Big Pharma gets a driving lesson from carmakers

LONDON Wed Dec 14, 2011 5:00pm IST

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LONDON (Reuters) - Big drugmakers, under pressure to streamline operations in the face of rising costs and slowing sales, are looking to the automotive industry for tips on tuning up their profit engines.

Cars and medicines may seem to have little in common but executives are starting to join the dots between the sectors, applying the lessons of "lean" car production systems and fragmented value chains to the world of pharmaceuticals.

It shows a new openness to outside ideas by Big Pharma.

GlaxoSmithKline (GSK.L), for example, teamed with McLaren in September to get innovation and process know-how from its Formula One engineers, mirroring a 2009 move by AstraZeneca (AZN.L) to tap manufacturing expertise from Jaguar Land Rover, part of India's Tata Motors (TAMO.NS).

The 250-strong consulting arm of German sports carmaker Porsche (VOWG_p.DE) (PSHG_p.DE), for its part, has targeted pharmaceuticals as a sector ripe for advice.

That may raise eyebrows because profitability in the drugs industry, with a 10 percent pretax return on invested assets, is roughly double that in the global auto sector.

But as drugmakers face healthcare cuts, a record wave of patent expiries and increased regulatory hurdles for new drugs, they may need to take a page from carmakers' playbook when it comes to ruthless streamlining and cost cutting.

Vivian Hunt, European pharma head at consultancy McKinsey, sees clear parallels between the way autos have "disaggregated" and what is starting to happen in pharmaceuticals.

"The auto industry has been through a huge number of structural changes yet is still a hugely innovative sector, and is a growth industry in many countries and for many players," Hunt said, adding that this offered lessons to others.

RETREATING TO THE CORE

Once upon a time, the auto sector was vertically integrated and dominated by large, mainly Western companies. Today, some 70 percent of a car's value is attributable to suppliers, according to market researcher SupplierBusiness.

Major carmakers have retreated to a few core operations such as brand marketing, design, and final assembly of key modules such as engines and chassis.

They now orchestrate an army of contractors who supply brakes, transmissions and sometimes even bodywork, along with thousands of other parts needed to build a car.

A similar trend may be emerging in pharmaceuticals as research budgets are cut, more drugs are licensed in from biotech companies and certain operations, including parts of the clinical trials process, are farmed out.

As of now, drug firms still rely heavily on creating value in-house, suggesting there is a way to go yet and moving down a similar track could potentially yield big rewards.

According to Porsche, the average product development time in the auto industry has fallen by 28 percent in recent years, while in pharmaceuticals it has risen by 31 percent.

In a report last week, McKinsey warned that drug majors need to change their ways since "the good old days of the pharmaceutical industry are gone forever" as profit margins head substantially lower.

In addition to pressures from medical insurers and regulators, large drug companies are also finding more upstart competitors moving in on their patch. The world's top 10 firms may still control nearly half the market but Big Pharma has a growing bunch of more focused rivals, from biotech to generics.

PERFECT STORM

"We are in a perfect storm," the head of Swiss cancer drug maker Roche (ROG.VX), Severin Schwan, told an industry conference last week.

He sees the drugs industry becoming polarised, with only companies that are truly innovative or extremely efficient makers of generic medicines being able to survive.

As times get tougher, returns on pharma research have fallen nearly 30 percent in the past year, according to a recent study by Deloitte and Thomson Reuters. That has pushed the sector into territory familiar to carmakers.

"The auto industry in Europe has not always been able to recoup the costs of capital, to put it mildly," said Reto Hess, who coordinates analysis of global car makers at Credit Suisse Private Banking.

"But in terms of production costs, the auto industry may be a model for other industries. The amount of high tech that is offered at affordable prices in today's cars is remarkable."

Simon Hammett, Deloitte's head of European pharma, sees some parallels with autos but is wary of pushing the analogy too far, given the unusual and serendipitous nature of drug discovery.

"Different parts of the pharma value chain have different analogies. There are some lessons from the automotive industry but there are also some really interesting analogues in the creation of productive talent in the media industry," he said.

Drug companies, while keen to reduce inventories, also need to be careful before embracing the auto industry's "just-in-time" supply lines, given the imperative to avoid supply disruptions in life-saving medicines.

The case of Boeing's (BA.N) 787 Dreamliner shows how emulating carmakers' radical approach to outsourcing can go wrong. The U.S. plane maker's decision to rely on a complex supply chain of about 50 partners put the project nearly three years behind schedule.

(Editing by Jane Merriman)

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