Beyond The Patent Cliff

A cliff. It is a handy geographic metaphor for an impending deadline with perilous consequences. For example, all eyes are on Washington, D.C., this month as the White House and Congress confront the fiscal cliff, an end-of-the-year deadline for budgeting that will trigger a slew of automatic penalties if an agreement cannot be reached. But that isn’t the only precipice around.

For the pharmaceutical industry, the last days of 2012 will mark the end of the patent cliff, an approximately 18-month stretch during which major drug companies lost exclusive rights to many billion-dollar-selling drugs.

The cliff could be seen coming for a long time. Indeed, efforts to mitigate the expected loss in profits kicked in years ago as drugmakers struggled to invent and commercialize replacement blockbuster drugs.

As, one by one, those efforts failed, the industry turned to more creative ways of going over the cliff and surviving. They shifted their focus to developing drugs for unmet medical needs, expanding in growing geographic markets, licensing drug candidates from biotech companies, buying biotech companies, partnering with innovative research organizations, and gutting bloated research organizations. Some companies played the “if you can’t beat ’em, join ’em” card by bolstering generics portfolios.

While this business revamp was going on, the sector was also being transformed by changes in U.S. health care laws that solidified in 2012 when the Supreme Court upheld the Affordable Care Act and President Barack Obama was reelected. All of these events are coalescing to create a significantly reformed, if for now less profitable, pharmaceutical industry.

For instance, the industry is known for megadeals, but the early weeks of 2012 brought a flurry of research pacts focused on oncology, typical of a more targeted approach. Takeda Pharmaceuticals, Merck & Co., Eli Lilly & Co., and AstraZeneca all gained access to compounds that biotech firms were developing for cancer. Only one deal involved an acquisition, and none of the drug companies paid more than $190 million up front.

In January, Bristol-Myers Squibb (BMS) did announce the acquisition of Inhibitex, which focuses on hepatitis C drugs, for $2.5 billion. But in the months that followed, multi-billion-dollar acquisitions continued to be outnumbered by more modest research pacts and partnerships in which drug companies acted to add promising compounds to their pipelines.

Patient advocacy groups scored early this year with the approval of Kalydeco, a cystic fibrosis therapy and the first major success to emerge from a partnership between a drug firm, Vertex Pharmaceuticals, and a patient group, the Cystic Fibrosis Foundation, which bankrolled much of the development of Kalydeco. The milestone marked a triumph for patient organizations, which are fast making inroads in big pharma research.

An industry-wide decline in sales also characterized 2012. On the basis of third-quarter earnings, Ernst & Young estimates combined sales at the global top 13 drug companies will drop by close to 4% this year from about $557 billion in 2011.

Patent expirations were an obvious culprit. The impact was felt in the first quarter nowhere more succinctly than at Pfizer, which lost patent protection for its cholesterol reducer Lipitor, the world’s top-selling drug, at the end of 2011. Lipitor sales dropped 42% in the first quarter of 2012 compared with the year-earlier period.

Lilly’s October 2011 loss of exclusivity on the schizophrenia treatment Zyprexa resulted in a 56% hit to first-quarter sales for the drug. And AstraZeneca, which lost patent protection for its schizophrenia drug Seroquel IR in March, suffered a 25% drop in sales for the drug in the first quarter. The company also faced generics competition for its breast cancer drug Arimidex and its heartburn drug Nexium.

The encroachment of generic drugs on the sales of major brands continued through the first nine months of 2012, setting the industry on its course to finish the year with sales below the level of 2011. If that happens, it will be the first sales drop after a steady run of recession-defying growth since 2008.

Most companies pointed to patent expiration as the cause, but Michael Kleinrock, director of research development at the IMS Institute for Healthcare Informatics, says more factors were in play. He attributes the decline to the cliff’s convergence with other economic problems, a kind of perfect storm that finally caught up with the drug industry. The tumble from the patent cliff was worsened by the continued economic crisis worldwide, which has European health care payers in a state of disarray.

“The environment in which pharma companies operate has really taken a knock this year at the same time that the big expiries happened,” Kleinrock says. “The combination of factors is something that makes a lot of numbers look pretty bad.”

Todd Evans, director of pharma and life sciences at the consulting firm PricewaterhouseCoopers (PwC), adds that economic pressure, unfruitful R&D efforts, and health care reform conspired to push the major drug companies toward partnerships not only with other drug companies, but also with insurers, patient advocacy groups, and nontraditional partners, especially in information technology (IT).

“One of the most important bellwether events of the last year was the Supreme Court ruling that the Affordable Care Act is constitutional, followed by President Obama’s reelection,” Evans says. The advance of health care reform solidified the industry’s shift toward measuring health care outcomes in determining which drugs come to market and which are reimbursed. With the key legislation surviving attempts to derail it, drug companies lost their justification to put off necessary adaptations to drug research and business development.

“People have come to realize that a wait-and-see strategy is now obsolete.” There is a clearer picture of the future going into 2013 than there was a year ago, Evans says. “I think 2012 put the last heap of dirt on the grave of the past.”

And the future is looking a little brighter. Most big drug companies were affected by major patent expirations over the past 18 months and have spent a lot longer preparing, notes Glen Giovannetti, life sciences leader at Ernst & Young. Chief executive officers have had their 2011 and 2012 patent events marked on their calendars for years, he says.

“And sure enough, revenues are down,” Giovannetti says. “But ironically, stock prices of most of the big companies are up. Wall Street is attuned to the fact that, next year, these big companies will again look like growth stocks.” One reason is that the companies have launched new growth strategies, spurred by a failure to replace old blockbuster drugs with new ones and the maturation of markets in the U.S., Europe, and Japan. Drugmakers are pursuing partnerships and licensing deals to acquire therapies that, in an age of personalized medicine, will target relatively small patient populations. They are also moving to take advantage of high-growth markets such as Latin America and China.

Health care reform is changing how care is given and paid for, Giovannetti observes. “Long term, we think this will result in changing business models,” he says. “We think there is an opportunity for life sciences companies—drug companies, medical device companies, IT companies—to play a role in adding value beyond traditional pharmaceutical products. It is not a big revenue generator at all today, but a lot of experimentation is going on with companies entering into partnerships to manage health and partnering with providers for improved outcomes.”

Changes pulling big pharma down helped buoy the biopharmaceutical sector in 2012. Biotech firms and analysts at the annual J. P. Morgan Healthcare Conference in January pointed to BMS’s acquisition of Inhibitex and to Gilead Sciences’ $11 billion purchase of Pharmasset as indicators that drug companies are prepared to invest in innovative science. Barry Greene, chief operating officer of Alnylam Pharmaceuticals, told C&EN that big drug companies had completely restructured their R&D programs and were concentrating on building up their pipelines through acquisitions and partnerships.

Despite optimism regarding new paths to growth, 2012 took a toll on the pharmaceutical sector.

The patent losses and sales declines have been accompanied by job cuts. AstraZeneca moved early in the year when it disclosed that 7,300 positions will be eliminated, including more than 2,000 in R&D.

Notably, the company made big cuts in neuroscience research. But it also made a strategic change. AstraZeneca increasingly employs scientists who work primarily on data generated by academic and other research partners that perform experiments designed in collaboration with the drug company. The move highlights an increasing emphasis on research partnerships and on mathematical modeling and statistical analysis in the drug industry.

Other firms cut staff in reorganizations in 2012. Merck Serono cut 500 jobs in April in the process of closing its headquarters in Switzerland and moving operations to its parent company in Germany. And in a move that heavily impacted New Jersey’s “pharmaceutical alley,” Roche announced it will close its operations in Nutley, N.J., which had served as the company’s U.S. headquarters for decades. About 1,000 jobs will be eliminated.

Novartis said it will shed nearly 2,000 jobs in the U.S. in the face of losing patent exclusivity for Diovan, a blood pressure medicine that had sales of $6 billion in 2010. Meanwhile, Sanofi Pasteur, the vaccines arm of Sanofi, launched a manufacturing-oriented restructuring program expected to eliminate as many as 2,000 jobs across France. Sanofi itself announced a revamp of its research operations in France that will eliminate 900 jobs by 2015.

Sanofi was also among the big drug companies and biotechs forming nontraditional research ventures and partnerships. A deal between Sanofi, Third Rock Ventures, and Greylock Partners, for example, garnered much attention when it was announced at the J. P. Morgan conference.

Warp Drive Bio, an independent company launched by the partners, will use genomics for natural product drug discovery based on technology developed by Harvard University scientist Gregory L. Verdine, a partner in Third Rock. Established with an investment of $125 million, Warp Drive will have full rights to develop and commercialize assets based on the technology or form partnerships with other drug firms.

Merck & Co. decided to invest $90 million over seven years to help launch the California Institute for Biomedical Research (Calibr), a research facility that acts as an intermediary between academic and commercial drug R&D labs. Calibr will partner with university researchers anywhere in the world to bring their drug development programs to proof of concept in animal models, at which point Merck will have an option to license a candidate. If Merck passes on the opportunity, Calibr can enter an agreement with another drug firm or spin off research as a stand-alone company.

Research pacts between drug companies and academic labs advanced with several deals in 2012, including Novartis’ pact with the University of Pennsylvania to develop and commercialize immunotherapies for the treatment of cancer.

BMS teamed with the Vanderbilt Center for Neuroscience Drug Discovery to develop drugs for Parkinson’s disease. The center, located at Vanderbilt University and funded in part by the Michael J. Fox Foundation, has been among the most active academic research groups teaming with drug companies. The neuroscience center also is nearing clinical trials of a schizophrenia treatment developed with Janssen Pharmaceuticals.

Pfizer, among the most active drug firms cultivating links with academic labs, advanced its campaign to develop therapies through partnerships. The company’s Centers for Therapeutic Innovation (CTI) now operate in San Francisco, San Diego, New York City, and Boston. The program, Pfizer’s key move to advance research after paring back its traditional in-house labs, started in 2010.

CTI has set a goal of delivering four first-in-patient studies per year across multiple therapeutic areas, Anthony Coyle, chief scientific officer of CTI told C&EN in September.

As it redirected its R&D efforts, Pfizer also moved to divest itself of noncore businesses this year, fulfilling CEO Ian Read’s promise that the company would focus on pharmaceuticals. In April, Pfizer sold its infant nutrition business to Nestlé for $11.9 billion. The company followed up by spinning off its animal health business into a new company to be called Zoetis.

Pfizer also acted to elevate generic drugs and emerging markets in its business plan through deals such as a joint venture with China’s Hisun Pharmaceuticals to commercialize off-patent products. Similarly, and in the same week in February, Merck announced it would partner with Supera Farma Laboratorios in a generics joint venture in Brazil.

In another move keyed on generics, Pfi­zer acquired NextWave Pharmaceuticals, a specialty drug company focused on attention-deficit hyperactivity disorder and other central nervous system disorders. NextWave’s Quillivant XR is an extended- release version of the generic ADHD drug methylphenidate. Pfizer also acquired the rights to Nexium, AstraZeneca’s over-the-counter acid reflux therapy.

To be sure, the year was not without the kind of major acquisition drama that has long characterized the sector. Roche, for example, made a hostile $5.7 billion bid for the gene-sequencing firm Illumina in January and was rebuffed. The drug firm tried to nominate directors for election at Illumina’s annual meeting before withdrawing its bid. Meanwhile, GlaxoSmithKline prevailed in its $3.6 billion acquisition of Human Genome Sciences after the genomics pioneer’s failed attempt to attract a better offer.

On the regulatory front, the Food & Drug Administration approved 31 new molecular entities through mid-November, one more than the total approvals in 2011. In its push to better police the supply chain, the agency was aided this year by the reauthorization of drug user fees, which partially fund quality oversight efforts. The House of Representatives and Senate delivered near-unanimous yes votes in June to legislation that for the first time includes a generic drug user fee.

Suppliers of active pharmaceutical ingredients lobbied Congress to include generics under the user fee program, citing a growing impact on public health from falsified or counterfeit generic drugs, thanks to the steadily increasing share of the market taken by generics. Meanwhile, FDA continued to talk with drug companies and other government agencies about crafting a strategy to protect the supply chain.

New technology continued to fill drug discovery laboratories as well. The steady influx of genomics data into pharmaceutical research fostered an IT-intensive environment in which software vendors vied to supply comprehensive laboratory networks. At the same time, lab managers were looking for people with an increased level of math competency to be involved in development projects. They spoke of the rise of “data scientists,” researchers adept at mathematical modeling and statistical analysis.

Evans, the PwC consultant, says health care reform is placing greater emphasis on patient outcomes. FDA is evaluating new drugs not only on the basis of safety and efficacy, but also on how much better they perform than therapies already on the market. The bar is similarly raised by insurance companies determining reimbursement.

“Historically, stakeholders in the pharmaceutical value chain have operated independently,” Evans says. “There has been so much money washing around in the system that everyone could pretty much succeed without openly collaborating—without even liking each other. Drug companies, insurance companies, physicians, hospitals, and other communities could operate to a great extent in isolation and still make an acceptable return.”

With the emergence of lowest-cost delivery of the highest-quality outcome as a shared goal, collaboration is unavoidable. And with passage of health care reform, that shared goal actually has the rule of law behind it, Evans says.

Kleinrock at IMS says the higher standards present a clear challenge to drugmakers attempting to recoup losses after their blockbusters became generic. New drugs, for example, will have to be shown to deliver better value to patients than much cheaper generic drugs that may represent the gold standard in a therapeutic area. The cost of innovation will thus increase at a time when budgets are far more constrained than they were during the decades when companies were developing their blockbusters.

The upside, Kleinrock suggests, is that there are huge opportunities to develop drugs for unmet needs such as Alzheimer’s disease, cancer, and Parkinson’s disease—therapeutic areas that will require companies to form the kind of collaborative partnerships that are emerging in the industry. The efforts to carry out lower-cost research that characterized 2012 will continue, he says.

Industry watchers agree that a change in the pharmaceutical industry business model is already under way. “A lot of experimentation is going on,” says Giovannetti at Ernst & Young. A huge, long-profitable industry has been brought to the point of inevitable transformation.