Why Drug Makers Are Failing In Quest for New Blockbusters

By Gardiner Harris
The Wall Street Journal,  March 18, 2002

In laboratories around the world, scientists on the hunt for new drugs are coming up dry. Patents on one blockbuster drug after another are expiring. Managed-care companies are successfully pushing patients away from high-priced new drugs and toward cheap generics.

The $400 billion-a-year drug industry is suddenly in serious trouble. After nearly a decade of double-digit growth, highflying stocks, and some of the world's loftiest profit margins, one big company after another is taking a beating. Analysts estimate that combined profits at the nation's top nine drug makers grew by less than 1% in the first quarter of 2002.

Victims include industry giants Bristol-Myers Squibb Co., Merck & Co., Eli Lilly & Co., Schering-Plough Corp. and Bayer AG, nearly all of which have lost sales of many of their old standbys to low-cost generic drug manufacturers. Merck has seen its shares slide more than 40% since the start of 2001. Lilly reported this week that its profits dropped 22% in the first quarter. Schering-Plough is facing the loss at the end of this year of most of the sales of Claritin, which last year provided more than half of its high-profit U.S. drug sales. GlaxoSmithKline PLC could be the next to feel the pinch: It is expected to lose patent protection next year on four drugs with nearly $3.9 billion in annual U.S. sales.

Consumers stand to benefit in the short term, as best-selling drugs such as heart-burn remedy Prilosec, allergy treatment Claritin and antibiotic Cipro become available in cheaper generic versions. But, in the longer term, the newest treatments promise to get more expensive, as the industry invests more in research and development and gets less out of it. Meanwhile it will continue routine price hikes on its existing drugs.

The likely outcome is worsening battles among the drug industry, managed-care companies, and federal and state governments over drug prices. Increasingly, the newest drugs are only slightly better than older, much cheaper medicines. Nonetheless, the industry's growing blitz of consumer advertisements drives patients to demand them.

The industry's latest flare of distress is coming from Bristol-Myers, which has spent $16.5 billion on R&D since 1990, without producing a single new star of its own. In the past few months, three of the New York-based company's biggest-selling drugs -- Taxol for cancer, BuSpar for anxiety and Glucophage for diabetes -- have lost most of their sales to generic competitors. Bristol-Myers thought it had lined up potential replacements, but so far it's had nothing but disappointment.

Days before Christmas, federal regulators refused even to consider the application to market a cancer drug produced by Bristol-Myers's partner, ImClone Systems Inc. And last month, Bristol-Myers researchers reported that their studies of the company's new blood-pressure pill, now under review by the Food and Drug Administration, found the drug less effective than expected.

Partly as a result, Bristol-Myers has warned that its earnings this year will be only about half those of last year, when it reported income from continuing operations of $4.74 billion on revenue of $19.09 billion. Since 1999, Bristol-Myers shares, which trade at around $32, have lost about two-thirds of their value. This week, Bristol-Myers fired its chief financial officer, and its CEO is on notice from the board that he has to shape up.

The industry is caught in a gap between an old way of developing drugs that's increasingly tapped out, and a new way that isn't yet bearing a lot of fruit. For decades, drug makers have focused their R&D efforts on enzymes, chemicals that serve as catalysts for most of the body's functions. Cholesterol drugs Lipitor, Zocor and Pravachol, for instance, work by inhibiting an enzyme in the liver that the body needs to make cholesterol.

But there is a growing sense among researchers that many of the body's major enzymes have already been fully exploited. "I think there are a limited number of enzymes that you can target in some systems, and many of those targets have already been dealt with," says Peter Kim, deputy chief of Merck's research operations.

For long-term relief, industry executives are looking to gene hunting. They hope to discover the genetic roots of most chronic diseases and use that knowledge to devise novel treatments. But they generally don't expect to see any big payoffs from the new technology until the end of the decade.

"People got way too excited about the genome being unlocked," says Fred Hassan, chairman and chief executive of Pharmacia Corp. "Five to 10 years from now, it might help our product flow. In the meantime, the industry is going to go through rough times."

Growing Desperation

One sign of the industry's growing desperation for new products is the rising price drug makers are willing to pay for discoveries made outside their labs. In 1992, Bristol-Myers licensed the best cancer drug of the day, Taxol, for a 0.5% royalty. Last year, it licensed Erbitux, one of many good cancer prospects, for an upfront investment of $2 billion, plus a 60% royalty. (Erbitux is the drug that federal regulators later refused to consider.)

The pharmaceutical industry has survived hard times before. And while its fortunes have declined, it is still producing profits. Moreover, the nation's demographics continue to favor the industry's long-term growth. Prescription-drug spending by Americans tends to increase sharply with age. But much of that growing market is likely to be served by cheap generics.

Brand-name drug makers have come under increasing pressure from generics since 1984, when Congress passed the Hatch-Waxman Act, creating the modern generic-drug industry. The law reduced the amount of testing generic-drug makers had to do in order to market their products. Those requirements previously had presented such a hurdle to generics that branded drugs often continued to post strong sales for decades after their patents expired.

But within a year of the bill's passage, nine of the industry's 10 best-selling drugs had new generic rivals. Suddenly, pharmaceutical giants found themselves facing precipitous sales declines after their drugs lost patent protection, rather than a long, slow tapering off.

The Hatch-Waxman law put the drug industry on an innovation treadmill. If its labs didn't produce new products, the companies would eventually collapse, as generics snatched away their sales.

At first, the industry adjusted to this new reality with one of its most well-worn tools: price increases. Since there were few large medicine buyers back then, the industry could raise prices almost at will. If a patent expired on one of a company's drug, it could jack up prices on its others.

"All through the 1980s, a lot of the industry's growth came from price increases," says Raymond V. Gilmartin, chairman and chief executive of Merck.

The rise of managed health care in the early 1990s changed all that. In 1990, most drugs were bought with consumers' out-of-pocket money. Now, most drugs are bought by huge purchasers like managed-care health plans. If drug companies don't offer discounts, they lose sales to a competitor's pills; hefty price increases have become less common. As the decade progressed, managed-care companies became increasingly adept at holding down costs by promoting generics. Many hired pharmaceutical-benefit managers, such as Merck's Merck-Medco unit, who used their phone banks to press doctors to approve switches from name-brand drugs to their generic equivalents.

In August 2000, when Merck lost its patent on Vasotec, a blood-pressure drug, the drug's sales dropped two-thirds within three months. When Lilly's antidepressant Prozac lost its patent in August 2001, generics stole 80% of the drug's new prescription sales within two months, according to Atlanta-based market researcher NDC Health. Lilly was surprised by the drug's breathtaking collapse. Merck-Medco, meanwhile, boasted of its success in switching patients to generic Prozac.

The collapse of Prozac was a landmark for another reason. Through the 1980s and 1990s, when a branded drug lost its patent, sales of branded competitors often improved. When Tagamet lost its patent in 1993, for example, sales of other branded heartburn pills soared, even though they cost many times the price of generic Tagamet.

Now, doctors largely prescribe drugs approved by patients' insurers to avoid patient complaints and harassing calls from managed-care pharmacists. As a result, the balance has shifted to generics. In 1986, less than a quarter of prescriptions were filled by generic pills. Last year, it was nearly half. Prozac's main competitors are Pfizer Inc.'s Zoloft, GlaxoSmithKline's Paxil and Forest Laboratories Inc.'s Celexa. Each drug works in a similar way. With a generic version of Prozac available for pennies per pill, there is little scientific reason for doctors to prescribe Zoloft, Paxil or Celexa unless the patient is already on one of those drugs or has tried Prozac and found it didn't work. Marketers for each company nonetheless are fighting for their drugs, but managed-care formularies favor generic Prozac.

After Prozac lost its patent protection last year, the growth of new prescriptions for each of its branded competitors fell by at least half, according to NDC Health. Kaiser Permanente, the big California health-maintenance organization, says that its 11,345 doctors now prescribe generic Prozac to about two-thirds of patients who need an antidepressant for the first time, twice the proportion who took branded Prozac a year ago.

None of that would matter so much if drug companies' labs were producing innovative new therapies. But, these days, launches of breakthrough drugs -- such as Novartis's Gleevec, brought out last year to wide acclaim because it led to the recovery of some near-death leukemia patients -- are few and far between.

Last year, the drug industry spent $30 billion on research, more than three times what it spent in 1991, according to the Pharmaceutical Research and Manufacturers of America, a Washington-based trade group. But the industry launched just 24 new drugs last year -- half the number it did in 1996. According to a 2001 study by Tufts University, it now costs about $802 million to discover and develop a new drug, two and a half times what it did in 1987, in inflation-adjusted terms.

One of the subtler causes of the major drug labs' slowing productivity is that there are already so many good drugs on the market. Heart disease, for example, is the nation's biggest killer and a potentially profitable area for drug discovery because patients typically take the same heart drugs for years. But cholesterol pills already available -- Lipitor, Zocor, Pravachol, Lescol -- can safely cut a patient's cholesterol levels by as much as 45%, a remarkable accomplishment.

Similarly, to treat high blood pressure, doctors have an entire arsenal at their disposal -- diuretics, beta blockers, angiotensin-converting enzyme inhibitors, angiotensin II receptor antagonists and calcium-channel blockers. All attack the condition in a different way. Many of them are available in generic versions. That means a new drug would have to be extraordinarily effective in order to find a market, especially at a premium price.

Many of the industry's most productive labs have managed to remain so by frequently launching drugs that are only slightly better than those already on the market. Then they charge a premium for these incremental improvements.

AstraZeneca PLC is among the drug makers pursuing that strategy. The London-based company will soon lose U.S. patent protection on its huge-selling heartburn drug, Prilosec. Last year, in an attempt to hang on to some of Prilosec's $6 billion in annual sales, AstraZeneca launched Nexium.

Now, it is feverishly trying to convert Prilosec users to the new medication. But Nexium is at best 3% better than Prilosec in curing one form of heartburn, according to a company-sponsored test. That means managed-care companies will have to decide whether to pay a lot more for Nexium's small measure of superiority once generic versions of Prilosec hit the market in coming months.

New Cholesterol Pill

This year AstraZeneca says it plans to launch a new cholesterol pill called Crestor that may be slightly more effective than those already available. Whether managed care will pay a premium for the pill once generic versions of competitors' Pravachol and Zocor reach the market in 2006 is uncertain.

"Drugs like Nexium are a desperate attempt to save sales from nearly identical drugs losing patents," says Sharon Levine, associate executive director of Kaiser Permanente. "Generics are a real value."

AstraZeneca declined to comment.

Many executives and industry watchers believe the dearth of big new drugs will force the industry to consolidate further. But Robert Temple, a top FDA official who oversees many new drug applications, says consolidation has been one of the chief causes of the industry's diminishing lab productivity. "I can't believe that when you take two or three companies all frantically producing drugs and put them together that they produce as many drugs," he says.

Pfizer may be a case in point. Two years ago, it absorbed Warner-Lambert Co. in a hostile takeover, and it is now one of the few healthy drug companies. The takeover left Pfizer with more than $32 billion in annual revenue. To ensure that its double-digit sales-growth continues, Pfizer would need to launch at least two or three billion-dollar drugs every year. But Pfizer, despite annual research spending that this year will likely amount to $5.3 billion, hasn't introduced a big seller of its own since Viagra, in April 1998.

At GlaxoSmithKline, which has undergone three big mergers in the past decade, Chairman and Chief Executive Jean-Pierre Garnier was concerned that his company's vast size might impede its lab productivity. So, he recently split the company's research operations into six largely independent labs, each targeting different diseases. "The industry is spending 15 times what it did 20 years ago on research, but our organizational structures haven't changed much at all," says Mr. Garnier. "You want creativity. You don't want layers."