Future Scenarios for the German Pharmaceutical Industry

Table of Content

Abstract

Table of Content

Table of Figures

Table of Abbreviations

1. Introduction

2. The German pharmaceutical industry
2.1 Definition and scope
2.2 Overview of German pharmaceutical industry
2.2.1 Industry characteristics
2.2.2 Market size and growth
2.2.3 Research and development
2.2.4 Key players and products
2.2.5 Business models
2.2.6 Regulatory environment
2.2.6.1 Essential components of the health system
2.2.6.2 Pricing system
2.2.6.3 Novel reimbursement systems
2.3 Key opportunities
2.3.1 Macroeconomic opportunities
2.3.2 Market opportunities
2.3.3 Business opportunities
2.3.4 Technological opportunities
2.4 Key challenges
2.4.1 Political challenges
2.4.1.1 Pricing and reimbursement
2.4.1.2 Rebates
2.4.2 Business challenges
2.4.2.1 Business model
2.4.2.2 Patent cliff and protection
2.4.2.3 Competition
2.4.2.4 R&D productivity

3. Theoretical foundation
3.1 Need for scenario planning
3.2 Traditional scenario planning methods
3.3 HHL’s scenario-based approach to strategic planning

4. Scenario development and strategy definition
4.1 Definition of scope
4.2 Perception analysis
4.2.1 Questionnaire design process
4.2.2 Analysis of the results
4.2.2.1 Blind spots and over-awareness
4.2.2.2 Weak signal
4.3 Trend and uncertainty analysis
4.3.1 Deduction of the impact/uncertainty grid
4.3.2 Aggregation of key uncertainties
4.4 Scenario building
4.4.1 Scenario matrix
4.4.2 Influence diagram
4.4.3 Scenario foundation
4.4.4 Scenario description
4.4.4.1 Healthy Co-Existence
4.4.4.2 Blockbustermania
4.4.4.3 Generics’ Paradise
4.4.4.4 Struggle for Survival
4.5 Strategy definition
4.5.1 Formulation of the core strategy
4.5.2 Strategic options

5. Limitations and conclusion
5.1 Limitations
5.2 Conclusion

Table of Annexes

Annexes

Bibliography

Table of Figures

Figure 1: Sales of top 12 global pharmaceutical markets for 2009 [in million EUR]

Figure 2: Sales development of the German pharmaceutical market [in million EUR]

Figure 3: German pharmaceutical market by product category in 2009

Figure 4: German pharmaceutical market by therapeutic class in 2009

Figure 5: Total pharmaceutical R&D expenditures in Germany [in million EUR]

Figure 6: Top ten leading pharmaceutical companies in Germany by sales (2009)

Figure 7: Top ten leading products in Germany in 2009 by sales

Figure 8: Traditional value chain of a pharmaceutical company

Figure 9: HHL’s scenario-based approach to strategic planning

Figure 10: 360° Stakeholder Feedback

Figure 11: Impact/Uncertainty Grid for the pharmaceutical industry in Germany

Figure 12: Overview of critical factors and selected trends

Figure 13: Overview of scenario matrix for the pharmaceutical industry in Germany

Figure 14: Overview of influence diagram for the pharmaceutical industry in Germany

Figure 15: Launched NCEs in Germany and value share of generic drugs by sales for 2009

Figure 16: Fact sheet: Healthy Co-Existence

Figure 17: Fact sheet: Blockbustermania

Figure 18: Fact sheet: Generics’ Paradise

Figure 19: Fact sheet: Struggle for Survival

Figure 20: Overview of the core strategy and strategic options

Table of Abbreviations

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1. Introduction

The global pharmaceutical industry has been a great success story in recent years. The pharmaceutical industry’s innovative power has significantly contributed to the improvement of the quality of health care. Medical innovations have completely transformed the treatment paradigm, have dramatically increased individuals’ chances of surviving certain diseases such as cancer and heart disease, and have reduced the likelihood and impact of diseases such as HIV/AIDS or arteriosclerosis (PhRMA, 2010, p. 2; Schumacher & Reiss, 2006, p. 7). From a business perspective, the pharmaceutical industry has been the most profitable one during the last decade. With a median profit margin of 17 percent compared to 3.1 percent for all other industries on the Fortune 500 list, and representing 20 percent of all global research and development (R&D) investments as well as generating revenues of over USD 700 billion, the pharmaceutical industry has visibly shaped the global business world (Anscombe, Wise, Cruicksbank, Hanfland, Thomas, & Sawaya, 2009b, p. 1; Public Citizen , 2003, p. 1).

However, the pharmaceutical industry is facing an increasingly volatile and uncertain environment. Evolving challenges such as an increase in regulatory state interference including the cost containment measures of health care reform, decreasing R&D productivity, and many blockbusters going off-patent are just some examples of the complexity and upheaval the industry is exposed to. Due to the increasing complexity and volatility, traditional planning tools are no longer suitable to adequately support conventional decision-making processes, since they insufficiently take uncertainty into account (Grant R. , 2003, pp. 491-493).

This problem can be resolved by implementing scenario-based planning. This tool is applied to depict possible future scenarios, i.e., to identify a wide range of possible developments, which makes it a suitable tool in a volatile and complex environment.

Hence, the objective of this thesis is to develop four plausible scenarios and secondly, to determine a core strategy, as well as strategic options for the pharmaceutical industry in Germany. First, an overview of the pharmaceutical industry in Germany is presented and major industry-related opportunities and challenges examined. Second, the theoretical foundation of scenario-based planning and its methodology is discussed. The HHL scenario-based approach to strategic planning is presented and briefly explained. Third, the approach is applied to the pharmaceutical industry in Germany, and four distinct scenarios developed. Finally, a core strategy and strategic options are derived.

2. The German pharmaceutical industry

This chapter provides an overview of Germany’s pharmaceutical industry. First, the pharmaceutical industry is defined and the scope of the thesis established. Second, a detailed overview of the industry’s size, key figures and players, as well as the currently prevailing business models are presented. Furthermore, the regulatory environment is described and major regulations and important mechanisms of regulatory bodies, which have an impact on the pharmaceutical industry, analyzed. Third, the opportunities and challenges of the pharmaceutical industry are discussed and the degree of impact assessed.

2.1 Definition and scope

The German pharmaceutical market comprises ethical drugs, i.e., patented, generic, and over-the-counter (OTC)^[1] drugs. Sales figures cover pharmacies, hospitals, and outlets at ex-manufacturer price levels^[2]. Patented drugs are defined as drugs that are under the protection of a patent; generic drugs, on the other hand, refer to drugs that are not protected under a patent, whereas OTC drugs are defined as non-prescription products for self-medication (IMS Health, 2010a, pp. 113-114). Throughout this thesis, the terms patented drugs and innovative drugs are used interchangeably.

The scope and focus of this thesis covers the German pharmaceutical market. This includes all market participants ranging from large international pharmaceutical companies to small local German enterprises. However, it must be noted that the development of scenarios is primarily based on the perspective of the Big Pharma companies. Thus, the focus lies on the factors and trends that predominantly influence and have an effect on the competitive environment of traditional Big Pharma companies (please refer to Chapter 2.2.3 for a definition and description of a Big Pharma company and its business model).

2.2 Overview of German pharmaceutical industry

2.2.1 Industry characteristics

The German pharmaceutical industry is one of the largest pharmaceutical markets in the world in terms of sales and unit production. There are approximately 1,100 manufacturers that employ over 114,000 people, making Germany the second largest pharmaceutical exporter in the world after the United States of America (US). Germany hosts many of the world’s largest drug companies, including Germany-based Merck, Bayer-Schering, and Boehringer Ingelheim, as well as multinationals such as Novartis Pharma, Pfizer, Sanofi-Aventis, and GlaxoSmithKline. These multinational companies are represented through production and R&D facilities or through sales and marketing locations (IMS Health, 2010b, pp. 41-44). Furthermore, the industry is characterized by high innovative power (measured in terms of R&D investments) and has one of the highest gross added values per employee (VFA, 2009, pp. 1-9). Innovativeness is a key characteristic of the pharmaceutical industry. In terms of net added value per employee, the pharmaceutical industry ranked first among all German industries in 2006. With approximately EUR 100,000 gross added value per employee, it surpasses by far the chemical industry with EUR 91,300 and the electric engineering sector with EUR 65,200 (VFA, 2009, p. 9). The significance of German pharmaceutical companies, however, has been decreasing. According to Booz & Company, the number of German pharmaceutical companies in the top 50 reduced from seven to four between 2001 and 2008, and market share in terms of sales dropped from 12 to 6 percent (Booz & Company, 2010a, p. 12).

2.2.2 Market size and growth

In 2009, the total German pharmaceutical market amounted to EUR 29,567 million, a 3.7 percent increase compared to 2008. This makes Germany the third largest drug market in the world after the US and Japan (Figure 1) (AT Kearney, 2008, p. 12; IMS Health, 2010c, pp. 80-85; IMS Health, 2010a, pp. 9; 71-73).^[3]

Figure 1: Sales of top 12 global pharmaceutical markets for 2009 [in million EUR]

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Source: Adopted from IMS Health 2010b, p. 62; IMS Health 2010c, pp. 80-85; 91-93, own analysis (Annex 1).

From 2005 to 2009, the market grew by a compounded annual growth rate (CAGR) of 4.5 percent and the market is forecasted to grow by a CAGR of 2.8 percent from 2009 to 2015 to reach a value of EUR 33,998 million (Figure 2) (IMS Health, 2010a, pp. 9; 71-73; 85).

Figure 2: Sales development of the German pharmaceutical market [in million EUR]

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Source: Adopted from IMS Health 2010a, pp.9; 71-73; 85,

In terms of volume, 1.61 million packages of drugs were sold in Germany through pharmacies in 2008, a 1.7 percent increase compared to 2007 (VFA, 2009, p. 45). This corresponds to 8 percent of total world production (AT Kearney, 2008, p. 12). However, the value and volume shares vary for each product category. Non-generic products (patented drugs) have a high value, but a relatively low volume share in the German pharmaceutical market. On the other hand, generic drugs and OTC products have a relatively low value, but a high volume share. Hence, the OTC and generic drug markets are characterized by a high volume, but low price levels (Figure 3) (IMS Health, 2010a, pp. 64-66).

Figure 4 depicts the leading first-level categories of the Anatomical Classification System (ATC) in Germany and their respective market share by sales for 2009 (IMS Health, 2010a, pp. 86-87). Please see Annex 2 for a detailed overview.

Figure 3: German pharmaceutical market by product category in 2009^[4]

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Source: Adopted from IMS Health, 2010a, pp.64-66

Figure 4: German pharmaceutical market by therapeutic class in 2009

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Source: Adopted from IMS Health, 2010a, pp.86-87

2.2.3 Research and development

The pharmaceutical industry is one of the leading industries in terms of R&D investments. In 2009, the German pharmaceutical industry invested approximately EUR 5.6 billion in R&D, a 6.6 percent increase from 2008. The share of total R&D investment in Germany thus rose from 8.7 percent (2007) to 9.2 percent (total R&D investment in Germany 2008: EUR 56.78 billion) (Figure 5). That is, the pharmaceutical industry in Germany ranks third in absolute value after the automotive and electronic industries (BPI, 2009, p. 14). Furthermore, with 18 percent R&D expenditure as a percentage of sales in 2008, the pharmaceutical industry is one of the most research-intensive in Germany (BPI, 2009, p. 15).

Figure 5: Total pharmaceutical R&D expenditures in Germany [in million EUR]

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Source: BPI, 2009, p. 14; VFA, 2009, p. 19

Germany is also one of the leading countries in terms of pharmaceutical innovativeness. According to VFA, intensive research is carried out, inter alia, in the areas of cancer, inflammatory diseases, infections, and Alzheimer’s dementia. In 2008, 31 new molecular entities for first therapeutic options were launched and another 442 new projects are expected to receive market authorization by 2013 (VFA, 2009, p. 18). In 2008, 11,425 pharmaceutical patents for drugs were registered in Germany. From the total amount, German registrations accounted for 12 percent (1,380), second behind the American and ahead of the number of Japanese registrations (Annex 3) (BPI, 2009, pp. 15-16).

2.2.4 Key players and products

The German pharmaceutical market is largely dominated by multinational corporations. According to IMS, Novartis Pharma was the market leader in 2009 with sales amounting to EUR 3,038 million and a market share of 10.7 percent. Novartis Pharma also experienced the highest growth rate, followed by Ratiopharm^[5][6]. Of the top ten leading pharmaceutical companies in Germany, four experienced negative growth, with Merck & Co demonstrating the sharpest decline of -12 percent (see Figure 6) (IMS Health, 2010a, p. 62).

Figure 6: Top ten leading pharmaceutical companies in Germany by sales (2009)

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Source: Adapted from IMS Health, 2010a, p.62

Figure 7: Top ten leading products in Germany in 2009 by sales

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Source: Adapted from IMS Health, 2010a, p.63

Figure 7 lists the top 10 leading products in Germany in 2009. The highest growth rates were achieved by Wyeth Pharma’s ‘Enbrel’ and Abbott’s ‘Humira’ with 39.7 and 28.4 percent, respectively, compared to the previous year (Figure 8) (IMS Health, 2010a, p. 63).

2.2.5 Business models

Two main distinctive business models apply to the pharmaceutical industry: The blockbuster and the specialty model. In general, a business model is defined as the concept behind a business in terms of its underlying economic logic and the basis on which profit is made. It addresses how the company makes a profit, how it interrelates with the marketplace and how it deals with business relationships (Grant R. , 2005, p. 16). To contrast these two business models, the traditional value chain and their functions are briefly explained, followed by a closer look at the blockbuster and specialty model.

Value chain

The traditional value chain of a pharmaceutical company generally consists of five elements: Research, development, production, marketing & sales, and distribution (Figure 8). These five core elements are essential for a pharmaceutical company to conduct its business activities (Booz & Company, 2010a, p. 1). ‘Research’ comprises pre-discovery, discovery, and preclinical activities. The main objective is to find a drug candidate that matches a molecule with a given disease and, ultimately, to test the drug to determine its safety. ‘Development’ involves the investigation of new drug applications and clinical trials. In this phase, applications for approval to test the drug on humans are submitted to authorities, clinical trials to test the drug’s safety and effectiveness take place, and the new drug application process is initiated to obtain a market permit (PhRMA, 2010, p. 27). ‘Production’ encompasses the manufacturing of drugs and medicine. ‘Marketing & sales’ consists of the conceptualization and launch of marketing activities, as well as provision of training to the sales force about the drug. ‘Distribution’ refers to the distribution of the drug to wholesalers (IMS Health, 2010a, p. 67).

Figure 8: Traditional value chain of a pharmaceutical company

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Source: Adapted from Booz & Co., 2010a, p.10

Blockbuster model

The blockbuster model of a pharmaceutical company includes all parts of a value chain in which each element is carried out individually (PwC, 2009, p. 1). This model emerged in the 1980s and mainly focuses on the mass market and highly prevalent diseases (Nickisch, Greuel, & Bode-Greuel, 2009, p. 310). The key objective of the traditional blockbuster model is to focus the majority of the company’s activities and investments on the production of drugs that have a blockbuster character, i.e., brands that achieve global sales of more than one billion USD (Gilbert, Henske, & Singh, 2003, p. 3; EFPIA, 2009, p. 2). Hence, the model strongly relies on the company’s ability to identify and develop promising new molecules, test them, and, finally, to rigorously promote them through extensive marketing and sales activities. In 2007, the average marketing and promotional activities accounted for 23 percent and manufacturing costs for 21 percent of Big Pharma companies' total turnover (EFPIA, 2009, pp. 7-8). Multinational corporations such as Novartis Pharma, Pfizer, and Sanofi-Aventis implement the blockbuster model. These companies are also referred to as ‘Big Pharma’ companies on the basis of which this thesis’ future scenarios are developed.

Specialty model

No clear definition for the term specialty model exists and it builds on various approaches. According to Nickisch et al, there are three major types of specialty model companies in the pharmaceutical sector: Niche therapeutic area concentrators, drug delivery experts, and specialty generics (Nickisch, Greuel, & Bode-Greuel, 2009, p. 311). The distinction between the blockbuster and the specialty model is that the former model encompasses the entire value chain, while the latter focuses on specific parts of the value chain. Thus, specialty model companies can concentrate their resources and capabilities on areas that are crucial to their business. Companies that focus on niche therapeutic areas generally acquire de-prioritized drugs from Big Pharma companies. Investments into the further development of these drugs and extensive marketing promotions are undertaken to increase sales volumes and to reach the mass market. Drug delivery experts usually in-license early and late stage development drugs with the intention of introducing them in the market. Specialty generic companies generally focus on the final three elements of the value chain: Production, marketing & sales, and distribution. They are not involved in R&D and market drugs that are not under patent protection. Thus, they can offer drugs at significantly lower prices because they did not invest in R&D (Nickisch, Greuel, & Bode-Greuel, 2009, pp. 311-312). In 2007, manufacturing accounted for 51, marketing for 13 and R&D activities for 7 percent of the average costs of specialty generic companies (EFPIA, 2009, pp. 7-8). In this thesis, the terms ‘generic drug manufacturer’ or ‘generic drug company’ refer to this type of company.

2.2.6 Regulatory environment

This section provides an overview of the regulatory environment of the German pharmaceutical industry.

2.2.6.1 Essential components of the health system

Social health insurance system

The German social health insurance system is based on the principle of solidarity and collective negotiation. Health coverage is provided by 169 statutory health insurances (SHI) known as sickness funds (Krankenkassen) and 50 private health insurance funds. Health care services are provided to citizens and are financed by a combination of statutory and private health insurance funds, public institutions and private payers’ contributions (IMS Health, 2010a, p. 21).

Central health fund

The centralized health fund (Gesundheitsfonds) was the key component of the 2007 SHI Competition Strengthening Act (GKV-Wettbewerbsstärkungsgesetz, GKV-WSG) reform. Effective since 1 January 2009, the underlying objective of the health fund is to make the health insurance contribution and cost management system more transparent and encourage competition between the sickness funds. The central fund has fostered the consolidation of sickness funds and has turned them into stronger and more powerful organizations. This, in turn, has generated greater contracting freedom for sickness funds to negotiate deals with individual doctors, hospitals, and other service providers. As a result, sickness funds now have more flexibility to manage their expenditures (IMS Health, 2010a, pp. 20-24).

BfArM

The Federal Institute for Drugs and Medical Devices (Bundesinstitut für Arzneimittel und Medizinprodukte, BfArM) is an independent national medical agency responsible for drug licensing, pharmacovigilance, and other regulatory activities. BfArM handles applications for drug approval and since the transposition of the EU Directive on clinical trials into national law in 2009. BfArM has also been responsible for regulating clinical trials (IMS Health, 2010a, p. 58). Nevertheless, the German Government is currently evaluating a proposal to establish an independent regulatory agency to replace BfArM in order to speed up drug approvals and to broaden the role of the new agency in the promotion of pharmaceutical research and to centralize pharmacovigilance activities. Yet, whether this proposal will actually be debated in the near future is uncertain.

IQWiG

The Institute for Quality and Efficiency in Health Care (Institut für Qualität und Wirtschaftlichkeit im Gesundheitswesen, IQWiG) is an independent scientific institute that investigates the benefits and drawbacks for patients of medical interventions. It aims to objectively evaluate the advantages and disadvantages of medical services for patients. To serve its purpose, IQWiG produces independent, evidence-based reports on drugs, methods on screening, and treatments (IQWiG, 2010). Simultaneously, IQWiG is also the cost-benefit assessment body that publishes opinions on the marginal benefits of a tested drug for similar indication areas (please see Chapter 2.2.6 Reimbursement system for further details).

2.2.6.2 Pricing system

Price determination

In general, the pharmaceutical manufacturer can freely determine the price of a patented drug. The rationale behind free price determination is that the manufacturer should have the opportunity to recover the costs incurred for R&D (BMG, 2010). However, in certain cases, the SHI’s central association (Spitzenverband) can limit the price of a patented drug by setting a reference price, in case the drug does not prove to have additional or improved benefits. Prices for non-prescription drugs, such as OTC products, are also freely determined and are not subject to any regulatory restrictions (BMG, 2009; Börnsen, Inland: Pharma, 2010). On the other hand, generic drugs are subject to price references and rebates.

Reference price

One of the most effective price control mechanisms for prescription drugs in the retail sector is the reference price system. It is applied to off-patent and ‘me-too’ products. However, prices for hospital drugs and products not reimbursed by the SHI are not included in this price control mechanism. Reference prices covered 43.8 percent of the market in terms of sales in 2008 or three-quarters of all prescriptions (IMS Health, 2010a, pp. 46-51). In essence, drugs that are considered to be interchangeable are classified into therapeutic groups and reimbursed up to a certain threshold, which corresponds to the lowest or median price within the given group (Petkantchin, 2006, p. 2; BAH, 2010; BMG, 2010).

Rebates

Since 2003, pharmaceutical companies have been required to grant compulsory rebates (Zwangsrabatte) to sickness funds in accordance with Paragraph 130a of the Social Security Code V (Sozialgesetzbuch, SGB). The rates depend on the drug category and are as follows: (1) a 10 percent rebate on all off-patent drugs, unless they are priced 30 percent or more below the reference price; (2) a 6 percent rebate on all drugs without a reference price; and (3) a 16 percent rebate on generic drugs without a reference price. In addition, according to Paragraph 130a, Clause 8 SGB V, sickness funds have the possibility of negotiating individual drug rebates with pharmaceutical manufacturers (IMS Health, 2010a, pp. 56-57; BPI, 2009, pp. 54-55; Bundesministerium der Justiz, 2010, pp. 141-143). As a result, 203 sickness funds and 127 manufacturers negotiated 5,972 rebate contracts, amounting to nearly half of the drugs prescribed by the SHI in 2009 (BPI, 2009, pp. 58-59; BMG, 2010).

2.2.6.3 Novel reimbursement systems

EVITA

To counteract increasing health care expenditures, the sickness funds and the German Federal Government have introduced tools to evaluate the benefits and costs of drugs. The sickness funds, for instance, introduced the Evaluation of Innovative Therapeutic Alternatives (EVITA) in June 2009, a cost benefit system for innovative drugs. EVITA is integrated in outpatient physicians’ software and uses traffic light colors to indicate which products can be prescribed cost-effectively, with caution or not at all. The objective is to promote the prescription of drugs from a therapeutic group that has lower price levels (IMS Health, 2010a, pp. 6-7, 41).

IQWiG’s cost-benefit assessment

Another cost containment tool is the cost-benefit assessment of innovative drugs by the IQWiG. The overall objective of this form of assessment is to identify the incremental benefit and its respective cost. This highly mathematical analysis also includes a budget impact analysis which determines the effect different decisions have on overall health care expenditure. The reimbursement approval of off-patent and ‘me-too’ drugs is based on this assessment (BMG, 2010; IMS Health, 2010a, pp. 6-7, 49).

2.3 Key opportunities

Today’s pharmaceutical industry is characterized by a dynamic and volatile environment. As the environment changes, industries need to adapt to these changes in order to survive. New opportunities are created that offer possibilities to reinforce or improve one’s competitive position. Hence, the following section takes a closer look at macroeconomic, market, business, and technological opportunities.

2.3.1 Macroeconomic opportunities

Two major macroeconomic developments provide opportunities for the pharmaceutical industry in the future: Changing demographics and the increasing income base. First, owing to numerous improvements in science and technology, including in the health care industry, life expectancy in the developed and also in the developing countries is rising steadily (Davidson & Greblov, 2005, p. 6). Furthermore, the overall population and share of elderly is rapidly rising. According to a PwC study, the world’s ageing population (65 and above) is projected to increase from 477.4 to 719.4 million, corresponding to the growth rate of the world’s inhabitants from 7.3 to 9.4 percent (PwC, 2007, p. 2). In Germany, this share will increase from currently 19.3 to 33.2 percent by 2050 (HWWI, 2008, p. 5). Medical expenditures increase over-proportionally to the ageing population, e.g., 80-84 year olds are said to cause eight times higher medical expenditures than 20-24 year olds. The increasing population and growing share of elderly will lead to a rise in demand for health care products and thus provide opportunities for the pharmaceutical industry to increase its sales and profits (Davidson & Greblov, 2005, p. 4; Deutsche Bank Research, 2010, p. 27).

Second, the rising share in health care expenditure in terms of gross domestic product (GDP) in the world (from 16 to 20 percent in the US; from 9 to 15 percent in the Organisation for Economic Co-Operation and Development (OECD) countries) and increase in income also impacts the demand for health care and pharmaceutical products (HWWI, 2008, p. 17).

2.3.2 Market opportunities

Growing emerging markets such as China, as well as increasing health awareness in society provide tremendous opportunities for the pharmaceutical industry. First, the pharmerging markets^[7], for instance, have an 11 percent world market share and contribute 51 percent to global pharmaceutical market growth. Furthermore, the pharmerging market is projected to grow by a CAGR of 13-16 percent by 2013, thus significantly surpassing the global pharmaceutical market growth of 3-6 percent and, consequently, contributing nearly 50 percent to the world’s pharmaceutical market growth (Hill & Chui, 2009, pp. 2-3; IMS Health, 2010d, p. 4).

In addition to these growth opportunities, society’s increasing health awareness could have a fuelling effect on the pharmaceutical industry. In Germany, an increasing number of people are prepared to pay for drugs out-of-pocket to improve or maintain their health condition and to prolong their active life style. The doubling of health expenditures of private households since 1992 is evidence of this trend, and has increased the private household share of overall health expenditures from 10.5 to 13.4 percent (Deutsche Bank Research, 2010, p. 1).

2.3.3 Business opportunities

From a business perspective, new forms of delivering health care and establishing collaborations represents yet another opportunity for the pharmaceutical industry. First, pharmaceutical companies are facing increasing demands from payers^[8] and stakeholders to deliver effective treatment pathways as opposed to clinical effectiveness of a particular drug. This is a result of the growing price sensitivity and pressure to cut costs. In this regard, pharmaceutical companies have the opportunity to demonstrate that their drugs can minimize the exacerbation of a given disease when combined with other interventions and thus reduce overall health care costs. In other words, the stand-alone effectiveness of a given drug will no longer be key, but rather the contribution it makes to the overall improvement of health care (Anscombe, Thomas, & Sawaya, 2009a, p. 50).

Collaborations and strategic alliances offer yet another business opportunity. Cooperation in sales & marketing are common in today’s pharmaceutical industry. However, R&D and network collaborations offer prospective opportunities to cope with the ever-changing and volatile business environment (Davidson & Greblov, 2005, p. 5). Network collaborations in particular represent opportunities to reduce costs, enhance productivity, manage risks more effectively, and to gain better access to innovation. Using networks to create virtual R&D programs and to focus on different therapeutic areas, among others, represents a great upside potential for the industry (PwC, 2009, p. 4).

2.3.4 Technological opportunities

As time progresses, so do technological developments. New technologies and methods such as biologic (bio), genetic, and nano technology provide a basis for new drugs or for efficiency improvements. Several technological advancements promise to generate the pharmaceutical industry’s growth and profits in the future.

First, personalized medicine is one of the most promising areas of biopharmaceutical research. In personalized medicine, a medical treatment is tailored to the individual’s specific characteristics. In addition to the advantage of providing health care that goes beyond ‘one size fits all’, using individuals’ molecular and genetic profile represents tremendous growth opportunities for the industry (PhRMA, 2010, pp. 28-29; HWWI, 2008, p. 14).

Second, biologics offers further growth potential in the future. Compared to traditional drugs which are made of organic chemistry, biologics are created through genetic engineering and are derived from living material. Biologics thus provides benefits such as greater disease specificity of the underlying causes to prevent or treat it (PhRMA, 2010, p. 31).

2.4 Key challenges

Even though numerous opportunities are available to the pharmaceutical industry, it will inevitably also face challenges that will affect it. Political and business challenges pose a threat to existing companies. These companies will have to therefore find ways to counteract and adapt their strategies accordingly in order to effectively cope with these challenges and survive in the long run.

2.4.1 Political challenges

One of the major challenges the pharmaceutical industry has been confronted with over the past years is the increasing influence of the German Government. As described in Chapter 2.2.6, the pharmaceutical industry in Germany is heavily regulated. Hence, the government can impinge on the industry by ratifying new laws and regulations in favor of the state and its system which, in this case, is the social health insurance system. Due to its current deficit and the rising health care expenditures, the German Government has introduced cost containment regulations to counteract this trend. The most critical cost containment regulations have affected pricing and reimbursement, as well as the rebates.

2.4.1.1 Pricing and reimbursement

Pricing and reimbursement comprises the price determination of a drug and the health insurance’s respective reimbursement policy. As mentioned in Chapter 2.2.6.2, free price determination of innovative and patented drugs is crucial if pharmaceutical companies are to recover their R&D investments. Setting prices freely offsets the high costs for developing the drug and ensures the realization of sufficient returns for investors (Ernst & Young, 2009, p. 10). However, free price determination has been criticized for quite some time. The criticism is that many “alleged” innovative drugs do not provide an incremental benefit that justifies their costs. As a result, the government has begun to introduce reference prices for “me-too” and off-patented drugs and is carrying out more thorough cost-benefit assessments for innovative drugs.

The government intends to reorganize the IQWiG and its cost-benefit assessment methodology by introducing a ‘fourth hurdle’ for innovative drugs in order to determine their incremental benefit in relation to the respective costs. It is, however, uncertain whether such an evaluation will be carried out prior to or up to three years after the launch of the drug. This measure has a direct effect on the price of patented drugs. If the assessment for immediate reimbursement approval is carried out prior to the launch, the drug could become subject to a reference price or price ceiling. Such interference would, consequently, affect the companies’ profits and, therefore, represents a major challenge and obstacle for the pharmaceutical industry in Germany (IMS Health, 2010a, pp. 6-8, 45-47; Booz & Company, 2010a, p. 14).

2.4.1.2 Rebates

The second challenge with reference to political regulation is the rebates. Rebates or discounts represent levers to reduce drug expenditures and have an immediate effect on the health care budget. In order to achieve short-term results and counteract the SHI’s nearly EUR 8 billion deficit, the government has considered implementing price freezes on drugs in combination with further rebates. Increasing the compulsory health fund rebates from 6 to 16 percent on drugs without a reference price to limit rising health care costs could be one alternative (BMI, 2010a; Booz & Company, 2010a, p. 14). Furthermore, with the introduction of SHI WSG in April 2007, sickness funds have the option of directly negotiating rebates and discounts with the pharmaceutical manufacturers. As a result, pharmaceutical companies are facing increased price pressures and profit losses. An increase in compulsory health fund rebates, for example, could generate savings of around EUR 1.1 billion per year (BMI, 2010b). Additionally, further rebates and reimbursement policies have an indirect effect on pharmaceutical innovation as they discriminate new innovative drugs and penalize incremental innovation (Petkantchin, 2006, p. 2; IMS Health, 2010a, p. 24). As a result, such cost containment activities which reduce profits and decrease incentives to conduct research on novel and innovative drugs, represent a major challenge for the industry.

2.4.2 Business challenges

2.4.2.1 Business model

The current blockbuster model of Big Pharma companies is outdated and does not meet current needs and market requirements. The business model is based on the notion that physicians are the key decision makers in drug prescription. Hence, the pharmaceutical industry focused on physicians as the primary target of their intensive sales and marketing efforts to influence physicians in their decision-making process. However, physicians are increasingly constrained by regulations and guidelines driven by public and private regulators (Anscombe, Thomas, & Sawaya, 2009a, p. 49). However, the industry’s target customer is changing as health care policymakers and payers increasingly gain control over prescription decisions. This shift requires the industry to refocus its sales and marketing efforts on new stakeholders and to adopt corresponding strategies.

2.4.2.2 Patent cliff and protection

One of the greatest challenges the pharmaceutical industry faces is the “patent cliff” and the protection of patents. The ‘patent cliff’ refers to the period - starting in 2009 and peaking in 2011-12 - when many of the leading blockbusters will lose their patent protection and other produced drugs will not be able to balance the lost sales. According to Bernstein, over the next five years, revenues of USD 157 billion will be lost because of the expiration of patents. This patent cliff will result in a massive decline in sales for some of the world's largest pharmaceutical companies (Bernstein Research, 2008, pp. 85-87). Consequently, the patent cliff needs to be overcome by introducing innovative drugs which may guarantee a future income (PwC, 2007, p. 9).

The second challenge is patent protection. Intellectual property (IP) is one of the most valuable assets of a Big Pharma company^[9]. An IP on a drug guarantees the company exclusive rights to promote and sell the respective drug for a period of time and thus recover its high R&D investments (Ernst & Young, 2009, p. 20). However, a rise in the number of ‘patent challenges’ is evident. Patent challenges, for instance, result when generic manufacturers produce patented drugs before the patent’s actual expiration, thus affecting the sales of the patented drug. According to Bernstein Research, the number of such challenges increased from 35 to 162, by a five-fold, between 2001 and 2007. In many cases, the patents can be protected, e.g., through a court decision, and a halt in the production of the generic version enforced, yet this requires much time and effort and inevitably results in a loss of sales (Bernstein Research, 2008, pp. 84-85). Due to increasing price pressures and patent challenges, patent protection is one of the most critical challenges the industry will face in future.

2.4.2.3 Competition

Another challenge pharmaceutical companies increasingly face is inter- and intra-industry competition. Within the industry, generic companies are aggressively competing with Big Pharma companies. They offer drugs at a much cheaper price since they do not have to recover any R&D costs (see Chapter 2.2.5). Once a patent expires, the Big Pharma companies experience considerable losses in sales and market share. One example is Schering-Plough’s Claritin which is used for allergies. Its sales fell from 3.2 billion to 0.37 billion USD in just two years after the patent had expired (Davidson & Greblov, 2005, pp. 7-8).

In addition to intra-industry competition, inter-industry competition is also on the rise. Competition from other industries is increasingly evident as non-traditional competitors gradually move into areas that have traditionally been covered by the pharmaceutical industry. Food companies, for instance, have expanded their product lines to include health-related areas and are increasingly carrying out R&D in these areas. Nestlé, for example, offers functional foods and is also involved in the field of “personalized nutrition” with products and services that focus on diet and nutrition. Cosmetics companies have begun to target the overlap between their traditional goods and health & wellness. Wal-Mart, for instance, offers mail delivery service for generic drugs and offers over 1,000 OTC items in its stores. A recent study by Ernst & Young underlines the potential threat emanating from such non-traditional competitors. 92 percent of the Ernst & Young survey respondents believe that non-traditional competitors will enter the market and have a high impact on the pharmaceutical industry (Ernst & Young, 2010, pp. 16-18). As a consequence, the industry will also face competitive pressures from other industries, thus exerting additional pressure on the margins.

2.4.2.4 R&D productivity

Paired with the patent cliff, R&D productivity represents one of the most critical challenges the pharmaceutical industry will face in the future. First, it takes an average of 10-15 years to successfully develop a new drug. Thus, the careful planning of the long-term R&D pipeline is imperative for Big Pharma companies (Davidson & Greblov, 2005, p. 9).

Second, as mentioned in Chapter 2.2.3, R&D expenditures are soaring. The industry’s R&D processes have become so complex and cumbersome that additional investments are required in order to achieve a reasonable result, i.e., the discovery of a successful drug (Bernstein Research, 2008, pp. 78-80). Several studies indicate that the chance of discovering a promising, new, and marketable drug is astonishingly low: The number ranges from 1:5,000 to 1:10,000. Once they have reached the market, only 20 percent of the marketed drugs will actually generate sufficient income to amortize the initial investment. The costs for developing a drug in 2005 were estimated at USD 1.3 billion, over four times higher than in 1987 (318 million USD) (EFPIA, 2010; Nickisch, Greuel, & Bode-Greuel, 2009, p. 310; PhRMA, 2010, p. 0). The main reasons for this surge in R&D costs are the high clinical trial costs, the high failure rates, and the intensive efforts required to obtain drug approval by the regulatory authorities.

At the same time, the efficiency of R&D and the discovery process have declined over the years. The introduction of new products, as measured on the basis of new drug applications (NDA), has dropped dramatically. In Europe, the number of NDA fell from approximately 90 to nearly 40 between 2004 and 2008 (Booz & Company, 2010b, p. 5). The reason for this is the decreasing rate of approval for new chemical/molecular entities (NCE/NME) and the generally slow regulatory approval process. In Germany, the number of NCEs decreased from 35 to 31 between 2004 and 2008 (Booz & Company, 2010b, p. 5; PwC, 2007, p. 5; VFA, 2009, p. 19). Consequently, a Boston Consulting Group (BCG) study estimates that current R&D investments provide a risk-adjusted yield of 11 percent compared to 15 percent five years ago (BCG, 2009, p. 1). In other words, the pharmaceutical industry faces a severe R&D productivity problem which could jeopardize the entire business model of Big Pharma companies. Hence, short-term and even more so long-term measures and strategies need to be developed to effectively deal with the R&D productivity problem.

3. Theoretical foundation

This section provides an overview of the theoretical foundation of scenario-based planning and its methodology. First, the theoretical foundation of scenario-based planning is presented. The purpose of this approach as well as its development is discussed. Second, the HHL scenario-based approach to strategic planning is introduced. The methodology and its respective steps are subsequently explained in detail.

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^[1] Registered pharmaceuticals only.

^[2] Ex-manufacturer price levels refer to prices charged by the manufacturers, excluding rebates, parallel trades, and other discounts (IMS Health, 2010a, p. 106).

^[3] All data provided in this section is based on MAT Quarter 3, 2009, i.e., the figures are from September 2008 to September 2009.

^[4] Value and volume share refer to the market share or proportion of total sales or total volume.

^[5] The numbers in this section are based on MAT Quarter 3 2009; Note that this table does not include Pfizer’s acquisition of Wyeth and Merck & Co’s merger with Schering Plough.

^[6] Please note that Ratiopharm was acquired by Teva on 03/18/2010 (Reuters, 2010).

^[7] Pharmerging markets refers to a group of seven countries with an above average growth rate and thus have a high sales potential for the pharmaceutical industry. They include Brazil, India, Turkey, Mexico, Russia, South Korea, and China. See IMS Health, 2010d, p. 4.

^[8] Payers refer to health funds and patients who, in the end, pay for the drugs.

^[9] Generally, Big Pharma companies face this challenge because of their blockbuster model (see Chapter 2.2.5).