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Can pharma meet the generic challenge?

Published on 01/05/07 at 11:10am

The global pharmaceutical industry has generally been seen as one of the most successful industries in delivering revenue growth with annual double-digit growth rates seen as the norm for the major companies. But increasing R&D expenditure and decreasing drug launches leave companies ever-more reliant on maximising returns from their existing products. Once patent protection and periods of marketing exclusivity expire for a branded drug, sales tend to decline dramatically as generic substitutes capture market share.

According to your viewpoint, generic drugs represent either the future of the global pharmaceutical industry or a drain on the profits of research-based pharmaceutical companies. Generics now account for more than 15% of the global healthcare market, by value, with combined revenues of $65 billion. The most significant markets for generic pharmaceuticals are the US with 2005 revenues of $18 billion, and Europe, especially Germany and the UK.

This tremendous growth in the generics market at 10-15% per annum is being primarily driven by the imminent patent expirations of many blockbuster drugs, notes Dr Peter Norman, industry analyst and author of a URCH Publishing report on patent expiry markets. Over the next four years, there could be up to 70 expirations in at least one of the major markets, which will provide the chief growth stimulus for the generics companies as they compete to capture market share from billion dollar products.

The other key driver for growth is the promotion and acceptance by healthcare authorities of the use of generics. Countries with the largest branded/generic price differential, in combination with high prices for branded drugs and government support, have the highest generic penetration. Generics have flourished in the US and UK where prices for branded medicines are high, and penetration by volume is 50% and 49%, respectively.

The trend looks set to continue as payers look for cost savings in the health budget, except for perhaps Japan, where generic penetration of the market is low. Since the Japanese Ministry of Health biannually imposes price cuts on approved branded drugs, the financial incentives for switching to generics are less pronounced than in the US and reimbursement rules also encourage prescribers to supply branded products.

Growing opportunities

The world's best-selling drug, Pfizer's Lipitor, which had 2005 global sales of $12.2 billion, represents the greatest chance for the generics industry, while Sanofi-Aventis' and Bristol-Myers Squibb's Plavix, (2005 sales of $6.1 billion), also represents a massive opportunity. Such opportunities will sustain the revenue growth for the generics suppliers throughout this period and ensure that the revenue growth of the generics segment continues to outstrip that of the innovative pharma companies.

Further opportunities for growth should come from the provision of biosimilar forms of recombinant biological therapeutics such as Amgen's Epogen, and Neupogen and Johnson & Johnson's Procrit, with combined 2004 sales of $7 billion. But the absence of an established legislative framework for the introduction of generic formulations of such drugs continues to hinder the market entry of cheaper substitutes for these products. If this is resolved, those companies which can surmount the significant entry barriers for large-scale production of such products should reap substantial rewards at the expense of the original suppliers.

Ignoring recombinant products, there are at least 70 major drugs that will suffer from generic competition in the US or a major European market in the next five years. Important legal cases have and will further influence the opportunities.

Both GlaxoSmithKline (Advair) and Merck (Fosamax) have seen the courts revoke patent protection for their products in the UK, while Sanofi-Aventis is currently fighting a critical legal case in the US to uphold the patents protecting its leading product Plavix. Elsewhere, Pfizer has been battling with Ranbaxy in courts to try to uphold two key patents covering Lipitor.

New generics threaten $100 billion of revenues generated in the US and Europe. The most dramatic change in this period will arise in the years 2010 to 2012 as the patents covering Lipitor expire. In 2010, Pfizer is likely to lose the bulk of its revenues from this product in the US, while generic equivalents are likely to become available in most other markets in 2012.

Levels of threat

There is a considerable difference between the top 20 pharmaceutical companies in both the number of products and the amount of revenues under threat from the potential introduction of generics. Neither Amgen, which only currently markets biological products, nor Merck KGaA, whose portfolio is primarily mature products, face any threat from generic competition, while Roche, Bayer-Schering, Abbott and Schering-Plough face limited threats to their revenues of between four and 10%.

Similarly, the Japanese majors Daiichi Sankyo and Astellas, plus Sanofi-Aventis and Boehringer Ingelheim are likely to see only a modest level of threat to their revenues in this period, but the remaining companies are faced with the loss of a major proportion of their revenues in this period. Johnson & Johnson, Novartis, Wyeth and GlaxoSmithKline could lose  about one-third of their 2005 revenues, and even more severely affected are Bristol-Myers Squibb (BMS), Takeda, AstraZeneca and Eli Lilly with 40% of their revenues threatened, while Merck and Pfizer both have the serious problem of potential erosion of more than 50% of their 2005 revenues.

One company that could be severely hit by generic competition in the next few years is Novartis, which has its headquarters in Switzerland. Novartis has been going through a period of strong growth and, so far, has suffered little from recent patent expiries. All will change between now and 2011 as seven key products will become exposed to generic competition, which collectively accounted for 31.3 % of Novartis 2005 revenues. However, there will be limited impact in the US before late 2010 and the most significant of these products, Diovan, will not be exposed to generic competition before 2012 in its most significant market.

So important is the loss of patent protection for key products, which can see revenues for the supplier fall tenfold within two years, that the investment community is placing increasing significance on it to assess the future performance of major pharmaceutical companies, as the loss of revenues to generic substitutes is a major influence on the financial performance of such companies. As Steger and Kristjnsdttir from Kepler Equities, a brokerage firm, comment in their paper Generics Industry Outlook 2007: Patent expirations of blockbuster drugs have dramatically changed the dynamics of the pharmaceutical industry.

The awareness of how drastically a company's revenues can be affected by the introduction of cheap generic substitutes has led most companies to now highlight in their annual reports which of their products are at potential risk from such competition. In addition, they are increasingly providing details of the ongoing litigation that they are pursuing against the aggressive tactics of the generic companies, primarily in the US.

Conversely, the successful identification and exploitation of the opportunities afforded by patent expirations provides a major growth driver for the pharmaceutical companies which focus their business on the provision of generic therapeutics.

The blockbuster conundrum

Another factor that has increased the financial risk for companies when patents expire on key products, is the transition of the industry into one dependent upon the blockbuster model, where a few drugs generate the bulk of the revenue for the company. Respected industry advisor Dr Barrie James, president of Pharma Strategy Consulting, says this sudden hit on a firm's revenue can be hard to handle.

The problem is that when you lose a mega-selling drug, or even two blockbusters in a short timeframe, this often compromises the integrity of the whole organisation and frequently precipitates either a merger or acquisition or a round of downsizing. Since this is happening with increasing frequency, it suggests that size has become a strategic albatross in the pharma industry.

While the likely patent expiration date is generally well-known, the unexpected loss of a court case, or other unanticipated factors, such as the enforced withdrawal of a major drug, can accelerate the revenue decline. Because of the focus on a few major products, there is a tendency for companies to have phases of little revenue growth due to the loss of income from one or more products exposed to generic competition. Companies such as GlaxoSmithKline and Schering-Plough have recently seen their performance suffer for just such reasons, while 2006 has seen both Merck and BMS suffer due to patent expirations on Zocor and Pravachol respectively.

However, Dr James is not so sympathetic about the plight of companies suddenly finding their profits drying up because of a generic competitor. You don't have to be a rocket-scientist to work out when you are going to lose your patent. Consequently, it is baffling when companies announce that they are in trouble over the loss of a patented product.

The fashion for mergers

A number of companies have found short-term respite from an unpromising pipeline by merging with an equivalent sized competitor. A wave of consolidation at the end of the 1990s, often referred to as mega-mergers, led to a great deal of name changing, but the longer term value of these deals has been questioned by the financial community who are not convinced that larger scale has produced rich pipelines.

Neil Ransome, head of pharmaceuticals at PricewaterhouseCoopers Corporate Finance was recently quoted in an article in The Observer as saying: "Evidence that mega-mergers in this sector improve the rate of discovery of new drugs is not compelling."

This view is backed up by Dr Andre Bates, managing director of pharmaceutical marketing analytics company Campbell Belman, who said in a recent article: "Unfortunately, drug companies continue to pour billions into research and development of new life-saving drugs without reaping the rewards of the past, and the pipelines are not as well stocked as in the past."

Last year, consolidation became fashionable again in Europe, as established mid-sized pharmaceutical companies merged (e.g. Bayer-Schering, UCB-Schwarz Pharma, Merck KGaA-Serono). Interestingly, some of these newly formed companies may divest their generics divisions to reduce debt and focus on the prescription market, while ironically, some R&D companies may jump ship altogether and focus on the growth of generics. Croatian player Pliva, has been busy reinventing itself as a generics company after exiting from its proprietary medicines sales, which were down 7.9% in 2005.

More recently, strong rumors indicate that Sanofi-Aventis, Europe's biggest drugs group is considering a merger with BMS, its smaller US rival, which would create the world's largest pharmaceutical company, with combined 2006 ethical drug revenues of around $49.1 billion. BMS suffered badly in the second half of 2006 as it lost a key legal battle with Canadian firm Apotex over a generic version of its best-seller Plavix (clopidogrel). Apotex flooded the market with generic clopidogrel, resulting in fourth quarter sales of Plavix declining by 62% from $906 million in 2005 to $343 million in 2006. Whether scepticism about such massive consolidation will have any bearing on this possible deal remains to be seen.

As Dr James succinctly points out: "The growth of the generic market is a reflection of the inability of research-based companies to renew their portfolios with new brands offering better clinical and economic value."

Major patent expiries of the next five years

The next five years could see more than 70 major drugs come off-patent in the major markets of the US and Europe.

2007:

14 major drugs lose exclusivity in the US including the superblockbusters Norvasc, Nexium and Riseprdal plus four other blockbusters.

Risperdal is the only significant drug that will lose patent protection in Europe together with three lesser products, in two cases only in France.

2008:

14 drugs lose patent protection in the US, including the superblockbusters Effexor and Fosamax, and potentially Advair plus three other blockbusters.

Nine drugs lose patent protection in at least one of the major European countries, including both Fosamax and Effexor.

2009:

Five major drugs lose patent protection in the US, with Prevacid the most significant of these.

Edwin Bailey is the managing director of URCH Publishing. For more information, visit www.urchpublishing.com

In Europe, seven drugs lose patent protection in at least one of the major countries, including Nexium and Pantozol and Cozaar.

2010:

The US patent for Lipitor expires on 24 March, and 12 other drugs, including the blockbusters Levaquin, Cozaar and Protonix also become exposed to generic competition.

In Europe, five drugs become exposed to generic competition with Keppra the most significant of these.

2011:

Patent protection expires for 10 major drugs in the US, including the superblockbusters Plavix, Seroquel and Zyprexa, plus three other blockbusters. But, patent litigation in respect of Plavix, may see the effective invalidation of the patent expiring in 2011.

Four of these, including Zyprexa, lose patent protection in three major European countries, as do seven other drugs, most notably Lipitor in November 2011.

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