By Roger van den Heuvel, Mary Rollman, and Jeff Stoll, KPMG
Generic drugs, which account for 90% of the prescriptions filled in the U.S., have been a constraint on pharmaceutical inflation for decades, with many payers touting their “drug trend” — a measure of spending growth of pharmaceutical drugs. Generic drug sales have grown 5.7% annually, from 2014 to 2019, and additional patent expirations could sustain 5.4% generic drug growth to $497 billion by 2025.
Amid this opportunity for generic drug makers to capitalize on patent expiration, they’re facing struggles around pricing power. COVID-19 also exposed the fragility of supply chains that were built with economic efficiency rather than resiliency in mind.
As generic drug making has been globalized with a wide range of manufacturers, the buyers in the United States are fairly consolidated, with wholesalers, pharmacy benefit managers, and group purchasing organizations asserting a great deal of market power. The three largest drug wholesalers represent 90% of all generic purchases by volume and pharmacy benefit managers have consolidated among health plans.
This has pressured generic drug maker margins in recent years, reducing them from 19.9% in 2016 to 12.8% in 2019. If a generic drug maker successfully challenges a brand company’s patent, that 180-day window of exclusivity for winning the challenge allows for some pricing power, where the generic is priced at 30 to 90% of the branded counterpart. As more competitors start making the drug, that falls to 20% or less.
This margin compression is coming as a multitude of blockbuster medications — those with $1 billion or more in annual sales — are facing patent expiration (see Table 1). Treatments for oncology, neurology, immunology, and systemic anti-infectives offer a great deal of potential opportunity for generic drug makers.
Table 1: Leading Medications Facing Patent Expirations, 2020-2026
To top off the declining margins, the supply chain for generic drugs has been disrupted, not only by COVID-19 but by product quality issues, with a significant amount of FDA enforcement actions being taken at facilities in China and India. Pricing pressures have led to discontinued production of certain products. In response, more than 1,200 hospitals teamed up two years ago to form Civica, a nonprofit organization that works to ensure supplies of necessary generic drugs through long-term contracts.
3 Strategies For Curbing The Downward Spiral
Without changes in the market for generics, profits will likely continue to erode in the sector as products become more commoditized. Generic drug makers do have some recourse to help improve margins. We’ve outlined three approaches that are not mutually exclusive for generic drug manufacturers’ future success. Each has its own set of investment requirements, risks, and growth potential.
1. Become bigger and better (high investment/ high risk/ high growth potential)
Consolidation among generic drug makers could strengthen the hand of manufacturers when they negotiate with wholesalers or pharmacy benefit managers. Consolidation could also address issues of oversupply in some products. Some larger drug makers have sold or attempted to divest some of their generic drug operations. For example, Pfizer merged its Upjohn division with Mylan, which will be called Viatris and will be the largest generics manufacturer in the world. Some of their product portfolios may need divestment to clear antitrust approvals, creating opportunities for some manufacturers to add scale.
2. Eliminate the middlemen (medium required investment/ low risk/ medium growth potential)
Generic drug makers can build profitability by moving into other segments of the value chain, such as investing more broadly in manufacturing or distribution. Generics manufacturers can capture some value from acquiring a distributor or building in-house distribution capabilities to sell directly to healthcare providers or retailers. A benefit from this can be to gain market intelligence that can shape portfolio decisions, create barriers to entry for competitors, and improve their bargaining position with existing distributors.
COVID-19 disruptions have illustrated vulnerabilities throughout the supply chain, especially for companies that depend upon overseas suppliers. India’s restrictions on the export of 26 APIs and finished pharmaceuticals led to the risk of significant shortages. Government incentives were recently expanded before and during COVID-19 to reduce dependence upon overseas API suppliers. For example, Phlow Corp. received a four-year $354 million contract in the United States in May to make APIs and generic drugs that could be in short supply due to COVID-19.
New manufacturing techniques also create opportunities for all varieties of drug makers, fundamentally altering the supply chain. Continuous manufacturing, mobile manufacturing models, and, eventually, 3D printing are shortening the value chain and enabling greater agility to meet patient needs closer to the point of care and respond to unforeseen market shocks. Also, these emerging technologies would likely fall in price as they mature.
3. Develop higher-value generics (high required investment/ high risk/ high growth potential)
The specialty generic drug segment is expected to grow 12.1% annually through 2024, generating $88.9 billion in sales, according to a 2019 study from ResearchandMarkets. Many of these specialty drugs target cancer, multiple sclerosis, HIV, and other complex medical conditions. These drugs have much more complicated manufacturing and handling requirements than those of small molecule compounds and present one of the fastest growing segments in healthcare spending.
The complexity of making and handling specialty drugs creates a significant barrier to entry in the business and can help generic drug makers differentiate their drug portfolios and improve profitability. Meanwhile, some opportunities may emerge for smaller biopharmaceutical companies, which have capabilities in developing complex molecules, to partner with larger generic drug makers to lower manufacturing costs by tapping into existing capacity, shorten time to market, and gain access to global distribution networks.
A relatively light R&D investment in an off-patent drug can open the door to modifying the strength, indication, or route of administration, giving manufacturers a shorter route to approval than specialty generics while opening the door to potentially higher profitability. Several nations have added incentives to increase the use of value-added generics through tax exemptions or, in the case of the United States, extended market exclusivity under certain conditions.
Biosimilars — A Challenging But Attractive Long-Term Strategy
Going beyond the “higher-value generics,” biosimilars are regarded as the generic equivalent of biologics. The Affordable Care Act included a pathway for biosimilars to enter the U.S. market, but the uptake has been slower than in Europe and Japan due to approval delays and low adoption by PBMs and payers, triggered by rebate and pricing strategies deployed by the makers of original products.
Biosimilars face additional challenges in the market due to complex and costly manufacturing processes that seem to favor large biotech companies, patent uncertainty, and competing technologies. New products from gene therapies, next-generation biologics, and messenger RNA are acting as headwinds to biosimilar growth. For example, infliximab has lost most of its market share in its indications for psoriasis and rheumatoid arthritis over the last 10 years and has largely sustained its market share in inflammatory bowel diseases, which is now threatened by a strong pipeline of new biologics for these indications. Another factor to be considered is that many biologics need to be injected or infused, but some disease-modifying anti-rheumatic drugs (DMARDs) to treat multiple sclerosis or rheumatoid arthritis, for example, can now be administered orally, adding to patient comfort and convenience.
The market opportunity is there for biosimilars, however. Some European countries, such as Denmark, boast significant uptake of biosimilars, topping 90% for TNF-alpha inhibitors infliximab and etanercept and the breast cancer drug trastuzumab. Biosimilars for the latter two medicines are not available in the United States, where biosimilars for infliximab only account for 6.2% of the market for that medication.
This lack of uptake in the U.S. market for biosimilars has Morgan Stanley projecting a much larger upside for the U.S. market, growing from $1.0 billion in 2018 to $8.6 billion in 2025, up 36% annually, compared with a 13.8% growth rate in Europe to $4.7 billion in that time frame. However, these growth rates are far from certain, because there will be new competition in many of these indications from more effective and potentially safer new branded therapies (as described above).
Innovation Or Efficiency: Which Route Makes Sense For Your Business?
As these strategies start to take hold in the generic drug making business, we expect the market to split into two categories: innovation players and efficiency players. The innovation players will focus on innovative drug development, participating in branded and generic markets to sidestep some of the pressures of selling traditional generic drugs. Efficiency players will operate in markets with relatively low prices and focus on traditional generic drugs with the objectives of gaining scale and minimizing costs to offset pricing pressures.
Given the numerous variables in play, each company will need to assess its position and develop a customized response to address the financial pressures on the generic drug business, whether to focus on innovation or efficiency, or some combination of the two.
About The Authors:
Roger Van den Heuvel is a partner and the global life sciences leader within KPMG’s Strategy practice. He brings over 20 years of consulting experience in life sciences with proficiency in strategy development, (value-based) organizational transformations, and breakthrough performance improvement, particularly in response to disruptive trends in technology and business models.
Mary Rollman is a partner in the Life Sciences Strategy organization at KPMG. She advises life sciences clients on all aspects of supply chain and operations. With more than 20 years of experience as both a practitioner and consultant across multiple industries, Rollman has experienced all aspects of running a global business, including large transformation programs, and has managed deal activity and transactions from strategy to execution.
Jeffrey Stoll is the lead partner for life sciences in Deal Advisory and Strategy for the US market. His primary focus is helping corporate and private equity clients through the entire transaction process including: inorganic growth strategy, target investment thesis/strategy, commercial due diligence, and supporting post-merger integration by aligning the operational integration workstreams to align with the deal strategy and value drivers.