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 / Fourth Quarter 2002 / Issue 29(originally published by Booz & Company)


Flipping the “Switch”: Big Pharma’s Biggest Challenge

Drug companies believe they’ll reap billions taking prescription medicines “over the counter.” But the strategy is no substitute for real innovation.

Illustration by Lars Leetaru
Consumer health care looks more and more like a business in need of strong medicine. Wheezing along with flat sales and anemic innovation, the industry that stocks America’s medicine cabinets with everything from Sudafed to Sani-Wipes finds itself increasingly hanging its hopes on what it calls the “switch” — the transformation of a prescription-only drug into a product that can be sold over the counter.

The industry definitely has the itch to switch. Virtually all consumer health-care companies assume switches will contribute significantly to over-the-counter (OTC) revenue growth in the near future — possibly creating new categories while reinvigorating such old warhorses as cold, cough, and allergy treatments. But our own extensive study of consumer health-care research and development shows prospects are less sanguine. Of the $50 billion worth of prescription sales derived from drugs that are losing patent protection over the next five years, we conclude that, at best, only about $3 billion can be captured by switches. This translates into a 2 percent compound annual growth rate over the next decade — in an industry that needs far higher growth to satisfy shareholders.

Our research provides compelling evidence that OTC industry players will have to perform a massive overhaul of their innovation engines to compete in the coming years. Our study, which consisted of a detailed questionnaire followed by a series of interviews with company managers (ultimately, nine of the 11 major consumer health-care companies elected to participate in exchange for a copy of the 200-page report and a follow-up briefing), also holds implications for a range of consumer products companies, many of which face economic and market forces that are compelling them to kick-start creativity.

A Fragmented Industry
Although OTC represents only about 3 percent of total U.S. health-care spending, it’s still big business, reaping almost $30 billion in sales last year. Its major categories are cold and cough (24 percent of the market), analgesics (22 percent), and digestive remedies (20 percent), followed by medicated skin-care products, smoking cessation aids, and eyedrops. The industry remains fragmented, with Wyeth Consumer Healthcare (formerly Whitehall-Robins Healthcare/American Home Products) and McNeil (owned by Johnson & Johnson) each owning approximately 10 percent of the market, and runners-up Pfizer and GlaxoSmithKline holding just more than 8 percent each. Despite fragmentation, individual brands do command attention in certain segments. McNeil’s Tylenol has more than 17 percent of the analgesics market, for instance, and Wyeth’s Robitussin commands about 10 percent of the cold and cough category.

Not surprisingly, most of the major companies in the industry are owned by much larger pharmaceutical “druggernauts”; of the top 11 consumer health-care players, only two (Procter & Gamble and Johnson & Johnson’s McNeil) are part of companies known for consumer products. Ownership by big pharma has critical repercussions for the entire industry, the most significant being that OTC divisions — which generate 10 percent of parent companies’ sales at most — often feel like unloved stepchildren. (As one consumer health-care manager told us during our study, “We’re a pimple on the back of big pharma.”) Over the last five years, while the pharmaceutical industry’s top line has averaged 13.5 percent annual growth, consumer health care has limped along at 3 to 4 percent, or about the pace of inflation plus population growth.

In many ways, consumer health-care companies are at the mercy of forces beyond their control. Strict FDA regulations make product differentiation on the basis of active ingredients all but impossible; some 100,000 OTC products are on sale in the U.S., but they contain fewer than 1,000 distinct compounds. Every major cough syrup, for instance, contains some variation of the same five active ingredients. The consequence is that private-label brands like Walgreens’s Wal-Tussin don’t just look and taste like Robitussin — they are Robitussin. Unable to create truly new products, OTC players are trapped in a cycle of line extensions, new claims, and line extensions of new claims, as, for example, Excedrin becomes Extra-Strength Excedrin becomes Excedrin Migraine, and so on. In this benighted world, when Pfizer’s Benadryl managed to eke out 0.3 percent share growth in 2000 by launching Benadryl Fastmelt tablets for kids, it was considered a major success story.

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