Aging business models in the pharmaceutical industry

The pharmaceutical industry is an interesting field to observe. Not because the industry still reaps impressive profits and because a graying and wealthy population in Europe and Japan promises more profits to come, but because the mainstream pharma business model seems ripe for a makeover.

One of the first business model building blocks under attack will be their value proposition. The mainstream value proposition of today’s big pharmaceutical companies still relies on patent protection for their blockbuster drugs. The big companies make heavy earnings from a few important drugs and rely on the discovery of new drugs. This however is becoming an increasingly unreliable part of their business model. R&D has somewhat let them done and their new product pipelines are emptier than ever before. Also, brining a drug to the market is estimated to coste somewhere between 800 million USD to 1.5 billion USD. As a consequence the entire pharmaceutical industry puts more money in patent protection on the one hand and marketing on the other.

This brings us to the next and maybe most important business model building blocks under attack: distribution channels and customer relationship. It is well known that most pharmaceuticals already put more money into sales and marketing than into R&D. A recent article of The Economist mentions that Novartis is spending 33% of sales on promotion, while it is only spending 19% on R&D. Or take Pfizer who is known for its huge sales machinery consisting of over 38’00 employees. But who is pharma actually marketing to? It is their final customer, the patient, one the one hand, but more importantly doctors on the other. The former however, are increasingly well informed (thanks to the Internet) and less vulnerable to marketing messages. The latter will come more and more under pressure to use the cheapest and best drugs and not those with the most attractive marketing.

So how will the business models actually change? There are several trends already emerging and some speculations to be made. One part of the mainstream pharma’s business model to change is R&D. More and more of it will be outsourced or at least offshored, particularly since India (among others) has introduces more rigid Intellectual Property Rights (IPRs). Furthermore, many companies already inlicence so-called “molecules” from small and medium-sized innovative biotechnology companies. The pharma’s added value is reduced to running a huge marketing machinery. This would be in line with some management theories that have already talked about the “unbundled corporation” for years, which means that companies will either concentrate on innovation, marketing or infrastructure.

Another possible, but still speculative business model change is the emergence of a whole new value propositions. While it seems probable that the blockbuster model is unsustainable it is not yet clear what will replace it. Some, such as Steven Burill, believe that diagnostics will become the main revenue generator in the future. In general, many bet on a more personalized approach to pharmaceutical products which will be tailored to the genetic profile of patients. This is one of the reasons, why IBM is investing heavily in Bioinformatics.

Finally, it will be interesting to observe whether the cornerstone of the aging pharma business model, patent protection and Intellectual Property Rights, will eventually tumble. The software industry with the emergence of the Open Source Software (OSS) movement, but maybe even the music industry has some valuable lessons to teach to incumbents in big Pharma. The most visible threat, generics producers from countries such as India and Brazil might just be the tip of the iceberg…

Have a look at the Tropical Disease Initiative and you might be looking at the future of pharma's open source business model.