The Conventional Pharmaceutical Business Model Business Essay

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The conventional Pharmaceutical Business Model incorporates vague drug development timelines and a very complex distribution system which leads to an industry economics of depending on a few profitable drugs to hedge risks and increase profit margins. A recent investor perception about the industry is of one with high risk and low returns. This with the ongoing financial crisis brings about a renewed sense of urgency to explore new growth opportunities and execute newer and long term strategies.

Andrew Witty the new CEO of GlaxoSmithkline (one of the world's Large Cap Pharma Company) has recently set out three definite strategic priorities focussing on operational efficiencies and a diversified product portfolio. In wake of the current financial crisis and low yield environment it would be interesting to find out a suitable fit of Witty's new business model to the demands of the industry and analyse the economic durability of their strategic objectives.

Question A


'Big Pharma's traditional Business Model hinges on the ability to identify promising new molecules, test them in large clinical trials and promote them with an extensive marketing and sales presence.[1] However changing market needs and the inherent characteristics of the pharmaceutical industry ensure that this model doesn't sustain itself over the next 10 years. As J.P. Garnier, former chief executive of GlaxoSmithkline, recently pointed, it is a "business model where you are guaranteed to lose your entire book of business every 10 to 12 years."[2]

The Blockbuster Drug Business Model on which Large Pharmaceutical companies have relied on for years for their profit is facing extinction, with Blockbuster drugs totalling up to US $120b in annual sales set to lose patent in the next one to three years.[3]

Discerning Payors and patients demanding cost effective and customized healthcare, the rise of Generics and healthcare reforms burdens the industry with unprecedented challenges.


According to Datamonitor the top 20 pharmaceutical companies have access to an average of US$7.5b in cash, cash equivalents and short-term investments; some of the largest companies have in excess ofUS$20b. Average net debt, as a proportion of capital employed for these top 20 companies, is a slim 6%, compared to an average of 95% in the financial services industry.[4] .However the challenge is to have the right cash in the right place at the right time. Hence Working capital management and integration of the value chain rather than the quick fix strategy of cutting costs is the key to the paradigm shift of the Pharma Business Model. This can be effectively achieved through three major operational strategies.

  1. Effective and comprehensive Risk management
  2. Improvement of capital allocation
  3. Extending market reach

It's been more than a year that GlaxoSmithkline's newly appointed CEO Andrew Witty laid down three strategic priorities to alleviate the effects of the challenges burdening the pharmaceutical industry on GSK:[5]

  1. Grow a diversified Global Business (shift from small molecules business to newer products like vaccines and consumer healthcare)
  2. Deliver more products of value ( Cost efficient R&D collaborations)
  3. Simplify GSK's operating model (Achieve increased working capital savings)

In order to assess the efficacy of Witty's strategies in adopting the paradigm shift that that the industry calls for we need to align them to the strategic priorities that have been suggested for the industry.

  1. Risk Management can be effectively achieved through collaborative efforts at different levels of the value chain:
  2. 1)A shift from the traditional Pharma Model of 'profit alone' to the 'profit together' model which states that companies can only 'profit together' by collaborating with a large number of organizations to produce medicines more economically, help patients manage their health and ensure that the products and services they provide really make a difference.[6] Some of Glaxo's recent R&D partnership events seem to be working towards fetching high royalties:

    I)ViiV: (November 2009) HIV joint venture between Glaxo (85%) and Pfizer(15%) combines the former's established products in the market with Pfizer's pipeline of related drugs in development. Dominique Limet, chief executive of ViiV Healthcare predicts his company will generate £1.6bn a year in sales to finance its own research and would begin paying a dividend to its two owners in 2011 as it sells new products. The advantages for GSK include boosting future sales and keeping its marketing and manufacturing facilities in business, as its own drugs move towards patent expiry, while forPfizerit avoids creating a new infrastructure as it seeks to refocus activities and cut costs.[7]

    II) STIEFEL: [8] Stiefel, the world's largest independent dermatology company, acquired by GSK in deal valued at up to $3.6 billion New global business will have combined revenues of approximately $1.5 billion and robust new product pipeline Significant step forward to grow and diversify GSK's business, providing immediate new revenue and synergy opportunities.

    Prioritizing the pipeline: Payor adoption has become critical in pharma R&D's reimbursement goals and when deciding which products to prioritize, continue or discontinue. Glaxo is increasingly trying to consult with payors at early stages of their clinical development e.g in Europe Glaxo has already established such a risk sharing agreement with two European governments in 2006 under which the prices of two new medicines will be increased or reduced, once enough data are available to judge their true efficacy and cost effectiveness.[9]

  3. Improvement of capital allocation: Most pharma companies focus on revenues instead of R&D returns. The new industry model represents a shift in how Large Pharma creates shareholder value. Research activities currently demand a disproportionate investment relative to the value they generate. Shifting resources from in-house to virtual R&D should yield greater capital efficiency in research and early-stage development.[10]
  4. Glaxo is managing it's R&D interface by launching the Centre of Excellence for External Drug Discovery (CEDD) to access "best from anywhere science." By establishing CEDD, an independently managed group with a dedicated budget, GSK's goal is to put external and internal R&D on the same footing and make objective choices about the most-promising products to fund in late-stage development and commercialization.

    More recently GSK has continuted in the same theme by establishing discovery performance units (DPU) within each CEDD. Each DPU will have about 8-80 scientists, an established three- to five-year plan of action which is subject to review and approval of an investment board.. The intent is to have smaller flexible units that co-exist with the huge platform capabilities of GSK - like high-throughput screening whilst also providing stability in long term funding.

  5. Extending Market Reach: Emerging markets are forecast to grow by 13 per cent a year - triple the rate in the West - and account for 40 per cent of growth in the worldwide pharmaceutical market by 2020.[11]. GSK has accelerated bolt on acquisitions in vaccines and consumer healthcare to enhance their presence in the emerging markets over 2009: a double edged strategy of expanding product portfolio and geographic spread. Vaccines provide the greatest opportunities to Pharma during challenging times because of two major reasons: a) The Pandemic Flu phenomenon and b) the most significant threat to the oligopoly of the Big 5 Pharma companies in the vaccines market which comes from companies from emerging markets, which have large manufacturing capacities for biologics and are able to produce even complex substances like vaccines at low costs.GSK has tried to make the best of both these opportunities:

1) In 2009 GSK announced significant investment in pandemic Flu vaccines development and secured government orders of £2.15 bn H1N1 and £130m for bulk adjuvant to be shipped across 2009-2010.[12]

  1. BRAZIL: In 2009 GSK collaborated with Fiocruz in Brazil to to develop a dengue vaccine. Furthermore, GSK will provide Fiocruz with access to the technology behind its 10-valent pneumococcal conjugate vaccine Synflorix, which the company expects to be incorporated in Brazil's national immunization program in the coming months.[13]
  2. CHINA: In June 2009 GSK entered into a joint venture with Shenzhen Neptunus in China to combine the potential of GSK's adjuvant technology and expertise in vaccine development together with the extensive experience of Shenzhen Neptunus in the Chinese vaccines market. [14]
  3. The company has also signed a deal with Uni-President China Holdings to distribute Lucozade (GSK"S trademark energy drink) in supermarkets in China.The drink had made 90% of it's £382 million sales in the republic of Ireland and Hong Kong last year.

  4. INDIA: In 2009 GSk signed a deal with Dr.Reddy's Laboratories (NYSE:RDY) gain exclusive access to Dr. Reddy's rich and diverse portfolio and future pipeline of more than 100 branded pharmaceuticals in fast growing therapeutic segments such as cardiovascular, diabetes, oncology, gastroenterology and pain management.The products will be manufactured by Dr. Reddy's, and licensed and supplied by GSK in various countries in Africa, the Middle East, Asia Pacific and Latin America. In certain markets, products will be co-marketed by the GSK and Dr. Reddy's. Under the terms of the agreement, revenues will be reported by GSK and shared with Dr. Reddy's as per the agreed terms.[15]

Question B


While delineating the objectives of the new strategic priorities of GSK Andrew Witty pointed out that "Our aspiration to improve the lives of patients and consumers is intrinsically aligned to the requirements of our shareholders,"(ref press release). However on the same note he did mention that "We are committed to generating value for our shareholders and believe this will be best achieved through delivery and investment in our new strategic priorities,"

KEY FIGURES: Sustainability of New Product and Geographic Mix:

According to GSK the unusually high SG&A figures in 1Q'09 was due to "investment in growth markets and increased pension costs". A critical analysis shows that this was largely due to

  • Increased A&P spending in Consumer healthcare division and investment in Consumer R&D projects and acquisitions[18]
  • Loss of exclusivity on several highly profitable U.S. products: 2009 saw lamitux.welbutrin and imitrex go off-patent and the pressure should continue into 2010 with $1bn in U.S. sales of valtrex at risk from 2009.

The company maintained that the second half of 2009 would see significant improvements due to growth from 'bolt-on' acquisitions ((BMS Egypt & Pakistan,.UCB Tail, AZN OTC, Stiefel). In the last 3 years GSK has always had better margins in 1H than in 2H (see Figure 5).So according to company guidance if it's considered that there will be a peak in margins in 4Q'09 it could be only achieved by a significant reduction in SG&A to allow for such positive margin expansions .

However the insignificant effect of this decrease in R&D costs concerned that top-line pressure would not allow GSK to maintain sufficient spend behind Advair and Consumer without jeopardizing the bottom line.

Sales projections for vaccines in 2011 should however be able to allow GSk to maintain the high level of SG&A necessary to maintain momentum behind Advair and Consumer Business.[19] [20]Their sales contribute little to R&D and SG&A and should reduce COGS due to better capacity utilisation.

GSK has announced orders of 195 m pandemic flu vaccines (£2.15 bn H1N1 and £130m for bulk adjuvant) to be shipped acroos 2009 and 2010.Moreover the Sales of Cervarix should also get a boost due to the recent US FDA approval and the recent market share gains outside US at the expense of merck's Gardasil.

b) Shareholder Interest: GSk have refused to provide any earnings guidance 2009 onwards because according to the CEO Andrew Witty ' providing short-term earnings guidance drives wrong types of behaviour.'(ref) So in the absence of any earnings guidance and in light of the industry's paradigm shift from the blockbuster model a few yardstick's of interest to investors would be:

1) New product uptakes: Substantial sales of Synflorix outside EU and US in line with GSK's strategy of fully globalizing it's brands.According to analysts at J.P. Morgan and chase there is potential upside for GSk's EPS valuation if synflorix does achieve it's numbers.(ref fig 8)

2) Late -Stage Pipeline quality: a) One of the most important products in gsk's R&D pipeline is BENLYSTA and is being developed by HGS(Human Genome Sciences inc) and GSK under a co-development and commercialization agreement that they signed in August 2006.It has been described as the first 'lupus'(an autoimmune disease) drug in decades to show effectiveness in phase III clinical trials. Gsk shares had appreciated 13% since the initial announcement on 20th July 2009.According to J.P. Morgan and chase's SLE model it presents a blockbuster opportunity for GSK with sales peaking at pound 2.9 bn by 2014.


GSK has come a long way from a company focussed on short term earnings. It's recent restructuring efforts seem to be in sync with the emerging landscape of the Pharmaceutical Industry. It seems on the right path to secure sustainability of the business by driving growth from non-traditional areas (Consumer, Emerging Markets). However, we still don't know the full impact of the change in product mix on GSK's profitability. Low trading margins pose a concern about earnings estimates for the next few years. Increased R&D returns and pipeline quality seem to be the deciding factors for the future success of GlaxoSmithkline.

  1. PricewaterhouseCoopers,(2009) "Pharma 2020:Challenging Business Models:Which path will you take?" Available from [Accessed 30/11/2009]
  2. PricewaterhouseCoopers,(2009) "Pharma 2020:Challenging Business Models:Which path will you take?" Available from [Accessed 30/11/2009]
  3. "Opportunity knocks for big pharma in credit crunch," Datamonitor press release, 8 October 2008, © Datamonitor. Available from [Accessed 10/12/2009]
  4. Ernst & Young (2009) "Lessons from change:A changing environment in the life sciences industry" Available from [Accessed 30/12/2009] 425
  5. GlaxoSmithkline Corporate press release (23rd July 2008):"GSK sets out new strategic priorities" Available from [Accessed on 17/11/2009]
  6. PricewaterhouseCoopers, (2007) "Pharma 2020: The vision - Which path will you take?" Available from [Accessed 30/11/2009]
  7. Jack.A (2009): ViiV vows joint venture will help HIV. The Financial Times 3rd November. Available from [Accessed 1/12/2009]
  8. [8]Words: 396 GlaxoSmithkline Corporate Press Release (2009) "GlaxoSmithkline and Stiefel to create new world leading specialist dermatology business" Available from [Accessed 12/12/2009]
  9. PricewaterhouseCoopers, (2007) "Pharma 2020: The vision - Which path will you take?" Available from [Accessed 30/11/2009]
  10. Cooper. Terri. (2008) 'Change and disruption in the Pharmaceutical Industry" Copyright © 2007 Deloitte Development: Available from [Accessed 9/12/2009]
  11. Boyle.Catherine (2008) :GlaxoSmithkline to break up research and development operations:24th July 2008 Timesonline. Available from [Accessed on 9/12/2009]
  12. WORDS:402 Hauber. Alexandra,Vosser.Richard (2009) :"GlaxoSmithkline-1Q'09 results miss on Higher costs" J.P.Morgan Europe Equity Research: Available from [Accessed on 12/12/2009]
  13. "GSK:Vaccine deal increases presence in emerging markets"(ONLINE) August 18th 2009 Available from [Accessed on 4/12/2009]
  14. GlaxoSmithkline Corporate Press Release: "GSk and Shenzhen Neptunus create new alliance to develop and manufacture influenza vaccines in China" June 9th 2009 Available from [Accessed on 8/12/2009]
  15. GlaxoSmithkline Corporate press release : "GSK announces a strategic alliance with Dr.Reddy's to further accelerate sales growth in emerging markets" June 15th 2009 Available from [Accessed on 1/12/2009]435
  16. Words:112
  17. Hauber. Alexandra,Vosser.Richard (2009) "GlaxoSmithkline 2Q'09 first take" J.P.Morgan Europe Equity Research: Available from [Accessed on 12/12/2009]
  18. Words:83
  19. WORDS:pgs 10 & 11 346