Pharmaceutical business model

In the past decades, pharmaceutical business model depends on identifying profit-potential medicines, promoting them with heavy sales and marketing and turning them into blockbusters. GSK’s business model is no exception. Its sales revenue is also driven by blockbusters. For example, in 2002, 8 blockbusters of GSK contributed to $14.240 million sales revenue, taking up 53% of its total ethical sales (Reuters Business Insight 2003a cited in Froud et al 2006). However, this business model will not suffice in the next few years, since the whole pharmaceutical industry will face challenges such as expiring patents of a large number of products and demand for new and better medicines.

The aim of this article is to analyze GSK’s new strategy under this circumstance. First, the relationship between GSK’s new strategy and the problems of the pharmaceutical business model will be discussed. Second, whether the new strategy will succeed or not will be evaluated. Finally, a conclusion will be drawn.

In July 2008 Andrew Witty, CEO GlaxoSmithKline, set out three new strategic priorities: “Grow a diversified global business, Deliver more products of value, Simplify the operating model” (GSK 2009). The new strategy is a response to the problems of GSK’s business model.

Firstly, GSK’s strategy to diversify its business reveals that it can not rely on its old blockbusters anymore and it tries to lower the risk of losing patent protection in the future, which is related to the problems of high dependence on blockbusters and patent protection in its business model.

Although GSK’s ethical drugs, especially blockbusters, contributed a lot to the sales revenue, this can not last longer. A large number of GSK’s ethical drugs are facing the fact that they are losing patent protection, which leads to more competition from other drug producers who launch generic version of these drugs. For instance, the patent of GSK’s blockbuster Valtrex expired in 2009, following which Ranbaxy, India’s largest pharmaceutical company, launched the generic version of Valtrex in the United States (Mathew 2009). What’s worse, in the USA, 12 of GSK’s 40 pharmaceutical products have expired and the patents of its bestselling medicines, Advair and Avandia, will expire in 2010 and 2012 respectively (GSK Annual Report 2008: 20f).

Moreover, there is high possibility that even GSK’s old blockbusters are losing its ability to gain huge profits. Their sales may decrease in the fierce competition. For example, in 2007 sales of Advandia dropped 22% globally due to generic competition, especially in USA (GSK Annual Report 2007: 5). On the other hand, it shows the importance of patent protection in pharmaceutical industry which guarantees a huge profit in ethical medicines and protects these medicines from fierce competition. When these medicines’ patents expire in the future, their sales will decrease dramatically. Like the sales of Zantac, the best selling drug in history, also went down 44.9% in 1998 after its patent expire in 1997 (Glaxo Annual Reports and Accounts, various years cited in Froud et al 2006).

Comparing to these old blockbusters, vaccine and consumer healthcare have more potential to drive further growth of GSK’s sales revenue. In 2007, the vaccine business generated strong sales growth by 20% to ¿¡2 billion and consumer healthcare business grew up 14% to nearly ¿¡3.5 billion (GSK Annual Report 2007: 5). In 2008, the sales of vaccine continued to grow to ¿¡2.47 billion and the sales of consumer healthcare increased to almost ¿¡4 billion (GSK Annual Report 2008: 5).

Furthermore, there are other opportunities to drive growth such as emerging markets, for example, China, India, Russia and Latin America where growth in both population and wealth makes high demand for medicine and ability to offer expensive medicine possible. Sales in emerging markets increased by 12% to ¿¡2.3 billion in 2008 (GSK Annual Report 2008: 5). In contrary, in GSK’s main market USA, sales declined by 11% in 2008 (GSK Annual Report 2008: 38). Therefore, it is wise for GSK to expand business in emerging markets.

GSK’s strategy of diversification is to capture these opportunities and maintain growth, since the business model which depends on a small number of blockbusters is too risky and difficult to maintain growth as mentioned above. Diversification is able to reduce high dependence on blockbusters and patent protection through allocating risk in different segments and markets, especially profit-potential ones such as vaccine, consumer healthcare and emerging markets.

Secondly, GSK’s recent active acquisitions and its collaboration with external partners imply that GSK needs external resources to achieve strategy of diversification due to lack of strong R&D productivity which has existed in GSK’s business model for a long time. A strong R&D productivity is not equivalent to a pipeline which contains a large number of drugs or many new medicines. Instead, it should help the company to create more drugs that have significant influence on sales revenue and be strong enough to support company’s strategy.

Although GSK has had more approvals than its competitors under the circumstances that gain more Image Drug approvals from regulators have slowed over recent years (Boyes 2008), the fact can not be ignore: GSK’s R&D productivity is declining. It reflects in its sales revenue in Exhibit 1. In 2006, GSK earned less than 5% of its revenue from major products that are less than three years old. It means that most of GSK’s sales revenue is created by its old major products or blockbusters that are more than 5 years old. Especially compared with other companies such as LLY and SGP, GSK depends heavily on its old major products. With more and more products whose patents are going to expire, if GSK is not able to create more drugs have strong and positive influence on sales, it will be very difficult for GSK to maintain growth.

Exhibit 1: In 2006, GSK earned less than 5% of its revenue from major products that are less than three years old.

Source: IMS Health and PricewaterhouseCoopers analysis

In addition, if GSK wants to diversify its business, especially to capture the opportunities in emerging markets and profit-potential segments, it needs acquisition and external collaboration with other companies as what GSK is doing because GSK’s R&D productivity itself is not strong enough to support this ambitious strategy. Through acquisition GSK can access to more new products which enrich its relatively weak pipeline and accelerate process to diversification. For example, in 2009 it acquired specialist dermatology company Stiefel to diversify its business (Gow 2009). Another example is the acquisition of Domantis to expand GSK’s biopharmaceutical pipeline which only makes up 6% of the total pipeline (GSK Annual Report 2008: 10).

Furthermore, collaboration with external partners enables GSK access to more innovation which further strengths its pipeline and meet patients’ demand for new and better medicines. For instance, in April 2009, GSK and Pfizer announced that they intent to create a new company dedicated to HIV medicine (Clarke 2009). It is a wise way to combine resources and intelligence to enhance productivity in GSK’s HIV business which has more and more demand in developing countries.

As mentioned above, it is apparent that one of the problems in GSK’s business model is the lack of strong R&D productivity. On one hand, GSK needs to diversify its business to reduce risk. On the other hand, its R&D productivity is not strong enough to support this strategy. Therefore, its acquisition and external collaboration in the second strategic priorities tend to improve its R&D productivity in order to meet the requirements of new strategy and other challenges such as the demand of patients for new and better medicines.

In all, the whole pharmaceutical industry is facing big challenges such as lose of patent protection and demand for better medicines. Under this circumstance, problems of the pharmaceutical business model which still could be ignored in the past urge pharmaceutical companies to change now. GSK’s new strategic priorities are a response to its business model problems: high dependence on blockbusters and patent protection and lack of strong R&D productivity. GSK mainly focuses on the first two and the most urgent problems as mentioned above with a diversification strategy and use the other two strategic priorities to support it, although there are still other problems of the business model haven’t been solved by GSK. For example, these years still saw a high expenditure on sales and marketing which is calculated in the cost of SG&A. It is increasing year by year. In 2006 advertising, promotion and selling grew 3% and in 2007 advertising and promotion increased by 2% (GSK Annual Report 2007: 42 and 59). But for GSK, its strategy is targeting higher risk and lower growth. The new strategy meets its urgent needs.

In the following years, whether GSK’s new strategy will succeed or not should follow three criteria. First, it improves GSK’s financial performance constantly. The second criterion is more confidence in the stock market. Third, the strategy should not only fully capture the opportunities but also help GSK to face the future uncertainties.

Based on these three criteria, GSK’s new strategy will work. Especially in 2009 GSK shows an improving financial performance compared with 2008 as Exhibit 2 indicates, although net income may not be satisfactory due to possible reasons, for example, acquisition activities. It seems that GSK’s new strategy does help. Diversification is able to balance loss and profit in different segments and thus creates a stable balance sheet. Take quarter 3 as example, sales in US continued to decrease by 12%, but sales in emerging markets, Japan and consumer health offset the loss, since they increased by 25%, 19% and 8% respectively (GSK Q3 2009 results announcement: 4).

Exhibit 2: Quarterly Review

Source: SEC and Worldscope-Millions GBP

Secondly, not only the sales revenue and gross profit but also the increasing EPS as Exhibit 2 shows enable investors gain more confident for the future of GSK. It also reflects in GSK’s share price. After reaching the lowest point in 2008, this year the share price is increasing. Although the share price hasn’t reached the highest point in the recent five years as in 2006, it depicts an improving reaction from the investors and the stock market.

Exhibit 3: GSK’s share price from 2005-2009

Source: GSK

Moreover, GSK has successfully captured opportunities such as growth in emerging markets and profit-potential segments. Especially in 2009, GSK’s vaccine business plays an important role. Globally severe H1N1 flu condition offers a good opportunity for GSK. Sales of GSK’s Relenza treatment are expected to top £600 million this year and GSK had received 195 million orders for its new vaccine. Analysts predict sales revenue of the vaccine business of GSK could reach ¿¡1.3 in 2010 (Wighton 2009).

However, it is highly likely that GSK’s new strategy will just work in a short time and can not follow the three criteria from a long term prospect.

Firstly, GSK’s strategy hasn’t totally changed its business model. The way pharmaceutical companies make tremendous profits hasn’t changed. The traditional pharmaceutical business model which depends on blockbusters and marketing of drugs still has deep roots in pharmaceutical companies. GSK admits that “…remaining competitive is dependent upon the discovery and development of new products, together with effective marketing of existing products” (Annual report 2008: 19). On the other hand, this also means that problems of GSK’s business model which haven’t been solved will continue to exert adverse impact on GSK since its strategy just solves the problems in a short term. For instance, if benefits from potential blockbusters such as vaccine run out, when their patents expire and GSK can not come out with more blockbusters, GSK will face the same problem again, which forms a vicious circle.

Secondly, GSK’s strategy hasn’t made itself a difference from other big pharmaceutical companies which is highly likely that the strategy will bring more competition, thus it will further have negative impact on GSK’s long term financial performance. Other pharmaceutical companies also have realized the challenges of the whole pharmaceutical industry and made the similar strategy. For example, not only GSK but also Pfizer, Novartis and Sanofi-Aventis support diversified business (McConaghie 2009). They expand more business in generic products through acquisition which will lead to more competition in generics. For instance, recently, Novartis enriched its generic business with the $1.2 billion acquisition of EBEWE Pharma which specializes in generic injectables (McConaghie 2009).

Thirdly, there are many challenges in emerging markets which may also affect GSK’s financial performance, but GSK’s strategy hasn’t targeted these challenges. For example, pharmaceutical companies have been forced to lower prices in developing countries due to their healthcare systems. And GSK is to reduce prices of its products in emerging markets significantly, below two thirds of western prices (Andrew 2009). Another example is the regulatory pressures in emerging markets. In Brazil, the rule to regular medicine prices is changed to impose more price control and the Mexican government may impose a value added tax to medicines in the future (Ernst & Young Global Pharmaceutical Center, 2009).

In all, in the following years GSK’s financial performance is expected to improve due to the effect of its new strategy. But its strategy may not work in a long term, since the problems of the traditional business model and more competition which may be brought about by its new strategy will affect its long term financial performance. In addition, its strategy just captures potential opportunities but doesn’t prevent GSK from future risks such as the challenges in emerging markets.

In conclusion, this paper has analyzed GSK’s new strategy related to its business model and evaluated its success. The findings show that GSK’s new strategy is a response to three problems of the pharmaceutical business model, including high dependence on blockbusters and patent protection and weak R&D productivity, but it doesn’t cover other problems in its business model such as high expenditure on sales and marketing. It probably will work in just a short term with many uncertainties in the future.

It seems that until now GSK still can maintain a stable balance sheet with strategies accommodating to the changeable environment such as the need to change the pharmaceutical business model. The new strategy is a good example targeting the problems in its business model and enables GSK has a relatively better financial performance this year. Therefore, it would be interesting to expect its future strategies and financial performance.