROCE) was dropped (see Exhibit 6 and 7) from 22.18% in three quarter of 2008 to 19.71% in three quarter of 2009. There is a probability that company is unable to deliver more values from money that put it investment. However, value added activities of this industry is more likely as R&D process. It takes long time to get outcome from money that invested today. For example, to evaluate the R&D performance, we should not consider only the approval of new drugs only, as it takes 10 – 15 years to develop a new drug which mentioned in part I but also we need to take in account the drug development in the early phase, this drugs which are in process cannot generate profit for company today. Overall, we can see that in this strategy. The company is unable to enhance in shareholder value as it cannot increase it operating margin. This is mean that at this period of time a company is inefficiency to control their selling, administration and R&D expense.
The third strategy, simplify the operating model. There is one mission in this strategy that related directly to increase shareholder value which is reducing working capital. As in September 2008, company was able to reduce its working capital by 500 Million GBP, therefore, shareholder value is increasing as money from working capital can be return to shareholder in form of dividend or can reinvest in company at low cost of capital. This strategy should able a company to lower cost of operation, in contrast, exhibit 6 shows that selling and administration expense was increasing by 24% while turnover increased only 16%. It seems that company cannot succeed its goal by this strategy.
If we take a look at stock price of company, we can see that price is hit the highest in 52 weeks in December 2009 (see exhibit 8). This can indicate that market gains confidence about the company performance. However, P/E ratio 13.79% of the company as 14 December 2009 is still lower than competitors; Pfizer at 15.19% and Novartis at 16.1%. This can be interpreted that price low of GSK is low than competitors.
All in all, despite the confidence of the market about GSK, in my opinion, up to the present moment the new strategy is not successful in term of maximizing its shareholder value. As we can see from the numbers such as ROCE and operating margin that company cannot build up or even maintain these ratios. However, it needs to be seen it long run whether strategy will succeed since only internal factors cannot make company to succeed.
â€¢ Exhibit 6 GSK; Nine Month ended Income Statement, 2008 and 2009
Source: GSK Press Release, 28 October 2009 Available at : www.gsk.com [accessed 13 December 2009]
â€¢ Exhibit 7 GSK; Nine Month ended Balance Sheet, 2008 and 2009
Source: GSK Press Release, 28 October 2009 Available at : www.gsk.com [accessed 13 December 2009]
â€¢ Exhibit 8 Stock Price of GSK, London Stock Exchange, 2years ended 14 December 2009