Drugs companies have lost far more than their health

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When an industry model is broken, the best business strategy may be to manage its decline.

Pfizer’s decision to close its research laboratory at Sandwich is widely seen as a setback for recovery in Britain, a country that played a leading role in the development of the modern research-based pharmaceutical industry. In the last century, high profitability characterised the industry, founded on blockbuster drugs that would typically relieve, but not cure, the ill-effects of affluence – depression, hypertension, stomach acidity and arterial degeneration.

George Merck, president of the eponymous company from 1925 to 1950, famously expressed his corporate philosophy: “We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear. The better we have remembered it, the larger they have been.” For many years Merck topped Fortune magazine’s list of most admired companies. Johnson & Johnson’s 308-word credo captures similar sentiments. In a classic business school case on ethics and corporate reputation, the company’s executives applied the credo to implement a speedy product recall.

The drugs industry has thus had an implicit contract with public and government. It was permitted extraordinary profitability in return for companies behaving as exemplary corporate citizens.

Pfizer was always an odd man out. While Merck was lecturing doctors on his commitment to social responsibility, John McKeen, his Pfizer counterpart, was assuring his shareholders: “So far as humanly possible, we aim to get profit out of everything we do.” In a 1994 business book by Jim Collins and Jerry Porras, Built to Last, Pfizer is Merck’s ugly sister. More assertive but less profitable, it epitomised the profit-seeking paradox – the most profitable companies are not the most aggressive in pursuit of profit.

But in the 1990s the supply of new blockbuster drugs diminished. Perhaps the low-hanging fruit had been picked, while able scientists from the academic world could more easily access venture capital to do their own thing. The industry was criticised for its focus on the minor ailments of the rich rather than the life-threatening diseases of the poor. Drug companies came under pressure from Wall Street to demonstrate commitment to shareholder value. The pay-off from marketing is immediate, the pay-off from research delayed, and their strategy reflected that. They also spent a great deal on buying each other. The greatest modern achievement of pharmacology – the cocktail of drugs that controls Aids, with public research leading the way – may be a model for future innovation.

As Pfizer jumped ahead in this environment, Merck stumbled – it would feature again in Mr Collins’s 2009 book, How the Mighty Fall. A new blockbuster painkiller, Vioxx, was promoted not just for the minority of patients who derived a unique benefit but for many who might as well have taken an aspirin. Merck withdrew the product amid recrimination and lawsuits. Even the revered J&J would find its reputation tarnished by the regulator’s discovery of bad practice – and dubious management responses – at the company’s McNeil consumer products group.

An industry that once seemed to exemplify a constructive relationship between private enterprise and public benefit is now widely detested. US customers face spiralling drug costs. Development groups believe the industry’s contribution to the world’s poor is grudging and inadequate. Medical professionals view its ethics with mistrust. Its response has been a lobbying effort rivalled only by that of the financial services industry.

Such lobbying may delay, but not ultimately prevent, reversion to profit margins that reflect the new nature of the industry in returns appropriate to consumer products rather than innovative research. The future of pharmacology will probably look more like the peer-reviewed open process of incremental development based on public and philanthropic funding found elsewhere in medical science.

Pfizer has decided to attempt to meet its earnings growth targets – the patent on its popular cholesterol drug, Lipitor, is about to expire – by cutting its research budget, correctly observing that its productivity has declined. Rival Merck, in contrast, has lowered earnings projections to maintain research spending. The market’s immediate verdict was that Pfizer was right. For its shareholders, perhaps. When an industry model is broken, the best business strategy may be to manage its decline.

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