Is Novartis situated to be on top of the pharmaceutical industry?


A corporate strategy article by Thunderbird students John Angstadt, Christa Gyori, Charbel Haber, Christopher Jones and Mike Zehender

On March 23, 2010, President Obama signed the Affordable Care Act. The law puts in place comprehensive health insurance reforms that will roll out over four years and threatens to have a major impact on the Pharmaceutical Industry. This is just one of a myriad of factors impacting the industry. The industry, once described as profitable by Porter due to the corresponding low structural forces, is facing significant changes to the competitive forces operating in its space. Many factors are threatening to change the industry structure; these included imminent expirations of major patents in 2011-2012 (coined as the “patent cliff”), pricing pressure due to cuts in reimbursement, and new regulations with stricter focus on drug safety. Novartis Pharma has made many smart moves, but is it fully prepared for the future?

1. Company background
Novartis Pharma: Founded in 1996, Novartis is one of the largest pharmaceutical companies in the world with a diversified portfolio of products that span across a number of categories including pharmaceuticals, generics, vaccines and diagnostics, and consumer health products. Novartis has more than 110,000 associates in more than 140 countries. Its headquarters is based in Basel, Switzerland and their net sales reached $50 Billion in 2010. Their Product Leadership business model is reflected in their Mission Statement, “We want to discover, develop and successfully market innovative products to prevent and cure diseases, to ease suffering and to enhance the quality of life.”

2. Changing Government Regulations
The evolving landscape of the US Pharma industry will lead to challenges in maintaining the present high growth rates. Following a number of safety crises such as Phen Phen, Vioxx, and Avandia, which were linked to severe adverse reactions including increase risk of deaths, the FDA has become more conservative. The FDA has been requesting more safety data, which translates to clinical trials, and therefore, higher cost of drug development.

Health Care Reform, specifically the Affordable Care Act and the recent passage of The Biologics Price Competition and Innovation Act of 2009 have also put more price pressure onto the pharmaceutical industry.

Potential effects of the Affordable Care Act will include lower pricing on prescription medication for elderly customers, but an increase in the number of Americans having insurance. While lowered pricing for elderly customers will lower profit margins, it is estimated that with increased numbers of insured younger Americans, more will take advantage of prescription medications, thus leading to long term higher volume and profitability. However, many prescription drug manufacturers have already cut R&D expenditures and outsourced manufacturing and clinical operations. Further, Pharma companies are focusing more attention on orphan drug development due to the reduced scrutiny and faster approval process by the FDA and higher profit margins due to niche marketing.

3. Current Trends
How are the industry leaders managing the change? A survey of the various strategies adopted by the pharmaceutical companies does not point to a single clear strategy. Mergers, acquisitions, divestiture and investment in new capabilities, are all de rigueur. Caven Redmond, Group President at Pfizer recently stated “I don’t think there’s been a time in recent history where the industry has had a more divergent approach to the future.” These approaches, as diverse as they are, stem from differences in opinion on the future of the health care industry in general.

Due to the power of insurance companies to affect the decision process in drug selection, more pharmaceutical companies are focusing their attention on insurance companies and negotiating pricing with them to encourage these companies to authorize their drugs. Some companies are even engaging payers early on in drug development in order to design pivotal studies aimed to support drugs and claims that would eventually be reimbursed by payers. More and more, pharma companies are having to prove that the new medications are more effective, safer or have a greater health value than already approved drugs that have generic substitutes.

Rivalry within the industry is intense and efforts to cut costs are increasing. Recent trends involve the outsourcing or transferring of labor to lower cost locations in countries such as China and India.
Additional strategies also involve opening new markets in developing or emerging countries where the middle class is growing. However, patent law and intellectual property rights within these countries vary from the US and Europe and could lead to losses of rights or patents.

4. Betting on the future
Though strategies differ among the top 50 Pharmaceutical companies, there is one common thread – Biologics and the associated generic version, Biosimilars. Nearly all large pharmaceutical firms have made an investment in this area. Biologics are treatments that are derived from living organisms and marketed after the patent expiration of similar therapies. But how successful are biologics? According to Global Pharmaceutical Market Review of the top twenty best selling drugs of 2010, “Six biologics made the top 12 as the best selling global drug brands.”

A natural extension of Biologics is their generic version, on Follow-on Biologics, also known as Biosimilars. According to Ian Evans, of the Yale school for Biomedicine “Key characteristics of follow-on biologics (Biosimilars) make them a worthwhile investment for big pharma companies: They command high prices, will likely have fewer entrants than generics due to high barriers to entry, and play to the existing strengths of big pharma firms.”

The development of Biosimilars represents a diversification strategy that is based in strategic alignment with a company’s core capabilities. According to Authors Alex Kandybin and Vessela Genova of Business + Strategy Magazine, this type of diversification is necessary in an industry where there is no telling what the future will bring. New investments should create further value for the company through strategic alignment. The steps in this process, much like the blue ocean process, are to 1) \Identify the company’s core competencies and value drivers, 2) Identify areas of new opportunity that can better position the company to succeed and where there may be some competitive advantage due to core capabilities or new demand and 3) Align the organization to leverage and support the new strategic direction. An example of this is the development of the generics business by Novartis. Joseph Jimenez, Chief Executive of Novartis explains “Fundamentally, we are pro-patent, but we believe that when those patents expire, it is our obligation to offer low-cost, high-quality generics to help lower total health care costs.”

5. Novartis Response Strategies
In order to mitigate the effects of recent changes to the pharmaceutical landscape, Novartis has implemented the following strategies:

Restructuring: Just like most pharma companies, Novartis has shed many jobs in Europe and in the US and shifted most of these positions to Asia. For example, in 2011, Novartis announced the elimination of 2,000 positions in Switzerland while it continued its integration of an R&D center in Shanghai’s Zhangjiang Hi-Tech Park. Further, Novartis has reduced R&D expenses by outsourcing some of its clinical trials to contract research organizations (CROs).

Re-Prioritizing Research Goals: Novartis has decided to exit the field of Neuroscience including work in Alzheimer and Parkinson because of the inherent development challenges in these disease areas including identifying the proper endpoints to demonstrate the efficacy of the drugs.

Expanding Niche Medicine: Novartis has been targeting diseases that present a high unmet medical need. Some of the diseases have a relatively small prevalence leading to small volumes; however, the regulatory hurdles are significantly lower and the corresponding prices are higher. In addition, after getting the drug approved in a smaller population, then Novartis would work on expanding the indications to target larger segments.

This strategy is highlighted by Ilaris (canakinumab) targeting cryopyrin-associated periodic syndrome (CAPS), a rare auto-inflammatory disease leading to death. With approval secured, Novartis is pursuing other indications including gout, Asthma and psoriasis using the same compound.

Mergers & Acquisitions (M&A): Similar to other companies, Novartis has decided to use its cash to acquire other companies to diversify its portfolio, enrich its pipeline, and target high growth markets. One key acquisition was the eye care company Alcon, for which Novartis paid Billion dollars.

Growth in Emerging Markets: Although most of the Novartis sales came from the US market ($30 Billion) in 2010, the highest percentage growth came from emerging markets, specifically China (Novartis Annual Report 2010). Novartis China grew 42% in the third quarter in 2011 (Q3 Financial Results).

Developing Own Generic/Biosimilar Division: Novartis recognized early on the value of generics and thus built a strong division, Sandoz, to develop generic and biosimilar compounds. Sandoz leverages on Novartis’ know-how and is able to deliver high-quality generics. It is important to note that Sandoz was the first company that was able to license a biosimilar, Omnitrope, which is a human growth hormone. The Biosimilars market has the potential to reach $76 Billion by 2020 (FierceBiotech, 2011).

Novartis Strategy - Corporate Social Responsibility (CSR): Novartis has created a foundation, Novartis Foundation for Sustainable Development that aims to create value by tackling societal challenges that are related to health care, which according to Porter, affords the optimal opportunity to use the company’s resources and maximize benefits to the patients. Although this Foundation has spearheaded a number of initiatives (offering malaria drugs at cost in Africa, leprosy medication free-of-charge, etc.), we are going to focus on one particular initiative. The aim is to provide access to healthcare to poor people living in remote areas in developing countries like India or sub-Saharan Africa. For example in Mali, 20% of children die before the age of 5, mostly due to preventable and treatable diseases.

Novartis reached out to partners in these remote communities and provided 1) training to educate people about diseases and manifestation of symptoms, 2) setting up the infrastructure with respect to roads and makeshift clinics, 3) sent out healthcare workers on a regular basis to the remote areas, and 4) provided a combination of generic drugs and vaccines at low cost to the patients. The program has been successful in reducing child mortality and treating a lot of people. What is striking is that this program is sustainable, in the sense that it does not require any additional funding from the company and it is paid for through the drugs that are sold. Although observers in the Western world may not have “social identification with the affected party,” this initiative received a lot of traction and generated a lot of PR value to Novartis. As example, the Foundation’s president was awarded the first-ever Outstanding Contribution to Global Health Award by the UN in Sep 2011. Most importantly, patients have access to healthcare, where they did not before, which forms a competitive advantage as Novartis was a 1st mover reaching a huge untapped segment of people and being positioned to serve this market as it grows and develops.

6. Summary

Given all of the changes in government regulations, pricing pressure from payers, and approaching the patent cliff, the structural forces around the pharmaceutical industry are intensifying and impacting negatively its profitability. Novartis, however, has anticipated some of the trends in the forces and is in a better position compared with the competition because of its leveraging on the acquisition of Alcon, growing its generic business through Sandoz, expanding geographically in emerging markets, refocusing its R&D strategy, and restructuring its workforce, and focusing on niche markets. Its CSR strategy, although sustainable but not profitable at the moment, positions the company to compete in the future in developing markets.


Exhibit 4 Investment Focus Areas


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