The pharmaceutical (pharma) sector is a major focus for investors, not just from a financial viewpoint, given its weight in equity indices, but also in the context of public health – the essential societal role of taking fundamental research, materialising it into drugs, and making those drugs available.
Pharma’s business model is unlike that of any other sector and is subject to intrinsic pressures. On the one hand, it must maximise its profits; on the other, it must meet public healthcare imperatives. These two forces are not always compatible.
This tension – between meeting public health needs and generating sufficient profits to be able to continue to invest in new medicines as well as fulfil shareholder expectations – was the central theme of a recent discussion attended by investment professionals and hosted by BNP Paribas Asset Management’ Sustainable Development Circle at the Pasteur Institute in Paris.
Leading the discussion were Jean-François Chambon, physician, clinician and specialist in HIV/AIDS infections at the Pasteur Institute; Erik Orsenna, author and Member of the French Academy; and Helena Viñes Fiestas, Head of Environmental, Social and Governance (ESG) research at BNP Paribas Asset Management.
The tensions pharma faces
Experience has shown that it is in the pharma industry’s own interest to take a longer-term approach aimed at aligning financial interests with public sector interests. Tensions have been rife within the industry, in various guises.
First, within research and development. The head of a large pharma group will invest in those diseases with the greatest likelihood of being “profitable”, i.e. those affecting the largest number of people able to reimburse healthcare costs either through public or private healthcare systems. This paradigm has traditionally explained both the “neglected” diseases affecting people living in poverty and “orphan” (rare) diseases, as well as certain types of drugs such as vaccines and antibiotics.
Another issue is how to make drugs more widely available. There is an implicit contract whereby society gives industry the responsibility for developing drugs in exchange for which the industry is granted patents and exclusive markets. These give pharma some clout in negotiating prices with governments, but not just that. In many countries, medicines are not covered by any public healthcare safety net; people have to pay for them out of their own pocket, even though prices, especially for drugs for chronic illnesses, are high, whereas more than three billion people live on less than USD 2.5 a day.
First steps to rectify market failure
Although governments hold the primary responsibility, the pharma industry has learned that it also has to find solutions. The first options were welcome but not enough, consisting of drug donations, some R&D in HIV/AIDS, tuberculosis and malaria and some price cuts for a handful of drugs.
How can common ground be found between fields where there exists a true market and others where there is none but where healthcare needs do exist?
This is a complicated matter. Purely private funding of applied research is viable only if the markets exist. Where they don’t, public funding beyond fundamental research is essential. Likewise there is a bulk of the world’s population that can hardly afford the cheapest generics. Companies cannot simply give away their medicines for free.
But the industry has learned a lot. And the global market has also changed.
Adjusting the business model
In 2007-2008, a source of tension emerged within the industry, patents began to expire with few innovations in sight. The industry’s until-then successful “blockbuster model”, which focused on a handful of hugely successful drugs, came to an end. The industry diverted its attention from breakthrough innovative drugs to prolonging the patent-life or providing minor innovations to its existing blockbuster medicines. Dynamic biotech companies have meanwhile won the innovation race.
Moreover, the emerging economies began to generate most of the growth in the industry, by 2013 accounting for 70% of it.
Investors concerned about diminishing growth returns asked the industry to adjust its business model to the new market realities. First, to reform R&D in line with new science, to diversify their portfolios and to dedicate more resources to respond to developing countries’ disease profiles.
A pharma group that wishes to make profits in emerging economies must address those countries’ specific needs. With little or no subsidised healthcare in these countries, companies need to adjust their pricing to the purchasing power of each country and its government.
The industry reacted. First it restructured its R&D units, widened its disease portfolios and acquired biotech frontrunners. Secondly it started to implement a more sophisticated approach to emerging markets. Some would issue voluntary licences to generic players within those countries to expand access; others would establish tiered-pricing policies.
Yet this has still not solved access for those diseases or parts of the population that remain unprofitable, even though companies are adjusting their approach to those markets.
Current developments in this area are also more compelling. Where the market is non-existent, collective multi-stakeholder action is the way forward. Many mechanisms have been created over recent years, for example in vaccines. Broad multi-partner consortiums such as the Global Alliance for Vaccines and Immunization (GAVI) help make the market more solvent.
Developments over the past half-century have been considerable. The World Health Organisation (WHO) and UNICEF launched broader vaccination programmes in 1974 and 1975, with universal vaccination targeted for the year 2000. This was not achieved, but vaccination is making progress, and that is where innovative financing and fund-raising mechanisms work best.
How should investors assess companies’ efforts in meeting societal expectations?
Sustainable investment aims to determine where the best use can be made of funding, combining cost-effectiveness with a long-term vision. BNP Paribas Asset Management’ ESG analysis of the industry reveals that the pharmaceutical industry rests on three main pillars: R&D or availability, accessibility and governance.
The R&D pillar involves the percentage of profits reinvested in R&D, how much human capital is dedicated to it, how R&D is conducted, the criteria for determining in which diseases pharma groups invest, companies’ portfolios, the productivity of their research and the type of partnerships they develop with other institutions to help meet public health needs. The transparency of clinical trials is also analysed in detail. Phase III in drug development determines how safe and effective a drug is and future markets for it; it constitutes 30% of the overall evaluation.
The second pillar is accessibility and includes pricing schemes, distribution, registration and marketing. Registration is necessary for selling drugs in each country, so it is a critical first step to ensuring access to any medicine. The pharma industry’s marketing practices have been seriously scrutinised and, despite genuine improvements, they continue to be in the spotlight.
The third pillar is governance and offers an avenue for analysing potential sources of corruption and illicit business practices. The pharma industry has been rocked by scandals. A critical component of governance is the relationship with public authorities, so investors should take an interest in drug companies’ relations with governments, particularly the consistency of their public statements, patent enforcement and pricing mechanisms, as well as their relationships with public institutions.
Today we can confirm that the top 10-ranked pharmaceutical companies for improving access to medicines in developing countries have outperformed their peers by 20 percentage points of stock price growth each year. We are unable to confirm whether the best managed companies also deal better with their responsibilities to expand access to medicines; or if a broader, more inclusive strategy in both R&D and pricing delivers better returns while improving access to medicines. There are advocates for both, but the reality is that in the long term, public health and financial interests or goals converge. And this is the main reason why long-term investors like BNP Paribas Asset Management are interested in how companies respond to their responsibilities regarding access to medicines. Yes because their behaviour can potentially damage their reputation, but primarily because it affects their long-term performance.
For a full transcript of the discussion at this meeting of the Sustainable Development Circle, please contact the Publication Centre: email@example.com