As the pharmaceutical industry grapples with the double whammy of patent and pipeline challenges, the key question being asked is how do drugmakers adapt? Neil MacAllister, who heads the AVOS Life Sciences consulting firm, tells us the undertaking will not be easy, because he says pharma has less experience than other industries in managing such structural changes. Here is an excerpt of our conversation…

Pharmalot: We know the outlook doesn’t look good. What’s the secret to survival?
MacAllister: In many ways, the drug industry has to manage itself financially and operationally for the first time. If you look at it from the point of view of the environment in which it has existed historically, illness doesn’t go away, there are more older people, more disease – up to recently, the volume of what they could sell was a big positiive. The targets looking at from disease point of view were relatively straightforward, the etiology was basically understood. And if they didn’t meet the numbers, they could raise the price. Now, the payers won’t pay for me-toos. The aility to drive price is diminishing. The easy targets aren’t there. And more illnesses can be treated satisfactorily by generics.

Pharmalot: What do you mean by manage ‘financially and operationally,’ though?
MacAllister: The problem is that the industry is unsophisticated relative to other industries in terms of management utilization, portfolio prioritization, capital management. We looked at other industries that had gone through a hiatus and the responses from the companies that eventually prospered were very similar to one another and the companies that were unsuccessful were also similar in the mistakes they made… The answer is to reduce costs, emphasize where you’re going to win and don’t try to do everything yourself.

Pharmalot: That process is already under way, yes?
MacAllister: Yes, but they need a dramatic rethink of the fully integrated pharma company. Furthest along is Lilly, which has the concept of a fully integrated pharmaceutical network. They’re looking at things that are non-core. They’ve virtually outsourced almost everything that could be perceived as a generic task. Remember this is dependence on two variables – new drugs in and patent expiries out. It’s the innovation ratio between drugs you develop and those you lose. One way to manage that is move to a smaller and flexible cost base.

Pharmalot: Yes, well, Lilly recently announced such a deal with Covance.
MacAllister: Right. That lab, so to speak, gets transferred to Covance books from Lilly books. Half of the Lilly force is outsourced through Quintiles involvement…Computer modeling is getting outsourced because drug companies no longer want to invest in every techology under the sun. The basic premise here is the industry needs to do what it has not done, historically. It’s like moving from GM, which does most everything, to doing the process of intellectual property and the funding of developing that property, rather than doing everything.

It does present a management challenge and it presents a significant one for the drug industry which, historically, hasn’t done these things. And one still needs a manager who can manage outsourcing to meet quality and technical problems. This becomes more like a Wal-Mart than anything the industry has done before.

Pharmalot: Sounds like you’re saying pharma doesn’t have the ability to put this in place.
MacAllister: Some drug companies that are more economically driven have jumped on the outsourcing bandwagon aggressively, but don’t have the ability to manage it. The skill set doesn’t historically exist within the drug company – the general manager who’s used to dealing with multiple suppliers, the legal components and ability to deal with internal demands. If you think about it, pharma managers have functional people – a sales manager, a marketing manager. Not like a GE, where someone is accustomed to pulling all the strings to get things done.

The telecom and computer industries are good examples where they manage the intellectual property. Apple doesn’t manufacture the iPod. They assemble it elsewhere. They understand client needs and consumer needs and package it attractively in a way that can support them. Wal-Mart and Kroger’s both manage their suppliers really tightly and have a partnership with them. The Mercedes environment where they don’t develop headlights but develop a partnership with whomever to get the best headlight. That’s what we’re talking about.

Pharmalot: No surprise then that more outsourcing means more downsizing then, right?
MacAllister: As employers, the drug companies will reduce significantly in size. There’s still a lot of fat in the major companies that needs to be taken out. And the need to downsize is compounded by the patent cliff in 2011 and on. To maintain margins, they have to cut aggressively – GSK, Pfizer. There’s a marked distinction between haves and have-nots.

Depending on the proximity to the decision maker, the jobs go further and further afield. If you take data management, the basic work becomes a commodity and goes overseas. At the moment, its India. Medicinal chemistry is seen as a commodity and goes to China. …You can retain a core number of decisionmakers, though.

Pharmalot: Do you see anything mitigating this trend?
MacAllister: I think it depends on what happens with the concept of personalized medicine and genomics. If they create products with value, the industry will be stronger. The value of the innovation would go up, but that’s not certain. What’s particularly uncertain is the timeframe in which that happens.

The pure innovation and insights won’t come from the drug company, though. The drug company has the process that can take the IP to becoming product. They won’t own the assets that do that. They’ll own the program management – expertise in clinical trial design and outsourcing of trials that bring products to market. Overall, the concept is they become more like the car company and manage the processing of the innovation professionally. They’ll do the funding and commercialization.

Meanwhile, they must use an aggressive defense in the short term – cut costs and try to ride through 2011 to 2014 timeframe for patent expiries until innovation comes back… This means changing from a shots-on-goal emphasis to emphasizing more quality than quantity and making decisions faster…And there has to be more risk sharing between drug companies so they get a share of something rather than 100 percent of nothing.