Operating margins are under pressure, and the growth promised from biopharma innovation is entering an increasingly tough payer reimbursement climate.
As the big pharma peer group revenue growth slowed in the late 2000s, companies were able to manufacture earnings growth through margin improvement. A key capability of high performers (rewarded by investors) at that time, was their effectiveness in driving operational efficiency. However, the last four years (2011-14) saw this trend reverse, with margins deteriorating against falling revenue post the patent cliff. The effect of this has been operating margins (Core EBITDA/Revenue) falling by three percentage points to 32% between year-end 2012 and trailing 12 months to third quarter of 2014.
Looking across our peer group, we see a wide range of core operating margins by company, and although High Performers are on an average higher margin, in reality they split into those at peer average and those out performing. Though, looking at the change in margin over the last two years we see that almost all (12 of 16) of the companies studied saw margins deteriorate. Furthermore, of the four companies that improved their margin, all were still average or below average. Underlying this deteriorating operating margin picture are companies consciously stepping up their investment in late-stage development, preparing for new launches and investing in transforming their strategy and operations in the face of falling growth. Investor’s eyes are likely to increasingly turn back to margins in the near future, as they look for new science delivering profitable growth.In addition to slipping operating margins, there is also the question of affordability. Current forecasts predict developed markets spending an additional $125 billion on drugs from 2014-2019. This is 34 percent below the $190 billion growth forecast by analysts for recent and upcoming NME launches over the same period. With developed markets accounting for most of forecast NME launch spending, this gap is particularly wide when considering the significant economic and demographic pressures on health budgets. Naturally, there is uncertainty in these forecasts, but they nevertheless serve to highlight that payers will have to seek greater savings from generics, since their drug spending as a proportion of total health spending is already creeping up. Additionally, payers are likely to continue shifting reimbursement to favor those new products that clearly differentiate on patient health and economic outcomes.
There will be new launch winners and losers in the battle to command a share of fixed healthcare funding growth in the increasingly crowded and price-competitive therapeutic categories. In this climate, successfully bringing new products to market will require pharmaceutical companies to develop new operating models that can rapidly turn new science into realized value and sustainable profitable growth.
For more information on these findings, please read our latest High Performance Business Research: Turning science into value: Biopharma high performance business research.