Strong R&D will continue to spur the development of great new pharma therapies and molecules. But to make those advances marketable, pharmaceutical companies will have to remain profitable. As these authors write, the surest road to future profits will not be the traditional one of innovation, but rather the ability to orchestrate partnerships and make sense of complexity.
Of the top ten global pharmaceutical manufacturers in 1981, five no longer exist. By 2020, a few of today’s top ten will be acquired. Clearly, there will be winners and losers, making it reasonable to ask what will differentiate the former from the latter. For the past 30 years, the deciding factors have been innovation and savvy marketing, as patented new products have driven outsized revenue growth and direct-to-consumer advertising heightened brand awareness. But several profoundly disruptive forces at work in the industry today will likely halt that trend.
Instead of innovation and savvy marketing, excellence in operations will distinguish tomorrow’s leaders. The rising profile of operations excellence will be driven by two emerging industry realities. First, vertical integration is dead. Tomorrow’s pharmaceutical industry will be a world of virtual partners, where orchestration is the essential competency. Second, pricing pressures will demand operational efficiencies. Rapid commoditization will erode the once-solid path to wealth via research and development (R&D). By 2020, the top pharmaceutical companies will be so efficient that they will be able to achieve profits even in the absence of glittering new innovations.
Six disruptors of the pharmaceutical landscape
Most pharmaceutical executives know about the fundamentally disruptive forces shaping the future of their industry. Yet they too rarely think holistically, about how the confluence of these forces under various scenarios could turn their current world on its head. Briefly, the transformative forces reflect these realities:
1. Innovation has lost its punch. The profit window from patents is shrinking, and average development costs are rising. Price-to-earnings ratios have been falling, despite rising revenues and R&D expenditures, highlighting stockholders’ lack of confidence that current innovations will deliver reliable future cash flows.
2. Complexity is up, visibility down. Complications arise in research (product science and the genesis and sourcing of ideas), manufacturing (outsourcing and increasingly varying controls and regulations), and the supply chain (a diversified supply base, complex portfolio, and worldwide sourcing network). Yet in today’s global networks, the ability to get a picture of that that complexity is limited.
3. Clinical data are the new frontier. Cost-conscious payers are diving into data on performance to determine which treatments get approved for reimbursement. In addition, regulatory scrutiny is heightening, as evidenced by the recent marked increase in the number of warning letters to pharmaceutical companies.
4. Market power is shifting. Decision-making authority is shifting from physicians to payers, and branded medications will increasingly lose out to generics. Meanwhile, as markets globalize, regulation is becoming more of a “black box.” Pharmaceutical companies are thus facing more uncertainty.
5. The funding model is broken. All developed countries have a structural inability to fund health care under existing models. The eventual solution will necessarily involve lower prices—the only question is whether they will be market driven or government mandated.
6. Emerging markets will drive growth. Emerging economies represent huge potential demand—if pharmaceutical companies can figure out how to capture that demand, given the underdeveloped infrastructure and comparatively lower incomes.
How are these forces interacting with each other to change the criteria for success in the industry? Many thoughtful people have sought to plan for the future of their business based on their knowledge of the forces individually. But when the forces combine, they generate a different set of implications. Our thinking is influenced by our experience using scenario planning, which encourages creative thinking about combinations of known inputs to generate surprising visions of the future. We believe that such an approach to dealing with these disruptors will have two unforeseen implications for the future of healthcare delivery.
The new orchestrators
A.T. Kearney worked with a healthcare company that bought plastic bottles from a company that bought the necessary resins from another company that in turn purchased the component chemicals from yet other sources. The healthcare company had made a backup plan to buy bottles from a different Tier 1 supplier as a rudimentary risk management strategy. But it lacked visibility into Tiers 2 (the resins) and 3 (the chemicals), and unfortunately, all of its potential partners relied on the same resins. When a single plant was knocked out by a natural disaster, worldwide shortages of an essential healthcare product ensued because of a lack of bottles.
The sad truth is that traditional risk management approaches do not account for the proliferating vulnerabilities in today’s complex value chains. We tend to look to the past rather than the future, we fail to grasp root causes, and we focus on what seems likely while totally ignoring the improbable. These inherent biases mean that we’re not very good at understanding risks. And yet our organizations tend to have their own deficiencies—limited relevant data, a lack of coordination, and no risk governance—that amplify rather than mitigate those human frailties.
Thus, risk management needs to start with visibility and governance. In our example, if the company had had visibility into its Tier 2 and 3 suppliers, it could have better foreseen risks. The best way to insist upon that visibility is to embed and sustain a robust risk management governance structure to articulate responsibilities, centralize coordination, and measure performance. Risk management can be sophisticated and effective without being terribly complex—but it requires a mindset — from top leadership down — to prioritize risk management as an essential component of partner orchestration.
What single company could adapt itself to handle all of these disruptive forces? Any one of them alone would be a challenge. Combined, they threaten nearly every traditional source of strength in the industry.
And so it will not be a single company that will do it all. Rather, it will be a network of collaborating partners. We’ve already seen the beginnings of this model, with the advent of contract research organizations (CROs), third-party manufacturers, suppliers, and logistics providers. But we’ve also seen many companies struggle to achieve profitability under this model. Why? Because they have not embraced the required change in their core competencies.
Such partnerships require orchestration. (See Figure 1) As an orchestrator, you manage information and relationships, not products. You’re in control of virtual partnerships. These partnerships are built on three pillars:
- Collaborate. In the past, a healthcare company needed to build skills in discovery, development, manufacturing, distribution, sales and marketing. But today, a company must instead develop one primary skill, which is the ability to orchestrate the work of its partners. In an “orchestration” analogy, you are no longer a violinist, but a conductor seeking to get maximum value from a section of stringed instruments, woodwinds, brass, and percussion. As a conductor, you must establish consistent processes and criteria for selecting and evaluating trusted partners, and establish systems of accountability and responsibilities that provide partners with the right incentives (innovation, cost control, quality, etc.). A well-run symphony can provide a much richer sound than a single violinist (no matter how accomplished)—but it requires a conductor to ensure that the musicians’ efforts lead to harmony, not dissonance.
- Develop a risk management mindset. The benefit of relying on orchestra musicians is that you don’t have to develop every capability internally. (As recent history has shown, that’s difficult to pull off.) The drawback of this model is that you are now only as reliable as your next partner. Thus, uncertainty is introduced. As the value-chain relationships increase, collaboration becomes more complex and vulnerabilities increase. But through active risk management planning, you can mitigate the damage that can come from many types of threats.
- Make information transparent: The phrase “virtual partnerships” hints at the information-rich nature of interaction needed for these relationships to thrive. The first two pillars rest on a foundation of real-time “intelligent” information flow, where you link systems (as when a pharmaceutical company and third-party manufacturer share bills of materials) and develop new analytics to gain purposeful and accurate insights. Yet, transparency extends beyond data to ensure standard processes, such as quality systems and compliance, so that all partners in the network achieve their shared business objectives.
By moving from operator to orchestrator, a pharmaceutical company is acknowledging that its success is intertwined with that of its trusted outside partners. As a result, those relationships are the company’s most valuable assets, and they are built upon trust. You need to actively manage the partnership by aligning incentives, minimizing risks and reducing inefficiencies so that your partner can maximize its own skill. Trust starts with collaboration, namely ensuring that manufacturers are working well with their network of suppliers, teaming with retailers for co-promotion, or reaching the right doctors. But the scope of collaboration can also extend to integrating assets, resources, and capabilities to benefit patients and save money. For example:
- In discovery, the orchestrator might target areas for researching and recruiting partners (not just standard CROs, but companies in complementary industries or even competitors) who could reduce discovery time or enhance product effectiveness.
- In manufacturing, the orchestrator might work with multiple third-party manufacturers in its network to pool resources and share best practices, with the goal of reducing total product costs by improving procurement processes, maximizing capacity utilization and streamlining production planning.
- In distribution, the orchestrator might optimize assets throughout the distribution network to reduce total delivered cost.
This represents a huge culture change for an organization. (At A.T. Kearney, we like to refer to “game-changing” business collaboration, which operates under the mindset, “What if we were just a touch away from merging?”) The orchestration of virtual partners thus requires significant leadership commitments and a thoughtful approach to partnerships. But the approach can create huge synergies—which is why we think it will be a hallmark of tomorrow’s top pharmaceutical companies.
The new differentiators
You can try to gain advantage over your competitors by out-innovating them. (See Figure 2) But with industry disruptors relentlessly driving prices down, that’s like wanting to drive ever faster on a clogged expressway. So, what if you sought to maintain your current level of innovation, but beat your competitors by delivering greater efficiency? Although the alternate route is not guaranteed to be free of roadblocks, the right company may find it smooth sailing.
With clinical data driving outcome studies, payers are gaining greater power over physicians. Coupled with less real innovation, the result is that the industry’s historical “innovation frontier” will be replaced by an “efficiency frontier.” But switching frontiers requires switching mindsets—when a 19th century homesteader moved from the Minnesota frontier to the Arizona frontier, different crops, planting cycles, and irrigation strategies were required. Likewise the new pharmaceutical frontier will require major changes in approach.
Picture a pharmaceutical company that makes two radical departures from current philosophies. First, its only meaningful differentiation of new products involves packaging and dosing, rather than new molecules. Second, its priorities call for balancing quality and efficiency, rather than sacrificing efficiency to quality. These are indeed radical stances, but before dismissing them, consider what that company could look like—to see if some of those qualities might be valuable in less-extreme form. We believe that success at such an efficiency-focused company would be driven by three maxims:
- Cut costs. Do you know all of your costs, even the hidden ones? For example, do you have redundant activities between the operations and quality functions? Do you have dated practices across maintenance and engineering? In the future, companies will place a high priority on eliminating those redundancies and updating those practices.
- Know thy customer. Today, all of your customers receive the same level of service and reliability. Tomorrow, leading companies will view certain customers as more strategic, thus requiring differentiated levels of service. Everyone else would receive a level of service that’s far less expensive to provide. The company would be optimizing efficiency based on its knowledge of not just its own cost structure but also what its customers value. Where does value lie and who deserves to receive it?
- Let information flow. As with the trend toward the orchestration of virtual partners, the first two pillars rest on a foundation of real-time, intelligent information flow. With good information, you can identify where your inefficiencies lie in the value chain. For example, visibility of inventory levels from the salesperson’s trunk to a retailer’s warehouse can drastically reduce inventory costs. Likewise, good information provides you with the knowledge of your—and your suppliers’—cost structures, which can help you provide differentiated customer service. It can also help you understand and evaluate supplier performance across all categories in which that partner operates.
The unique dynamics of the pharmaceutical industry have traditionally placed a huge burden on the R&D function. But the pressures of today’s marketplace are making that burden unsustainable. And sometimes you don’t have to innovate your way out of a dilemma. Sometimes you can take a step back, look at the big picture, and see where the innovators might need some help.
In the coming years, strong R&D will continue to bring great new therapies and molecules to improve the health of people around the globe. But to make those advances marketable, pharmaceutical companies must remain profitable. And the soundest road to profits is to improve corporate capabilities in partner orchestration and visibility, thus bringing the operational excellence that can improve efficiency, performance and profits across the entire value chain.
 For more on scenario planning, see the A.T. Kearney paper “Scenario-Based Strategic Planning in Times of Tumultuous Change.”