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Pharma: The Machine for Creating Value Is Jammed

C. Schoch & Sylvie Ouziel, Consulting Executive Accenture France Benelux

According to Sylvie Ouziel from the Accenture consulting group, the stock market has punished the low yield of R&D expenses in pharmaceutical companies.

Pharmaceutical companies today are faced with a historic challenge that questions the very foundation of their economic model. The rising costs of new product development combined with a decline in their launch value has led the return on investment of a new product to descend below 1, reaching a value of 0.8 in recent years.(1) This phenomenon has been observed particularly for products launched between 1995 and 2005, period during which development costs were multiplied by 3.2. Two reasons explain this phenomenon. First of all, for each product launched, the number of clinical trials to conduct is constantly on the rise, in keeping with a rationale of greater precaution. Secondly, the proportion of research that produces effective molecules has dropped: given the number of therapeutic fields that are already covered by existing medications, it is more and more difficult to innovate.

During the same period, the launch value of a product decreased by 38.5%. The pressure to lower prices, restricted product indications (some medicines are no longer reimbursed except in very limited and confined therapeutic case), the rise in generics developed before patents expire and the implementation of substitution incentives have led to a decline in the income generated by these two products.

How have the pharmaceutical "majors" coped? Between 1995 and 2005, they multiplied their R&D expenditures by 3.4, fueling "the machine for destroying value." Consequently, the stock market began to balk: between 2000 and 2005, 500 billion euros of stock market capitalization vanished at a time when the operational performance of laboratories was still excellent with net earnings before taxes, depreciation and amortization of 28% on average in 2005 for the 14 largest actors in the sector.

Moreover, if the stock market price of the 14 largest pharmaceutical companies is broken down into present value (in other words the value obtained mathematically by projecting current cash flows onto the years to come) and growth promise value (in other words by anticipation, already reflected in the stock market price, of larger cash flows in the future), we note that the "promise" value has gone from 69% of the total valuation in 2000 to 29% in 2005. Stock market prices thus reflect lower growth expectations. It is indeed the uncertainties as to future growth, in particular the return on investment in research, that the stock market has punished and not current operational performance.

(1) Findings of an Accenture study conducted in 2007 on the return on investment in the pharmaceutical sector.