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SDA BOCCONI SCHOOL OF MANAGEMENT Introductory Term, Managerial Economics Professor: Marco Ottaviani Group Assignment Market Analysis Report: The Pharmaceutical Industry

MBA 40: Blue Class, Group 6 Berti Giovanni Conzatti Narmina Karthik Arun Vartsou Marina Yang Shanshan

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Market Definition

The present analysis focuses on the market for insulin-based prescription drugs for diabetes, which represent one of the most rapidly evolving and profitable segments in the pharmaceutical industry. This market is identifiable in terms of its key product characteristics and geographical boundaries:

Products:

! Insulin injectibles & analogues ! Oral anti-diabetes drugs (OADs)

These products are essential for type I and type II diabetics. Further to this classification, the two most-widely used types of insulin are: human and modern. This study will focus on the insulin injectibles market, as it captures the biggest share (85%) in the diabetic sales portfolio of the industry.

Geographical boundaries

The focus of this analysis will be the US market; the world’s largest pharmaceutical market. The rationale supporting this choice is that the market for insulin-based prescription drugs for diabetes is highly concentrated in the US, the pricing architecture and regulatory framework under which it operates is uniform among all states and is very distinct from other countries.

The three dominant players of the US insulin market, but global dominators as well, are the following:

! Sanofi ! Novo Nordisk ! Eli Lilly

In 2013 the global insulin market size reached $20.8 billion and the three aforementioned companies accounted for 88.7% of market share. The US market totaled for over a third of the insulin sales globally that year ($8.3 billion)[1].

The buyers in this market are identifiable in pharmacies and hospitals and purchase the drugs by the manufacturing companies directly or through wholesalers.

Player Market Share by Volume

Market Share by Value Rank

NovoNordisk 37% 33% 1

Sanofi – Aventis 28% 33% 2

Eli Lilly 23% 26% 3

Other 12% 11% 4

[2]

 

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[3]

[2]

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Cost Structure

Figure 1 illustrates the typical cost structure of the pharmaceutical industry. This cost structure is calculated based on the 2013 income statements of the U.S. market leaders in production and sales of diabetic drugs, in order to accurately represent this industry’s segment [2,4,5]. The classification of costs (fixed/variable) is based on a short- term analysis (6 months).

 

Figure  1  

 

As one can see from Figure 1, over 40% of the cost structure in the pharmaceutical industry is related to the

manufacturing costs, precisely all the costs corresponding to the activities of planning and sourcing

(variables), producing (fixed), assuring and delivering products to patients (variables). The manufacture of

insulin is highly complex, it differs from other pharmaceuticals because it not based on small molecules but

on living cells. It requires a large amount of expenses and investments in biotechnology and sterile

production. Moreover, manufacturing processes are heavily regulated by governmental health authorities

with stringent requirements that significantly drive up the costs.

Marketing and sales represent 30% of the cost structure. Such a high cost reflects the characteristics of the

sales channel, which is very specialized and needs a highly educated and trained sales force, expensive to

develop and to support compared to other industries (variable) [1]. Furthermore, the marketing campaigns

(variable) have a very important impact on the cost structure, especially for the drugs, which are no longer

covered by patents [4].

Research and Development (variable/fixed) accounts for over 20% of the cost structure. This activity is

predictably crucial for the industry and is aimed at identifying both successfully and cost-effectively the

development of new products that address unmet needs[5]. R&D is the main driver of business growth and

of replacement of sales loss due to competition and expiration of existing patents. The impact of the

expiration of a patent is very important in the industry, as illustrated in figure 2 [6]. This industry is

experiencing a low productivity in R&D and as a result there is a tendency to reduce the R&D budget and to

seek interesting opportunities on the market through partnership and M&A.

41%  

30%  

21%  

6%   2%  

COST  STRUCTURE  C.O.G.S.  

MARKETING  &  SALES  

R  &  D  

GENERAL  &  ADMINISTRATION  

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[6]  

Finally, General and Administration expenses (fixed) account for the 6% of the cost structure; these include

legal costs as well.

Economies of scale in the pharmaceutical industry are crucially important. Industry efforts to manage costs

within manufacturing and the supply chain have focused on merging to increase the scale of their operations.

This industry has been one of the most active in the M&A market in the last years [7]. Driving the M&A rush

is also the decline on research and development productivity and the desire by pharmaceutical companies to

reach economies of scale in this department and to buy products aligned with their strengths, selling noncore

businesses and replenishing their new drug pipelines.

Demand drivers

Given that insulin prescribed drugs are an essential necessity for the diabetics, the indisputable and evident

demand driver is the condition of diabetes per se. In fact, insulin is the only treatment for type I and later

stages of type II diabetes. The identifiable demand drivers of the insulin market are strongly correlated to the

diabetes and are the following [8,9].

! High prevalence of diabetes (8% of the population/ 27 million people)

! Spiraling aging population

! Increasing obesity

! Presence of high patient disposable incomes (51,796 million USD GDP per capita)

! Health conscious consumers

! Low rates of undiagnosed diabetes cases

! Sophisticated healthcare infrastructure

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The below serves as evidence strongly correlating to the above statement:

! There are no substitutes for insulin injectibles for Type I and later stages of Type II diabetic

patients. As diabetes is a non-stable condition, in the early stages of type II diabetes, some cases

can be treated with a combination of insulin and OAD; but this depends on specificities of individual

patients and it is not an optional choice.

! Medical foods, functional foods & drinks and nutritional supplements serve as complements. As

demand increases for insulin injectibles, the medical foods’ portofolio increases in a similar manner.

! Consumer preference as such does not exist, however within the market there has been a gradual

shift from human to modern insulin, as it is more convenient and safe because it is injected

through a pen. There is significant potential of market penetration in modern insulin [10].

! Diabetic Insulin is covered by insurance in the US. Only 15% of the American population is

uninsured and this figure is expected to drop significantly, as a result of the Affordable Care Act.

Insurance coverage extension to more patients is positively correlated to an increase in the

demand of insulin in the US.

Considering all the above and the fact that regardless of how much the price of insulin increases, people with

diabetes will still need it and will end up paying the price for it. The diagram below indicates a linear positive

relationship between the 3% increase in the diabetic population of the US and a corresponding 15-20%

increase in the price of insulin [11]. This is reflective of the inelastic demand of insulin in the US market.

[11]

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Competitive situation

HHI Index: 3,464 (≈35%)

The U.S market is highly concentrated and oligopolistic in nature. Dominated by the three market leaders: Sanofi-Aventis, NovoNordisk and Eli Lilly. We calculated an equivalent HHI Index, based on the market shares by both volume and value of these three companies.

Pricing Rivalry

Price levels in this market are highly correlated to patents. A representative example of this is the expiry of the patent in 2015 for Sanofi-Aventi’s best-seller product Lantus. Sanofi increased the price of its Lantus insulin twice in 2013, by 15% in total without incurring any sales drop[11], reflecting the power of pharmaceutical companies over price-setting. The result of a patent expiration is a significant and rapid reduction in sales for the insulin patented products, because generic manufacturers typically offer their unpatented versions at sharply lower prices.

U.S. manufactured insulin drugs are also protected from parallel imports, as FDA prohibited the importation from Canadian pharmacies, further consolidating the dominant players’ power and pricing strategy[12].

Threat of new entrants

There are high barriers to entry due mainly to:

! Magnitude of economies of scale: complexity and highly-regulated production. ! Strict regulatory policies and standards ! Lengthy approval procedures (FDA) ! Patent system ! High switching costs: sticky consumers (close to 95% of patients stay on their current therapy from

year to year) ! Risk-averse physicians

There is no guarantee that the investment by potential rivals associated with R&D to produce commercially viable new products will pay off and that is a risk which cannot be hedged by most of the potential aspiring entrants in this market.

Overall, there is a minimal likelihood of de novo entrants in this industry.

Conclusion

The U.S diabetic population is already large and is forcasted to grow by 4% year by year, thus there is significant potential for future increase in sales.

Pharmaceutical industry is seeking efficiency in production by enlarging its operations and efficacy in R&D through M&A. Moreover, the existing firms tend to horizontally integrate with related market segments, such as the manufacturing of insulin pens, pumps and blood glucose monitors in order to offer a a more all-inclusive diabetes portfolio and hence capitalize on their resources.

The nature of demand dictates that prices will be sustained at a highly profitable level and large investements in R&D and high barriers to entry consolidate the firms’ pricing and market position.

Thus, the insulin market segment will remain one of the most profitable within the industry and will offset the drop in profitability in other less inelastic segments.

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References

1. http://www.cnbc.com/id/102045945

2. http://www.novonordisk.com/investors/annual-report-2013/default.asp

3. http://www.statista.com/statistics/219612/leading-companies-operating-in-the-us-insulin-

market/

4. http://files.shareholder.com/downloads/LLY/3563217665x0x736237/30C56C84-78DA-

4D16-97F7-A51284E56A51/English.PDF

5. http://en.sanofi.com/investors/events/corporate/2014/2014-02-06_Results_2013.aspx

6. Statista – The StatisticsPortal

7. FT Journal

8. World Helath Organization

9. http://www.grandviewresearch.com/industry-analysis/insulin-market

10. http://www.medpagetoday.com/Endocrinology/Diabetes/47603

11. http://insulinnation.com/treatment2/medicine-drugs/understanding-insulin-sticker-shock/

12. http://www.rxrights.org/the-rising-price-of-insulin