O N THE
P HARMACEUTICAL
I NDUSTRY
MIT Sloan School of Management
Cambridge, Massachusetts
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P ROGRAM
O N THE P HARMACEUTICAL I NDUSTRY MIT Sloan School of Management Cambridge, Massachusetts |
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Rebecca Henderson, 1994.
The continued vitality of the most successful U.S. and European pharmaceutical companies, in the face of accelerating scientific and technological change, holds valuable lessons for managers in all industries trying to respond to turbulent times. The pharmaceutical industry faces some serious challenges in the future, most notably the proposed reform of the U.S. health care system. Yet is success to date in the crucial area of research can serve as a benchmark for companies seeking to become more innovative in the overloaded environment of the information age.
New competitors skillfully exploiting a wave of technological change have displaced or seriously challenged the companies that once dominated such industries as machine tools, steel, xerography, automobiles, semiconductors, and computers. In contrast, companies founded in the 1940s and 1950s continue to dominate the pharmaceutical industry. These companies have demonstrated an ability to learn and grow that confounds conventional wisdom. Despite their age, size, and success, the best of these companies have found ways to retain the flexibility and responsiveness of companies one-tenth their size and age. And they have already solved some of the competitive challenges in the research arena that companies in other industries are just starting to grapple with.
Ernst R. Berndt, Linda T. Bui, David H. Reiley & Glen L. Urban, 1994.
The introduction of Tagamet in the United States in 1997 represented both a revolution in ulcer therapy and the beginning of an important new industry. Today there are four prescription H2-antagonist drugs: Tagamet, Zantac, Pepcid, and Axid, and they comprise a multi-billion dollar market for the treatment of ulcers and other gastric acid conditions. In this paper, we examine the determinants of sales in this market, using a carefully constructed data set made possible by IMS America. We concentrate particularly on the marketing of these drugs to physicians through detailing and medical journal advertising, and we make an innovative attempt to distinguish between "industry-expanding" and "rivalrous" marketing efforts. We find that the impact of total marketing on the expansion of overall industry sales declines as the number of products on the market increases. In addition, we find that the stock of industry-expanding marketing depreciates at near-zero rate, while the stock of marketing oriented towards rivalrous market share competition depreciates at a 40% annual rate. We also find that the products' sales are affected significantly by price, quality attributes (such as dosage frequency and FDA-approved indications), and order of entry into the market.
Iain Cockburn & Rebecca Henderson, 1994.
In 1971, the member of the Pharmaceutical Manufacturer's association spent about three hundred and sixty million dollars on research and development. In 1991, they spent 8.9 billion, an increase of over two thousand three hundred percent. But while industry sales have grown in line with research expenditures, there has been no significant increase in the number of new drugs introduced . Why have costs increased so dramatically? Breakthroughs in pharmaceutical research can lay the groundwork for qualitative improvements in the quality of life and for significant reductions in the cost of health care, but escalating health care costs have focused attention on every aspect of health care expenditure and have led several observers to question this apparent decline in pharmaceutical research productivity. This paper hopes to contribute to this debate by exploring the issue in the context of a broader study of the determinants of research productivity in ethical drug discovery.
Kaivan D. Munshi & Michael R. Reich, December 1993.
Strengthening the firm-bank relationship to reduce information problems associated with the debt contract leads to a new incentive problem. The bank receives the same return in all success-states under a standard debt contract, resulting in a concave payoff function. A close firm-bank relationship may thus allow the bank to promote the choice of excessively safe investment projects. The costs of this distortion could, in principle, dominate the benefits of the increased access to capital associated with a close firm-bank relationship. We demonstrate the importance of the incentive problem for the case of the Japanese pharmaceutical industry. The choice of R&D investments in that industry is found to have been severely constrained prior to the financial deregulation of the 1980s. Since the incentive problem has the potential to be particularly serious in R&D-intensive industries, we conjecture that this result may have more general implications for the global competitiveness of Japanese high-tech industries in the future.
Paul E. Greenberg, Laura E. Stiglin, Stan N. Finkelstein & Ernst R. Berndt, 1993.
We estimate in dollar terms the economic burden of depression in the United States on an annual basis. Using a human capital approach, we develop prevalence-based estimates of three major cost-of-illness categories: (1) direct costs of medical, psychiatric, and pharmacologic care; (2) mortality costs arising from depression-related suicides; and (3) morbidity costs associated with depression in the workplace. With respect to the latter category, we extend traditional cost-of-illness research to include not only the costs arising from excess absenteeism of depressed workers, but also the reductions in their productive capacity while at work during episodes of the illness. We estimate that the annual costs of depression in the United States total approximately $43.7 billion. Of this total, $12.4 billion -- 28% -- is attributable to direct costs, $7.5 billion -- $17% -- comprises mortality costs, and $23.8 billion -- 55% -- is derived from the two morbidity cost categories.
Depression imposes significant annual costs on society. Because there are many important categories of cost that have yet to be estimated, the true burden of this illness may be even greater than is implied by our estimate. Future research on the total costs of depression may include attention to the comorbidity costs of this illness with a variety of other diseases, reductions in the quality of life experienced by sufferers, and added out-of-pocket costs resulting from the effects of this illness, including those related to household services. Finally, it may be useful to estimate the additional costs associated with expanding the definition of depression to include individuals who suffer from only some of the symptoms of this illness.
Paul E. Greenberg, Laura E. Stiglin, Stan N. Finkelstein & Ernst R. Berndt, 1993.
Recognition of depression as a major illness has been slow in developing. Given the widespread prevalence and the enormous burden depression imposes on society, this article asks why the illness has not received more attention from the medical and public health communities -- especially primary care physicians -- employer groups, as well as society at large. We argue that the characteristics of the illness itself and the manner in which it exacts a toll on sufferers tend to reduce public awareness of the magnitude of this problem.
We present estimates of the number of people who suffer from depression in the United States and the annual cost associated with this illness. These estimates underscore the appropriateness of classifying depression as a major public health concern. We then present a framework for contrasting depression with other diseases using several criteria: economic costs, prevalence, distribution of sufferers, mortality, recognition, and treatability.
Alan N. Afuah, 1993.
This paper reviews nine studies of the effects of national public policy on innovation in the pharmaceutical industry. The studies suggest that the innovativeness of the local industry is promoted by increased local funding for basic research, tight patent protection, strict safety and efficacy laws and incentives for investment in R&D, but that local innovativeness is substantially reduced by the imposition of price controls. However, the paper suggests that more research is needed before differences in local public policy regimes can be unambiguously linked to differences in the innovativeness of the local pharmaceutical industry. Changes in public policy often interact with each other in unpredictable ways and have quite unexpected effects.
Iain Cockburn & Rebecca Henderson, 1994.
Recent advances in the theoretical literature have greatly expanded our understanding of the forces that shape the competitive dynamics of research and development, but a paucity of sufficiently detailed empirical data has left these insights relatively untested. We draw on unusually detailed qualitative and quantitative internal data provided at the research program level by 10 major pharmaceutical firms to explore the usefulness of the modern literature as a source of insight into the dynamics of competition in ethical drug discovery.
Our analysis focuses on one particularly compelling aspect of the literature: the suggestion that in "winner take all situations", competition in R&D becomes a Prisoner's Dilemma, leading to overinvestment in research. Without adequate measures of the social return to innovation, we can say nothing about whether there is "too much" or "too little" research undertaken by the industry, but our results do not support the suggestion that R&D investment in drug discovery is driven by the "tit-for-tat" or simple reaction function models hinted at by the institutional literature. First, R&D investment is only weakly correlated across firms once common responses to exogenous shocks are accounted for, and second, rivals' R&D results are positively correlated with own research productivity, which we interpret as evidence for extensive R&D spillovers rather than the depletion externality implied by "winner take all" models.
Rebecca Henderson & Iain Cockburn, 1994.
Renewed interest in the resource-based theory of the firm has focused attention on the role of heterogeneous organizational 'competence' in competition. This paper attempts to measure the importance of these effects in the context of pharmaceutical research. We distinguish between 'component' and 'architectural' competence, and using internal firm data at the program level from 10 major pharmaceutical companies show that together the two forms of competence appear to explain a significant fraction of the variance in research productivity across firms. Our results raise some intriguing questions about the nature of competencies and the ways in which they diffuse over time.
There has recently been a revival of interest in the 'resource-based view of the firm'. Those working within this tradition have drawn inspiration from the work of authors such as Selznick (1957) and Penrose (1959), and have suggested that inimitable firm heterogeneity, or the possession of unique 'competencies' or 'capabilities', may be an important source of enduring strategic advantage. This perspective promises to be an important complement to the strategic management field's more recent focus on industry structure as a determinant of competitive advantage.
G. K. Raju & Charles L. Cooney, 1995.
The continuing and dramatic changes in the pharmaceutical industry structure in recent years have left many pharmaceutical companies searching for the appropriate response. In this work, we explore the role that manufacturing can play in responding to the demands placed on the industry by these changes.
Our approach in this work has been to use "benchmarking" as a means to characterize the current state of pharmaceutical manufacturing and contrast it with the desired future state. Lead benchmarking partnerships were formed with 14 different pharmaceutical plants representing the brand name, generic and biotechnology segments of the industry. Using qualitative interviewing, and function and sub-process based questionnaires, performance was measured in these plants to identify the opportunities for improvement.
Preliminary results from our benchmarking study indicate that:
There is a need to benchmark core sub-processes within the plant rather than functional areas.
Manufacturing is still viewed as a cost center. This view is associated with a defensive mindset towards manufacturing.
Inventory management represents a significant opportunity within the industry. Many plants have high inventory levels worth up to $50 million in tied up capital. This represents an inventory level in excess of $30 billion for the global industry.
There is a large opportunity associated with the supplier management process. This is indicated by high raw material inventory levels, high QC test and release times, the number of defective lots passed, the % of vendor lots not accepted and the number of suppliers.
Cycle time reduction is a very large opportunity are within pharmaceutical manufacturing. Preliminary evidence indicates that more than 90% of the cycle time in pharmaceutical manufacturing is spent in non value-added activities.
Within the context of the cost of quality framework, it seems clear that the pharmaceutical industry is keenly focused on minimizing external failure costs through appraisal (inspection). There is a large opportunity to move the focus from external to internal failure costs and from appraisal to prevention.
There are many promising future directions from this study. They include consistency analysis, additional metrics, both a lower level and higher level of analysis, increased collaboration with benchmarking partners, interaction between R&D and manufacturing, the impact of regulation and a study of best-practices in other industries.
Ernst R. Berndt, Stan N. Finkelstein, Paul E. Greenberg & Laura E. Stiglin, November 1993.
Frank Basa & Thomas J. Allen, 1994.
While project management has existed, in one form or another, certainly since the days of pyramid construction in ancient Egypt, the modern day conception of project management emerged only very recently in the aerospace, computer and construction industries. Modern project management techniques developed as managers in these industries attempted and learned to better control large-scale projects. Project management has had a much shorter history in the pharmaceutical industry. In that industry, the earliest attempts date back only to the 1970's.
The slow adoption of project management in the pharmaceutical industry can be attributed to two factors: the strong disciplinary focus of the work force and the relative affluence of the industry. Pharmaceutical firms have traditionally had strong functional orientations due to the highly skilled and rather narrowly focused professional R&D workforces whose loyalties have often lain with their academic discipline. Concomitant with this was a munificent environment that allowed researchers to operate with little concern over the economic aspects of R&D. There was little pressure to control costs or to compress schedules. For many scientists and physicians in the industry, commercial considerations were secondary.
Stan N. Finkelstein & Peter G. Bittinger, 1993.
To compete successfully in global markets, pharmaceutical firms must develop innovative and global drugs -- those that represent therapeutic breakthroughs and that are targeted at categories not exclusive to the domestic market. A firm's ability to do this successfully is determined at least partly by whether the domestic climate itself establishes these conditions for success.
Why is the domestic climate important? The drug companies of every major country (except Switzerland) depend on their home market for a significant portion of their sales. Thus, a domestic climate that provides no incentives and resources for the research and development activities necessary to develop innovative and global drugs can have a major negative impact.
The national policies that often establish the climate in which a domestic pharmaceutical operates -- while not the sole determinants of international competitiveness -- are important factors in the equation. These policies often define whether sufficient R&D incentives, and the resources to realize R&D plans, will exist. The effects of price and profit regulation can be large factors in international competitiveness.
There are strong interrelationships among investment in R&D, national policy, profitability, and reward for innovation. If regulation truly rewards innovation and provides the resources to take the risks that achieve innovation, the domestic market conditions will provide a solid foundation for a globally competitive pharmaceutical industry. In fact, the R&D focus of a country's pharmaceutical industry is largely shaped by the national policies, and the level of investment in R&D general reflect whether a firm can achieve profitability in the domestic market through innovation, given national regulations.
Joseph J. Chow & Charles L. Cooney, 1992.
Just a decade ago, gene therapy seemed like a radical idea that existed only in the realm of science fiction. Gene futurists envisioned a world in which genetic diseases would be virtually eliminated by technologies to replace defective human genes with functional ones. Alarmists feared a world in which irresponsible research would lead to genetically engineered superhumans with dreams of global domination. Today, the vision of the futurists is rapidly evolving into an attainable reality and the fears of the alarmists have been allayed by responsible science and successful clinical trials.
Over the last decade, gene therapy research has progressed beyond studies in animal models to clinical trials in human beings. The first authorized human gene therapy experiment was conducted in 1990 in the United States. The experiment involved a child suffering from a rare inherited disorder caused by a faulty gene. The genetic defect impaired the little girl's immune system, confining her to live her life in an isolation chamber. To carry out the gene therapy, a small amount of her cells was removed and "transduced" with special viruses. The viruses transferred normal, functional copies of the gene to her cells. The cells were then re-implanted. Almost two years later, the little girl is reported to be doing remarkably well and living a normal life.
Since the, rapid progress continues to be made. By early 1992, a total of 17 gene therapy trials had been approved by the NIH's Recombinant DNA Advisory Committee and seven more are under consideration. Within the next two years, the NIH expects a quadrupling of applications to conduct gene therapy experiments in humans.
In the tradition of the biotechnology industry, new companies have been formed to commercialize advances in gene therapy technology. Supported by venture capital funding, these companies have set out transform newly developed gene transfer and cell transplantation technologies into profitable products and/or services. How gene therapy technologies are being transformed into commercial enterprises is the subject of this paper.
Ernst R. Berndt & Stan N. Finkelstein, 1992.
The health care industry is one of the more rapidly growing industries in the U.S. today. In 1970, for example, health care costs were 7.3% of the GNP, but by 1992, they have risen to an estimated 13.4% of the GNP. Within the health care chain, the prescription pharmaceutical industry has become increasingly visible. While prescription drugs and related supplies account for only 7% of the total health care bill, consumers are particularly well aware of price trends in pharmaceutical products, for patient co-payment is about 70% -- much larger than for most other components of health care.
Another factor contributing to the visibility of the pharmaceutical industry is its recent record of prosperity and profitability. The July 29, 1991 issue of Fortune magazine called the pharmaceutical industry "America's Most Profitable Business," which the April 20, 1992 issue noted that in 1991 the pharmaceutical industry outperformed every other industry in terms of returns on sales (12.8% vs. 3.2% for the median Fortune 500 firm), returns on assets (12.1% vs. 3.7%) and returns on common equity (26.1% vs. 10.2%). And while in terms of sales the pharmaceutical industry was 11th in the U.S., in terms of accounting profitability, it was second.
Rebecca Henderson, 1994.
Recent research has highlighted the ability to integrate fragmented knowledge across boundaries within a firm as a potentially potent source of competitive advantage. Yet this research raises a potentially puzzling question: if these capabilities are so central to competitive advantage, why do they not instantaneously diffuse across an industry? This paper draws on a detailed field study of the development of hypertensive drugs in 10 major European and American firms to explore this issue. I suggest that any particular integrative competence rests on a complex set of interlinked factors that usually evolve only slowly over time. Those firms that were fortunate enough to have focused early on more 'rational' modes of drug discovery have been much more successful in developing the integrative capabilities fundamental to modern drug discovery than those that initially achieved great success with the more traditional 'random' method of drug discovery. The results thus speak directly to evolutionary theories of competence development. They also raise intriguing questions about the relationship between the development of competence and the larger institutional context of the industry, since both the wealth and prominence of public sector biomedical research and the use of mechanism of action as an integrative device appear to have shaped the formation of capability in the industry.
Rebecca Henderson & Iain Cockburn, 1995.
We examine the relationship between firm size and research productivity in the pharmaceutical industry. Using detailed internal firm data, we find that larger research efforts are more productive, not only because they enjoy economies of scale, but also because they realize economies of scope by sustaining diverse portfolios of research projects that capture internal and external knowledge spillovers. In pharmaceuticals, economies of scope in research are important in shaping the boundaries of the firm, and it may be worth tolerating the static efficiency loss attributable to the market power of large firms in exchange for their superior innovative performance.
Are the research efforts of larger firms more productive than those of their smaller rivals, and if so, why? Answers to these questions speak directly to two central problems in the economics of industrial organization. In the first place, the relationship between the size of a firm and its innovative performance plays a central role in the analysis of industry structure, innovation, and the tradeoff between static and dynamic efficiency. In the second place, economies of scope and scale in research and development (R&D) play an important role in the theory of the firm: well-known problems in the market for information imply that they are fundamental to the existence of multi-product firms.
Alan N. Afuah, 1992.
What is the role of a drug's technical performance as a driver of product market success? Are drug prices really rising as fast as they appear to? Are more expensive drugs really more effective? This paper uses cholesterol drugs to examine these questions. The results suggest that:
Quality adjusted prices are lower than the unadjusted ones -- an annual increase of 6% compared to 9% when unadjusted for the years 1986 to 1992.
Expensive drugs tend to be more effective.
Technically superior drugs tend to be more successful in the market; the better the performance characteristics of a drug, the more successful it is in the market.
The technological generation from which a drug comes -- a proxy for the characteristics of the drug -- also has a significant effect on the drug's market success.
Ernst R. Berndt, Zvi Griliches & Joshua G. Rosett, 1992.
From January 1984 through December 1989, the Bureau of Labor Statistics (BLS) price index for prescription pharmaceuticals grew at 9.09% per year. Using BLS-type Laspeyres index procedures with monthly price and quantity data on all prescription pharmaceuticals sold by four U.S. pharmaceutical manufacturers accounting for 24% of industry domestic sales, we find that the four-company index increases at 6.68% per year. When we employ a Divisia price index with smoothed weights incorporating new goods, the index grows 6.03% per year. Why does the BLS index grow 50% more rapidly than the Divisia index? That mystery is the focal point of our article..
Stewart C. Myers & Lakshmi Shyam-Sunder, 1992.
This paper summarizes what modern finance can say, using publicly available data, about the cost of capital for investment in pharmaceutical R&D. It provides benchmark estimates for 1980, 1985, and 1990, and discusses how the estimates could change under different assumptions about financing and risk. It also discusses some of the practical difficulties encountered in evaluating commitments to R&D programs. The paper is an overview of standard theory and good current practice on these topics.
The standard theory is briefly reviewed in the next section. Section 3 gives preliminary estimates of the overall cost of capital for major U.S. pharmaceutical companies. Current practice would use these estimates as benchmarks, adjusting them up or down to set the cost of capital and discount rate or "hurdle rate" for particular classes of capital investments. This section also comments on cost of capital estimates used in past studies of costs and returns in pharmaceutical R&D.
Section 4 discusses the special risks that could justify a cost of capital for pharmaceutical R&D higher than the benchmark overall cost of capital for major pharmaceutical companies. We note some of the practical problems encountered in evaluating investments in pharmaceutical R&D. For example, the skewed payoff distributions encountered in R&D investments often make application or interpretation of standard discounted cash flow analysis exceptionally difficult.
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