Life sciences companies are a vital player in the healthcare delivery system through their discovery, development, manufacturing and marketing of innovative treatment options for patients. This role, and the innovation brought by the sector, are increasingly visible during the COVID-19 pandemic as life science companies lead the charge to develop novel treatments and vaccines, often in collaboration with startups, academic groups and public health organizations. In addition to ensuring patients have access to therapeutics when they are likely to improve their health outcomes, the activities of Life Science companies aim to achieve commercial success and economic returns on the investments they make in research and development. These returns are then continually reinvested, thus sustaining the cycle of investment and innovation, not just for large pharma companies, but for all those in the innovation ecosystem. 

Even before the emergence of COVID-19, pharmaceutical companies faced challenges in maintaining their financial health — typically measured in terms of operating margins — as Research and Development (R&D) investment levels have climbed and commercialization returns have been constrained.

Increasing R&D investment levels

Over the past 5 years, R&D expenditure has escalated, increasing by 26% or $22.6 billion, and rising 2.1% as a percentage of total sales (from 17.2% to 19.3%). The increase in R&D spending reflects both increased trial activity and the growing complexity of trials – reflecting the number of subjects, research sites, endpoints and inclusion/exclusion criteria included in those trials¹ (see Exhibit 1), 

Exhibit 1: Drivers of R&D Cost Increases, 2014–2019

Constrained commercialization returns

These trends in R&D costs have occurred at the same time multiple changes in the marketplace for medicines have constrained the level of commercialization returns achieved by life sciences companies.

Among the key elements of change are:

• Portfolio evolution: Over the past decade, the profile of new drugs being brought to market has shifted to specialty medicines — defined as those which are often injectable, high-cost, biologic or requiring specialized distribution — and they now account for 36% of spending globally and 44% in developed markets.² Among these are precision medicines and orphan drugs for patients with rare disorders. These medicines typically have smaller target patient populations than traditional drugs, and this is reflected in their average sales per product. In the case of orphan drugs, the average first year sales of new launches has averaged about $20 million over the past decade; lower than the average for non-orphans. At the same time, the number of orphan drug launches has increased at a faster rate than non-orphans — and exceeded the number of non-orphans for the first time in the U.S. in 2019. As a consequence of this portfolio evolution, commercialization returns, on average, for each new drug launched are smaller than in the past and this trend is expected to continue as more precision medicines emerge from the R&D pipeline.
• Demand for evidence of value: As total spending on medicines globally reaches the $1 trillion level annually,2 and medicines are sold at higher annual costs as their target populations have narrowed, payers are not surprisingly placing greater emphasis on ensuring they are receiving value for their money. In much of the world, payers have been demanding more compelling evidence of the value of products — through measures of outcomes, quality of life, disease severity, utilization of health resources, patient adherence, and a range of other measures. Over the past several years, a growing share of formal Health Technology Assessments have been negative recommendations or positive recommendations with restrictions. This typically results in reimbursement prices below the expectations of life sciences companies and thereby constrains the commercialization returns for these products.
• Limited price increases: The U.S. market has typically been the only one where manufacturers have been able to increase prices after launch based on competitive market dynamics. In other markets, payers generally require prices to remain stable or decline, based on reductions in reimbursement rates or market-based competition. In decades past, these U.S. price increases contributed significantly to a company’s operating profit growth. More recently, however, manufacturers have moderated their list price increases, and seen reductions in net price increases. This is in part due to heightened public scrutiny as well as intensified competition among manufacturers to win volume share with payers and intermediaries. As a consequence, operating profit lift due to price increases have become minimal for most companies in recent years.
• Impact of Exclusivity Losses: The lifecycle of innovative medicines typically provides about 10 years of market exclusivity before competition from generic manufacturers results in large declines in sales of the original product across the developed markets. In the past 5 years, originator companies saw about $107 billion of sales lost as their products were displaced by generics, and more lately, biosimilars. Over the next five years, that amount is estimated to total $139 billion, and provides companies with a significant revenue gap to fill through expanded use of existing brands or the launch of new drugs.

Collectively, these changes contribute to a constrained level of sales growth for typical life sciences companies (see Exhibit 2).

EXHIBIT 2: COMMERCIALIZATION ENVIRONMENT FACTORS

Operating margin outlook for life science companies

The combination of the rising investment in research and development with a more constrained environment for commercialization returns provides significant pressure on life sciences companies as they seek to maintain or increase their operating margins.

For the 15 largest life sciences companies, based on their corporate entities, operating margins averaged 25.7% in 2019, up about 1.0% over the prior five years. Over the next five years, if these companies are to maintain that level of operating margin, they will need to reduce Selling, General and Administrative (SG&A) operating costs by about $23 billion in order to maintain their current level of Research and Development activity. This is based on modeling the level of future growth from new and existing products, price changes and losses of exclusivity. Cost of goods sold are assumed to remain at current levels of 28.1% of sales. R&D activity — related to drug discovery, clinical development and registration — is assumed to incur 5% higher costs each year, reflecting increased specialization and complexity of efforts. With a $23 billion reduction in operating costs — about 15% of total SG&A in 2019 — these companies would, in aggregate, be able to deliver a 25.7% level of operating profit in 2024 (see Exhibit 3).

EXHIBIT 3: LARGE PHARMA OPERATING MARGIN DYNAMICS 2019–2024

¹IQVIA Institute for Human Data Science. The changing landscape of research and development: innovation, drivers of change, and evolution of clinical trial productivity. Apr 2019
²IQVIA Institute for Human Data Science. Global medicine spending and usage trends: outlook to 2024. Mar 2020.