This blog first appeared as Steve Wunker's piece for Pharmaceutical Executive
By Steve Wunker, Charles McLaughlin, and Clayton Christensen
Drug companies can do to specialists what Intel did to PC box makers: commoditize them.
PHARMACEUTICAL COMPANIES ARE MASTERS of innovation—at least they say they are. And with their business models based almost entirely on innovation, they ought to be. Pharma should be one of the most innovative industries in the world, but this is not the case—new drug launches are down, even as R&D costs have risen sharply. The industry suffers most because, on the whole, it aims at only one kind of innovation. When pharma sets out to make drugs "better," it usually tries to make them more effective. And while this sort of incremental innovation is key to developing new treatments or improving existing ones, it achieves little when the target market is already full of satisfied customers. In a marketplace increasingly crowded with good products, companies need disruptive innovations—new products that are more convenient, simple, affordable, and accessible than existing offerings—to achieve new growth.
Big Pharma´s new agenda for above-average growth
The most successful companies of the past 50 years—from Apple to Wal-Mart—have devoted significant resources to disruptive innovation. Typically, disruptive innovations either create new markets by bringing new features to non-consumers, or they trade off traditional measures of performance in a way that appeals to existing customers. Measured against established metrics, disruptive innovations may provide worse performance than best-in-class solutions. But these innovations still appeal to customers on the basis of convenience, simplicity, price, or accessibility—as long as they are good enough to meet the customer's need.
During the 1980s, Lilly, working with Genentech, spent about $1 billion to make a purer form of insulin than the animal-derived product many diabetics injected every day. As the largest supplier of insulin, Lilly viewed improvement of the product's purity as a critical platform for revenue growth. Key opinion leaders told the company repeatedly that this would reduce occasional side effects. Physicians and researchers, like Lilly's management, assumed that the market would embrace the purer insulin. However, the new formulation, called Humulin (human insulin injection [rDNA origin]), was a major disappointment. Instead of switching to the "better" product, users were largely satisfied with the pork-derived insulin that they had used for years. Most patients greeted the product with closed pocketbooks.
A successful disruptive innovation was achieved at about the same time by a then-small Danish company called Novo. Novo—not yet Novo Nordisk—developed an insulin-injection pen that users found much more convenient than the common syringe. Even though Novo's pen offered no improvement in terms of treatment efficacy (and sold for a price premium), the product took off rapidly because it was simple and easy to use. For Novo users, "better" had nothing to do with Lilly's billion-dollar improvement in insulin purity.
Lilly tried to improve its product along well-established measures of performance—we call this "sustaining innovation"—without considering whether the product was already good enough for most customers. The company listened to the input of leading physicians, who are often the doctors who focus on the most challenging cases. The leap in performance may have been a technological breakthrough, but most patients were already satisfied and saw no reason to change to the more expensive Humulin.
We have seen this tight focus on sustaining innovation in more than 50 industries during 15 years of research. Companies—from AT&T to Woolworth's—have stumbled when they failed to take a broad enough view. A company's drive to innovate backfires when it is unwilling to invest in innovations that depart from its well-established business model. Instead of investing resources in disruptive innovation, companies let competitors seize these growth opportunties.
There's more to success than better efficacy. A 2003 study by McKinsey located the most important drivers of drug-value creation in areas other than effectiveness. Specifically, the study showed that improved efficacy was the key driver of value creation in only two of ten therapeutic classes. In the other eight classes, measures such as safety and convenience drove commercial success. While this study focused only on blockbuster drugs, it confirmed a central idea of disruptive innovation theory: New performance measures are often more important than the traditional metrics used by many firms.
Today, new standards of performance make the delivery mechanism at least as important as the efficacy of the delivered medicine. For instance, development of controlled-release formulations can deliver longer-lasting doses of medication, or medications in variable bursts. There is no change in medical efficacy, but the innovation can address important healthcare needs, such as eliminating the need for children to visit the school nurse for medications or improving compliance of psychiatric patients.
Blockbuster drugs are not likely to be the value drivers they have been in recent times. At the top-end, new technologies like genomics are beginning to realize their promise, leading to effective therapies for more tightly defined target conditions. At the bottom-end, generics will continue their rapid growth. Their manufacturers—like low-cost producers in any industry—will seek to move up-market into large categories with their own, more profitable compounds. Squeezed in the middle, and going off patent, are the blockbuster drugs that provide so much of today's revenue.
Most pharma firms are focused on maintaining their price premium with ever-more effective, patent-protected therapies. They face pricing pressure not only from generics, but also from payers, who are consolidating and increasing their power in the United States. Genomics and other new fields on the frontier of pharmaceutical performance promise to alleviate that pressure. Will customers really demand so much increasing efficacy? Clearly, some existing treatments are not yet good enough. For other conditions, however, marginal improvements—some isomers, for example—are being introduced at steep price premiums. This unlikely strategy can succeed, as shown by AstraZeneca's launch of Nexium to replace the off-patent Prilosec. But AstraZeneca invested $224 million in DTC advertising in the United States, where the condition is very widespread.
Five Disruptive Trends
We see five disruptive trends in pharma that call for a different aproach than Nexium's build-a-better-mousetrap model. These trends call for re-thinking competitive and portfolio strategy, placing greater emphasis on new forms of product differentiation, and making money in unfamiliar ways.
The first is the much-heralded rise of consumer-driven healthcare. While the long-term effects of this trend remain to be seen, some aspects are already apparent. DTC advertising of prescription medicines, the rise of health savings accounts, and ready consumer access to the best available medical information are all moving companies away from the traditional doctor-centered revenue models of the past. Firms must find new ways to create brand relevance for consumers, not just through advertising (an effective but very blunt and expensive instrument) but also through initiatives, such as sponsoring user communities and creating direct-marketing dialogues with consumers, the way media companies do.
Second, the pharma industry is largely missing its chance to capitalize on the rise of simple diagnostics, which eliminate the need for lengthy and expensive lab tests. Simplified diagnostics in the primary care physician's (PCP's) office can provide enough information for effective diagnosis, treatment, or disease management—and serve as new generators of product demand. Historically, diagnostic firms haven't made much money, but time and again we have seen the profit migrate within an industry's value chain. Just as Intel seized profits from computer makers by putting the most difficult design work inside its microprocessors, diagnostic makers can raise their profits by precisely characterizing a condition and taking advantage of increasing patient price sensitivity.
The third trend is to empower PCPs and nurses to provide treatments previously reserved for specialists, such as monitoring diabetes management and cardiac treatments. This trend lowers costs, is more convenient for the patient, keeps the patient with the trusted PCP, and cuts the expensive specialist physician out of the value chain.
Fourth, consumption is set to grow dramatically in emerging markets. Some industry observers expect the number of reimbursable patients to grow six-fold in the next 10 years, in markets such as China. Many of these patients are opting for low-cost generic drugs from such firms as Teva, Raxbury, and Dr. Reddy's. Will the Western giants simply cede this market—one of the biggest frontiers in healthcare—or will they develop a coherent approach to contest the space?
Finally, these generics makers are beginning to move up-market. Just as Toyota moved into more profitable market tiers after it entered the United States with the lowly Corona, these firms begin by offering "good-enough" drugs for widespread conditions. Will Western pharma firms simply retreat into the highest market tiers? Or can they fight the entrants? Among Big Pharma firms, Novartis is among the few to make major investments in generics and low-end drugs.
Reasons for Hope
In the face of these disruptive trends, we see three major routes forward. For many conditions and patients, the performance of drugs and many diagnostics is becoming more than good enough, and therefore, the definition of quality will change for these consumers. They will be seeking convenience, simplicity, affordability, and easy access.
As healthcare costs come under pressure, pharma companies can do to doctors what Intel did to the PC makers: commoditize them. By becoming more precise about specific disease states with diagnostics and tailoring therapies accordingly, pharma can facilitate the migration of treatment from specialist to PCP. It can lower overall healthcare system costs while seizing a greater portion of industry profits. Pharma also needs to target common problems that may not be life threatening, but which still threaten quality of life, so it can open new, less competitive markets for growth.
For example, SleepUp, an Israeli firm, has found an alternative to expensive sleep-lab studies, which require polysomnography on a half-dozen or more vital signs to diagnose sleep apnea. Instead, the firm has introduced a moustache-like sensor that a patient wears under the nose in bed, at home. The sensor measures only airflow through the nose and mouth. The result is not good enough to diagnose apnea, but it does appear sufficient to screen out people who present with apnea-like symptoms but who are unlikely to have it. It is far more convenient, and costs 90 percent less than sleep-lab studies.
Genentech markets Herceptin (trastuzumab) for a specific subtype of breast cancer, HER2. By focusing tightly, Genentech begins to redefine an umbrella disease state into precise therapy targets.
GlaxoSmithKline's Requip (ropinirole hydrochloride) treats Restless Leg Syndrome (RLS), a neurological disorder that causes unpleasant sensations in the legs. Many who suffer from RLS never knew they had a medical problem. Doctors did not diagnose it because little treatment could be provided. GSK may help change that dynamic, as the firm invests considerably in DTC and detailing to drive prescriptions.
Building new growth businesses using disruptive innovation is not easy. However, if companies do not systematically build this capacity for above-average growth, they will cede disruptive innovation to start-ups and small challengers. At best, they will be forced to buy these firms later on at vast multiples. At worst, they will lose market share. US Steel, Sears, Zenith, Compaq, Polaroid, Chrysler, and countless other formerly great companies have learned these lessons at great cost. Doing the same thing a bit better is frequently a one-way path to ruin. Conversely, the firms that have pursued disruptive innovation include IBM, eBay, Sony, Nokia, Toyota, and many of the other champion value-creators of the past 50 years. Whether Big Pharma joins yesterday's great companies in the history books or grows in unanticipated ways depends largely on whether companies embrace the logic of disruptive innovation.