By Ali Asgar Kagzi
In 1990s, pharmaceutical companies were one of the leading shareholder value creators at the stock market. By 1998 the P/E ratio of the Big Pharma companies was twice that of the global stock market and there was a sudden rush among the investors to have a share of the Pharma pie. But according to the Harvard Business Review, May 2008, from December 2000 to February 2008 the top 15 companies lost approximately $850 billion in shareholder value and the price of their shares fell from 32 times earnings, on average, to 13. This suggests that something went gravely wrong. The following sections would highlight the reasons responsible for the industry’s tumble on the stock market and the steps the pharma companies have been taking to gain back their profitability and reputation.
Though the use of drugs dates back to the 9th century, the pharmaceutical industry came into existence only during the later 19th century. Minimal research was conducted using primitive methods and little development occurred till the mid 20th century. The discovery of Penicillin by Alexander Fleming in 1928 was a major breakthrough. But it was not produced commercially and was used mainly for the purpose of carrying out laboratory experiments. The widespread use and development of Penicillin during the World War II opened new avenues for the pharmaceutical industry. The conditions after the World War II further facilitated the industry’s development. The war exposed many diseases for which no drug existed, thereby providing ample opportunities for research and development. Additionally, public awareness and support for health related research boomed and public funding increased dramatically. The period from 1950 – 1990 can be termed as a golden period for the industry with massive R&D programs undertaken and a tide of new drugs launched in the market. It is noteworthy that the national institutions played an eminent role in the development of pharmaceutical industry in a particular country. Policies for intellectual property protection, drug approval, and pricing played a crucial role in the industry’s development. Consequently, USA dominated the industry with firms such as Merck, Eli Lilly and Pfizer growing rapidly and profitably. They invested huge amounts in R&D and developed drugs termed as “blockbuster” which enabled them to earn huge profits. Extensive patenting safeguarded these companies from the generic drug manufacturers and there was literally no market for the generics. In 1980, only 2% of the US drug market was held by generics. “Between 1980 and 1992 pharma stocks rose by 959%, compared to a rise of 386% in the S&P index.” (Ravenscraft et al, 2000, p292). But the dream run of the pharma companies was not to last long. The 21st century brought a number of challenges for the industry and it was left grappling for solutions. The investors began to lose confidence and market value of the pharmaceutical companies declined. (Henderson et al, 1999)
The beginning of the 21st century saw a downfall in the profits of the Big Pharma companies. They faced a host of problems such as pressure to lower drug prices, decline in R&D productivity, over-dependence on certain blockbuster drugs and patent expiry of these drugs in the near future, and competition from the new and emerging biotech firms. The cumulative effect of these factors was disastrous and share prices of the pharma companies plunged. Big Pharmas’ median P/E ratio declined drastically by about 40% in the period between 2000 and 2002 and continued to be at lower levels through 2004 (see figure 1)
Until 1980s the pharmaceutical companies enjoyed pricing flexibility because of the way the drugs were sold and there was lack of government...