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Preparing for Productivity Transformation in Pharma

2005 Pharma, Biotech, and Device Colloquium . June 7, 2005 . Preparing for Productivity Transformation in Pharma .

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Preparing for Productivity Transformation in Pharma

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  1. NJE-262622.366-20050606-jdonHR1 2005 Pharma, Biotech, and Device Colloquium June 7, 2005 Preparing for Productivity Transformation in Pharma This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

  2. NJE-262622.366-20050606-jdonHR1 TODAY’S DISCUSSION • Industry context for the growing need to focus on productivity • Practical challenges and constraints pharmacos will likely need to overcome • Some of our perspectives on what it will take to be successful

  3. Patent expiries • Over $65 billion in branded drugs* losing patent protection in 2004-2008 • 21 blockbusters** going off patent/exclusivity 2005-2007 • R&D productivity • 13% CAGR for R&D spending 1970-2002, while total IND and NDA output remained relatively flat • Survival rate in Phase II trials decreased from near 50% to less than 30% by some estimates • Top 10 pharmacos’ share of industry development pipeline decreased by ~40% from 1997-2002 • Legal challenges • Expensive product and business-practice related litigation • High-profile product withdrawals • Blockbuster infrastructure • Organization size and spending levels remain high in many situations despite slowing pace of blockbuster launch/discovery NJE-262622.366-20050606-jdonHR1 PHARMACOS FACE GROWING INTERNAL PERFORMANCE PRESSURES . . . • Slowing US performance • Pharma profit pool shrank by $10 billion in 2003, compared with 18% increase in overall US corporate profitability * 2003 sales levels ** Over US $1 billion in WW peak sales Source: SG Cowen Pharma pulse; Pharmaceutical Executive; Evaluate; literature review; team analysis

  4. Pricing pressures • Negative perception of industry NJE-262622.366-20050606-jdonHR1 . . . COMPOUNDED BY AN EVER MORE CHALLENGING EXTERNAL ENVIRONMENT • Uncertain U.S. pricing environment • Re-importation • Medicare Modernization • Up tick in generic substitution • EU reimbursement challenges • Directive price and reimbursement cuts (e.g. Germany, Italy) • Reference pricing within class or to generics (all EU5 markets except UK) • Reimbursement of off-label use being challenged • Rising copays making consumers increasingly aware of prices • Growing number of “follow-on’s” and “me-too’s” • Pharmaceuticals represented 11% of US healthcare spending and 58% of healthcare profits in 2002 • Lobby from uninsured populations • Government drug spend roughly doubled every 5 years since 1990, resulting in increased pressure to manage costs • High-profile product recalls • Business practice inquiries Source: Literature review; Evaluate; SG Cowen Pharma pulse; team analysis

  5. CAGR* • Percent NJE-262622.366-20050606-jdonHR1 CAPITAL MARKETS SEEM TO BE RECOGNIZING AND RESPONDING TO THESE CHALLENGES • Price index, Jan 1995-Dec 2004 S&P Pharma • S&P Pharma • S&P • 1995-2000 • 21.0 • 27.6 • 2001-2004 • -1.5 • -8.1 S&P 500 • TRS index, Jan 1995-Dec 2004 S&P Pharma • S&P Pharma • S&P • 1995-2000 • 23.1 • 29.7 • 2001-2004 • 0.2 • -6.3 S&P 500 • Jan 1995 • Jan 1997 • Jan 1999 • Jan 2001 • Jan 2003 • Jan 2005 * Based on average indices for each year Source: Compustat; team analysis

  6. NJE-262622.366-20050606-jdonHR1 HOWEVER, EARNINGS EXPECTATIONS FOR TOP PHARMACOS REMAIN OPTIMISTIC • Average EBITDA CAGR* • Percent • Implications • Driving productivity in the full P&L • Topline • Cost • Creating opportunities to fund growth, not only earnings • 2001-04 • 2004-07 * Average includes Merck & Company, Eli Lilly, AstraZeneca, Novartis, Johnson & Johnson, GlaxoSmithKline, Bristol-Meyers Squibb, Abbott Labs, Pfizer, and Roche Source: Evaluate; team analysis

  7. NJE-262622.366-20050606-jdonHR1 TODAY’S DISCUSSION • Industry context for the growing need to focus on productivity • Practical challenges and constraints pharmacos will likely need to overcome • Some of our perspectives on what it will take to be successful

  8. NJE-262622.366-20050606-jdonHR1 SUSTAINING IMPACT FROM PRODUCTIVITY EFFORTS IS NOT EASY • Cost reduction sustainability among the S&P 500* • Number of companies • Initiated cost reduction effort during 1999-2001* • Did not achieve cost improvement in Year 1 • Did not maintain improvement through Year 2 • Did not maintain improvement through Year 3 • Sustained improvement * Excludes 4 companies for which relevant comparison data was not available; based on costs as a percent of sales Source: Bloomberg; Factiva; Transformation Compendium; Beer and Nohria (2000); Conference Board report (Fortune 500 interviews); Press analysis; McKinsey analysis

  9. NJE-262622.366-20050606-jdonHR1 IN PHARMA, A LIMITED HISTORIC NEED TO OVER-EMPHASIZE MARGINS . . . • Weighted-average EBIT margins for selected industries, 1985-2003 • Percent • Pharma profitability is 5-15% higher than most industries and has seen sustained increases • Other industries (auto, consumer packaged goods) already forced to re-invent operating models to sustain margins (late 80s, early 90s) • Pharma • CPG • Media • Auto Source: Compustat; team analysis

  10. NJE-262622.366-20050606-jdonHR1 . . . HAS CREATED SOME UNIQUE CHALLENGES (AND OPPORTUNITIES) TO OVERCOME TO SUCCESSFULLY DRIVE PRODUCTIVITY • Senior management attention and focus on productivity • Institutional skills and capabilities (e.g., versus financial institutions) • Focus on “across the board” process excellence (e.g., versus auto companies) • Legacy of decentralized operations compounded with uncaptured M&A synergies • Frontline mindsets and behaviors (especially when the “sky is not falling”) • Effectiveness and efficiency of support functions (pharma rarely in the top quartile)

  11. NJE-262622.366-20050606-jdonHR1 TODAY’S DISCUSSION • Industry context for the growing need to focus on productivity • Practical challenges and constraints pharmacos will likely need to overcome • Some of our perspectives on what it will take to be successful

  12. NJE-262622.366-20050606-jdonHR1 WE OBSERVE 7 FACTORS COMMON TO SUCCESSFUL, SUSTAINED PRODUCTIVITY PROGRAMS •  • Illustrated in more detail • Carefully thought out architecture to the program including focus on approaches and tools to use, aimed at getting cost out and keeping it out • Absolute commitment (in word and practice) from CEO, CFO and every member of the executive team • Meaningfully changing the way the business works, fundamentally redesigning the organization, and reducing/changing work • A “modus-operandi” of delivering on stretch targets, with zero tolerance and major consequences for under delivery • Building capabilities to transfer “one-time” experiences into on-going “ways of working” • Driving the felt urgency and the need down to the frontline employees with focus on mindsets and behaviors • Having rock-solid performance metrics that measure the right things, providing transparency around them, living up to consequences of not delivering against metrics •  •  • 

  13. B. • Establishing the right governance and leadership • A. • Determining what to focus on and how to do it • C. • Communicating and gaining alignment around the program NJE-262622.366-20050606-jdonHR1 MAJOR DIMENSIONS OF A WELL-ARCHITECTED PROGRAM • Role of senior management/program leadership • Decision-making processes • Resource deployment • Tracking and monitoring progress Well-architected productivity program • Aspiration and target setting • Areas of the business to focus on • Approaches and tools to use • Engaging the organization, e.g., communication • Skills/capabilities

  14. NJE-262622.366-20050606-jdonHR1 THERE IS NO PERFECT APPROACH TO FIT ALL INITIAITVES WITHIN A PROGRAM • There is no shortage of productivity approaches to choose from . . . • . . . in our experience, simplicity works best • 6 Sigma • AVA • Activity Value Analysis • Rebasing • MiniAVA • No one right approach • Fundamental differences between initiatives drive the need to tailor approach • Breadth of analysiswillvary • Specific work should be easy to design and timely to implement • Approach should be simple to communicate and institutionalize in the organization to ensure sustainability • Should help identify inefficiencies in the system (e.g., redundant activities, low value products) to enable tangible action • Zero-base • Growth AVA • TOP • Total Operational Performance • GBB • Global Bureaucracy Buster • Delta cash • Corporate center optimization • FORT • Fast Overhead Reduction through Triangulation • Lean • BPO • Business Process Outsourcing • BPR • Business Process Redesign/ • Core Process Redesign • IM • Internal Market • IRTS • Intelligent Reduction Target Setting • Edict

  15. Changing the operating model • Redesigning processes and practices • Managing demand and supply levers on external spend • Issuing top-down mandates NJE-262622.366-20050606-jdonHR1 EXAMPLES OF CHANGING THE WAY THE BUSINESS WORKS • Time to diagnose/launch • Time to full impact of savings* • Examples of potential initiatives • European regional models • Aggressively managing non-strategic products • Global vs. regional vs. local marketing models • Differs by specific initiative but generally 3-4 months • Could start in 6-12 months with full impact likely in 12-18 months • Functional process excellence (e.g., portfolio prioritization in R&D and S&M) • Support function optimization (standardization, off-shoring, demand management) • ~2-3 months • Savings begin in 6-12 months with full impact in 12-18 months • Category by category business-driven procurement initiatives focused on unit price and demand (often >65% of savings) • ~2-3 month waves • Typically in ~6 month waves but may differ by spend category • Travel • Hiring • Compensation • Meetings • Less than 1 month • Immediate – within ~3-4 months * Timing post launch of initiative

  16. NJE-262622.366-20050606-jdonHR1 SUCCESSFUL COMPANIES HAVE SYSTEMATICALLY CHANGED MINDSETS AND CULTURE FOR LASTING IMPACT “I will change my mindsets and behaviors, if . . . ” • Capability • building • Leadership direction and role modeling “. . . I have the skills and confidence to behave in the new way.” “ … I see my leaders behaving differently” “… I know what I need to change and I want to do it.” “... the systems reinforcethe desired change.” • Communication • Metrics and tracking

  17. NJE-262622.366-20050606-jdonHR1 IN CLOSING . . . • The need for productivity focus in the industry is real and will likely continue • There is meaningful upside for those who can sustain productivity – particularly as a lever to fund medium to long-term growth (not only near-term earnings) • Players who want to achieve sustained productivity will need to put in place a careful up-front architecture coupled with a real execution/implementation focus over time

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