Big Pharma Seeks to Insulate Itself from the

As the pharmaceutical industry moves closer towards the ‘patent cliff’, Big Pharma is implementing strategies to lessen the impact of the loss of patent protection on some of the industry’s biggest sellers on their collective bottom lines.

In an effort to mitigate the impact, Big Pharma is seemingly investing time and energy into diversification. However, a report by Datamonitor suggests that diversifying away from the core business of developing prescription drugs is not the cure to the pending ails of the patent cliff.

Key patent expir ies within the pharmaceutical sector will intensify from 2011 onwards, affecting some of the biggest brands in the industry, such as Pfizer’s Lipitor (atorvastatin), driving down revenue growth for pharmaceutical companies.

Between 2001 and 2008, the collective revenues of Big Pharma companies grew by 8.6 percent year-on-year. If this rate of growth was maintained, revenues would have reached US$628 billion in 2014. However, revenue growth amongst Big Pharma will flatline at 0.2 percent between 2008 and 2014, leading to forecasted sales of US$387 billion in 2014.

This slow-down in revenue growth is almost entirely attributable to the expiration of patents for key products; a phenomenon from which few within the Big Pharma peerset will emerge unscathed. Therefore, the question is on how to deal with the forecast decline in revenue growth, leading some companies to consider diversifying away from the branded pharmaceuticals sector.

The pharmaceutical business model is currently undergoing major change, as the industry seeks to maximize operational efficiencies, driven both by the current economic climate and the patent cliff, says Datamonitor pharmaceutical strategy analyst Dr Pam Narang. “Although these changes might provide a cushion of sorts to the forecast decline in revenue growth for Big Pharma, a more aggressive response is required, and diversification away from pharmaceuticals is one avenue that a number of companies have pursued.”

Branded pharmaceuticals represent just one sector within the healthcare landscape. While pharmaceuticals has historically been the most popular single merger and acquisition (M&A) target sector for Big Pharma, it is notable that "ex-pharmaceutical" sectors were collectively responsible for just under half (47 percent) of all acquisitions undertaken between 2000 and Q2 2009.

The different sectors pharma can and have diversified into, include over-the-counter healthcare products, medical devices and diagnostics, animal health, retail pharmacy and health insurance.

Although Big Pharma could potentially off-set sales growth decline by diversification, the resulting fall in operating margin would act to reduce operating profit and somewhat negate the benefits of diversification. Therefore, pharma-focused companies have little to gain from diversifying away from branded pharmaceuticals, and should instead "ride out" the patent cliff by looking to increase operating margin.

While cost-cutting and restructuring can go some way to achieving this goal, merging with and acquiring other pharma companies and biotechs to gain access to their drug development pipelines is a more powerful means of improving operating margin; somewhat justifying the clutch of megamergers that Big Pharma have historically entered into.