PHARMACEUTICAL AND BIOTECHNOLOGY INDUSTRIES RISK ...

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Lisa S. Pazer
Industry Analyst
914-510-6444
lpazer@advisen.com

P
HARMACEUTICAL AND
B
IOTECHNOLOGY
I
NDUSTRIES
R
ISK
M
ANAGEMENT
P
ERSPECTIVES
An Advisen Industry Report
Risk Management Series
July 2006
Industry Overview
The recent malaise in the $600 billion global market for pharmaceuticals (including biotechnology healthcare
products) has turned chronic: the industry has been off its double-digit growth track since 2003, and 2005’s 7%
revenue increase is the industry’s lowest since the early 1960s. Unfortunately, for the industry overall, an easy
cure just isn’t in the pipeline as fundamental shifts in the market continue to roil the industry. For one thing, on a
volume basis, the lower cost, lower margin generic drug segment overtook that of branded pharmaceuticals for the
first time ever in 2005. And, the succession of patent expiries for blockbuster drugs expected over the next five
years will continue to fuel generic drugs at the expense of branded drug makers and overall industry
pharmaceutical industry revenue and profitability.
While the onslaught of generic drugs and their deadly impact on profits loom large for Big Pharma, even greater
challenges for the industry lie ahead. The onerous pressure on pricing already exerted by managed healthcare
providers and national healthcare systems will only worsen due to the demographics of an aging world. And
despite pharmaceutical firms’ seemingly omnipotent congressional lobby, the inexorable tightening in the
regulatory stranglehold over almost every aspect of the industry’s operations will keep driving legal and
compliance costs higher and higher.
Certainly, explosive pockets of the ever-innovative pharmaceutical industry remain, and many more will arise,
especially with biotech’s bulging product pipeline. Nevertheless, today’s harsh – if not hostile – business
environment for pharmaceutical firms demands that companies undertake a spectrum of new initiatives in order to
successfully align their business models and operations with the new market realities.
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Industry Definition
The U.S. Department of Commerce defines the pharmaceutical industry as “establishments primarily engaged in
one or more of the following: (1) manufacturing biological and medicinal products; (2) processing (i.e., grading,
grinding, and milling) botanical drugs and herbs; (3) isolating active medicinal principals from botanical drugs and
herbs; and (4) manufacturing pharmaceutical products intended for internal and external consumption in such
forms as ampoules, tablets, capsules, vials, ointments, powders, solutions, and suspensions”.

Understanding Biologics
In contrast to conventional pharmaceuticals that are chemically synthesized with well understood and easily
replicated structures, biologics are complex mixtures that are not easily identified or characterized because they’re
isolated from natural sources - human, animal, or microorganism. Biologics are almost universally very complex in
nature, often defying analysis and description. Few are truly homogeneous, and at the molecular scale, few are
composed of single, describable structures. In many respects, the structure and other properties of
biopharmaceuticals are dependent on their manufacturing processes. Even what many might consider to be
identical homogeneous recombinant proteins from different manufacturers (or even different batches from the same
manufacturer) may exhibit different properties.
Biological products include a wide range of products such as vaccines, blood and blood components, allergenics,
somatic cells, gene therapy, tissues, and recombinant therapeutic proteins. Biologics can be composed of sugars,
proteins, or nucleic acids or complex combinations of these substances, or may be living entities such as cells and
tissues.

Industry Notes
In late 2003, the FDA transferred the oversight of a certain class of therapeutic biologics from the Center for
Biologics Evaluation and Research (CBER) to the Center for Drug Evaluation and Research (CDER). According to
the FDA, the purpose of this transition was to provide “greater opportunities to further develop and coordinate
scientific and regulatory activities between CBER and CDER, leading to a more efficient, effective, and consistent
review program for human drugs and biologics.” In fact, the FDA move to integrate its traditional chemistry-based
pharmaceutical and biologics oversight functions reflects the maturation of biologics as an integral part of the
overall pharmaceutical market. With the exception of small firms plowing research and development funds into
highly specialized technologies, most of the “traditional” pharmaceutical industry has already integrated biologics
into their product lines and business models through acquisitions, joint development, and licensing agreements.
With the industry’s widespread structural integration and the fact that both small molecule drugs and biologics are
going after the same therapeutic markets, the distinction between “drug” and “biotechnology” company has largely
blurred beyond usefulness. As such, for the purposes of this report, pharmaceuticals and biologics are treated not
as separate industries, but as distinct products segments in the overall pharmaceutical marketplace.
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Market Sizing
The global market for pharmaceuticals,
including biotechnology-based healthcare
products (biologics or biopharmaceuticals),
grew by roughly 7% in 2005 to just over $600
billion – the most sluggish growth rate since
1963.
1
Moreover, in the 10 major markets
(excluding developing nations), growth was
only 5.7% in 2005, compared with 7.2% the
previous year. Industry profitability too has
slowed. From 1995 to 2002, the
pharmaceutical industry was the U.S.’s most
profitable. By 2005, it ranked 5th, with profits
of 15.7% of revenue – down from over 19% in
2002 and now half that of the most highly
profitable industry, oil and gas.
2

While industry growth continues to outpace
that of the overall economy and profitability remains staggering compared to the average 6% return on revenue
achieved by the Fortune 500 companies as a whole, the pharmaceutical industry is indeed on a losing streak and
fundamental structural shifts in both the marketplace and business climate indicate that there’s no easy path back
to the top of the heap.

The Rise of Generic Drugs
Branded “small molecule” pharmaceuticals
accounted for $485 billion, or 80% of industry
revenue in 2005 while generic drugs comprised
only about $65 billion or 11%. Nevertheless, this
small but potent segment of the market is the key
factor behind flagging industry revenue and profit
growth: while generics’ revenue is still only a
small fraction of branded drug dollar sales, 2005
was the first year in which a greater number of
prescriptions for generic drugs were filled than for
branded pharmaceuticals. Industry observers
estimate that generic drugs now account for over
60% of all prescriptions written
3.



1 IMS Intelligence360
2
Fortune Magazine, Fortune 500
3
Ibid
Branded
80%
Generics
11%
Biopharmaceuticals
9%
2005 Pharmaceutical Sales by Market Segment
$485
$52
$65
($Billions, Percent of Total)
Source: IMS; Advisen LTD
$0
$100
$200
$300
$400
$500
$600
1998 1999 2000 2001 2002 2003 2004 2005
0%
2%
4%
6%
8%
10%
12%
14%
Total World Market (current US$)
Growth Over Previous Year (Constant US$)
The Global Market for Pharmaceuticals
($Billions)
Source: IMS Health Total Market Estimates and Global Pharma Forecasts
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$0
$10
$20
$30
$40
$50
$60
$70
$80
$90
2004 2005 2006 2007 2008 2009 2010
11%
12%
12%
13%
13%
14%
14%
15%
Revenues ($Billions)
% Growth Rate
Source: Vision
g
ain, 2005
The Market for Generic Pharmaceuticals
(Forecasts from 2006 through 2010)
The lure of generic drugs is obvious: while
essentially the identical drug, they’re much
less expensive than their branded
counterparts, making them most often the
drug of choice, when available, for national
healthcare systems and domestic managed
healthcare providers trying to put the brakes
on rising healthcare costs. As such, the
market for generic drugs grew about 13% in
2005, nearly twice the rate of the overall
industry. Growth in the generics market
segment is fueled by the number and market
value of branded drugs for which patents have
expired. An estimated $100 billion worth of
branded pharmaceuticals will go off patent by
2010, $21 billion of which expire in 2006.
Patent expirations for major products can see revenue for these suppliers fall ten-fold within two years. One study
showed that within two weeks of Prozac going off patent, more than half the prescriptions being written were for its
generic counterpart.
4

The greater vulnerability of branded pharmaceutical revenue to generic incursion is a worsening side effect of the
“blockbuster” business model, where pharmaceutical companies’ fortunes are based on the prospects of a few
runaway bestselling drugs that ultimately see their patents expire and their market cannibalized by a hoard of
inexpensive (and low margin) generic versions.
Pfizer, the world’s largest drug company, for example, has a whopping 28% of its revenue based on one drug,
Lipitor, which racked up over $12 billion in 2005. Its top
three drugs, which include Norvasc and Zoloft, accounted
for over 45% of global company sales last year. This year
and in the following years, the story will be different,
however. Zoloft lost patent protection last month and Teva
Pharmaceuticals, one of the world’s largest generic drug
makers, has 180-day exclusivity to market its generic
version. After that, it’s open season on Pfizer as more
generic versions hit the market. All told, from $3.3 billion
in 2005, Pfizer’s Zoloft sales are expected to implode to
$470 million in 2006
5
. Carnage of the same magnitude is
likely to occur in Norvasc sales when it goes off patent in
September 2007. Pfizer is vigorously defending Lipitor
against invalidation by its would-be generic version
producers in courts worldwide. Even though Lipitor may
retain its patent exclusivity until 2011, Merck’s
competing anti-cholesterol drug, Zocor, just went off


4
Health Affairs, 23, no. 5 (2004)
5
Who stands to gain when Zoloft goes generic, CNNMoney.com, 04/04/2006
Generic
Therapeutic
Class
2004
Revenues
($Millions)
% Growth
over 2003
Hydrocodone Pain $1,339 -9.0%
Amoxicillin Antibiotic $928 -9.4%
Paroxetine Depression $925 237.0%
Omeprazole Antifungal $812 -43.0%
Lisinopril Hypertension $706 2.9%
Metformin Diabetes $653 -11.7%
Fluoxetine Depression $559 -9.6%
Albuterol Asthma $456 -12.0%
Ciprofloxacin Antibiotic $417 45.0%
Source: Drugtopics; Advisen LTD
Top U.S. Generic Drug Sales
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patent and some of Lipitor’s 2006 sales are expected to be siphoned off by generic versions of Zocor being sold at a
fraction of Lipitor’s price.
When any top selling branded drug in a certain therapeutic market goes off patent, sales for competitive branded
pharmaceuticals take a hit. Merck’s Zocor, the second biggest statin drug with a market of $4.4 billion,
6
went off
patent on June 23, 2006, and sales of Lipitor and all the other drugs in the cholesterol and triglyceride reducers
sector will most certainly suffer as a result. When Zocor went off patent in the U.K. in 2003, its generic
counterpart was six times less expensive than its branded counterpart. The U.K. National Health Service found
that raising the dosage of generic Zocor (simvastatin) would put it on equal clinical footing with Lipitor and would
save the government nearly $4 billion over the next five years by prescribing the increased simvastatin drug
instead.
7
Moreover, a recent survey by J.P. Morgan found that one in four doctors in the U.S. planned to switch
from Lipitor to the Zocor generic when it became available.
Manufacturers with top-selling branded products scheduled to go off patent have devised a plethora of strategies to
delay the inevitable – even delays for small periods of time can mean billions of dollars in sales. These strategies
include getting FDA approvals for additional indications, introducing an improved version of the drug, and filing
applications for OTC versions of prescription drugs. At the same time, generic drug companies aching to get their
hands on a blockbuster drug have their own tactics in attempting to end the patent period before its time. However
gruesome the market losses for the branded drug are once its patent
expires, the bloodiest battles between innovator companies and
generic drug producers are in the courts and regulatory arena.

Explosive Growth in Biologics
Safely out of the fray in the battle between the branded and generic
small molecule drug segments, the biotech healthcare market is the
most vibrant in the pharmaceutical industry. While biologics for
human and animal health only accounted for roughly 9% ($52
billion)
8
of global pharmaceutical sales in 2005, its piece of the pie is
rising rapidly as the market sector continues on its explosive near-
20% growth track with few signs of slowing. Over one third of all
products in active development in the industry pipeline are
biopharmaceuticals.
In 2005, publicly traded biotechnology companies’ revenue
surpassed $60 billion for the first time in the sector’s 30-year
history.
9
According to Ernst & Young:
• Revenue for the world’s publicly traded biotech companies grew 18% in 2005, reaching an all-time high of
$63.1 billion.


6
IMS
7
NHS "could save 2 billion stag" with cheaper stations; Reuters, June 9, 2006
8
Ibid
9
Beyond Borders: The Global Biotechnology Report 2006, Ernst & Young, 04/04/2006
Revenue
($Billions)
Amgen $12.80
Genentech $7.20
Genzyme $2.80
Serono $2.70
Biogen $2.40
Gilead Sciences $2.30
Medimmune $1.20
Invitrogen $1.20
Charles River Labs $1.10
Celgene $0.61
Top 10 Publicly Traded
Biotechnology Healthcare
Companies
Source: Company Data; Advisen LTD
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• As revenue increased, the industry’s net loss decreased by a dramatic 30%, to $4.3 billion. The United
States, Canada, and the Asia-Pacific region collectively improved their bottom line by about $3 billion.
• The industry secured 32 new product approvals in the United States, including 17 first-time approvals.
• The pipelines of Europe’s publicly traded biotech companies increased by 28%, with the strong growth in
late-stage development.
• The global biotech industry raised $19.7 billion in capital in 2005, its second highest total since the
bubble of 2000.
Biotechnology is no longer the sole domain of pure-play biotech companies. Big Pharma (defined as traditional
small molecule drug companies with annual revenue greater than $10 billion) has moved in with a vengeance over
the past several years, so much so that U.K. research firm Datamonitor projects that 60% of Big Pharma revenue
growth over the next five years will come from biologics. According to the firm, by 2010, annual sales of biologics
by Big Pharma will have increased by $26 billion, compared to a $13 billion increase for small molecules.
10
This
translates into compound annual growth rates of 13% for biologics and 0.9% for small molecule drugs. Within the
biologics segment, monoclonal antibodies (mAbs) will act as the strongest driver of growth out to 2010, recording
an absolute annual sales increase of $18 billion, equal to a CAGR of 26.2%.
The erosion of profits and market share associated with the growth of generic replacements for branded drugs has
yet to hit biotechnology firms, but indeed the battleground is being readied.
There are roughly 190 biotechnology medicines currently on the market, and nearly 400 additional biotech drug
products and vaccines currently in clinical trials targeting more than 200 diseases.
11
Already, the “off-patent”
biologics market is expected to reach $10 billion this year. And biotechnology therapies cost big money – many
can cost $10,000 per treatment and many thousands per year. Clearly, the impetus to create a generic market for
off-patent biotechnology products is acute and legislative initiatives to create a framework for generic
biotechnology products have been promulgated for years now.
However, the issue of generic biotechnology products is highly complex: biogenerics demand different assessment
and approval processes than generic pills due to the different ways the two kinds of medicine are made. For FDA
approval, generic drugs don’t have to replicate the long stream of clinical trials new drugs do – they simply have to
demonstrate bioequivalence (e.g., if the generic is absorbed into the bloodstream in the same fashion as the brand
drug). But few biotechnology products are truly homogeneous, pure substances readily definable by chemical
structure. At the molecular scale, few are composed of single, describable structures and even what many might
consider to be identical homogeneous recombinant proteins from different manufacturers, or even different batches
from the same manufacturer, may exhibit different properties. Moreover, it is not possible to test biotech medicines
for bioequivalency because they are injected or infused directly into the bloodstream. As such, other tests must be
devised to determine whether a biogeneric has the same therapeutic effect as a name-brand biologic.
While the FDA and members of Congress have prioritized the issue of establishing guidelines for the assessment
and approval of biogenerics, critics say they’re still years away. Meanwhile, the European Medicines Agency
(EMEA) has enacted guidelines creating a mechanism for approval of “similar” biologics. The framework laid out


10
Biologics driving growth to 2010, DataMonitor, 07/03/2006
11
Biotechnology Industry Association
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in Europe requires that the generic manufacturer of a biogeneric provide a “full characterization of the molecule as
‘biosimilar.’” In addition, the company must perform a small study with a certain number of patients in order to
demonstrate this biosimilarity. Guidelines published by the EMEA in February 2006 set out that the “similar
biological medicinal product” is defined by the following two sets of characteristics: “i) related to the
characteristics of the molecule (including product related substances and/or impurities), and ii) related to its
process (which may affect molecular characteristics and includes process related impurities).” The EMEA stated
that it is the duty of the applicant to demonstrate the “consistency and robustness of his own process according to
existing guidelines.”
Generic drug maker Sandoz, which has just received the regulatory go-ahead to market growth hormone
Omnitrope, has ignited debate about whether the approval could open the door more quickly for biogenerics in the
U.S. The FDA terms the Sandoz drug a "follow-on protein” rather than a generic, and indeed, the Office of Generic
Drugs did not review the submission. Yet, Sandoz was able to get additional indications approved based on the
drug’s similarity with Pfizer’s Genotropin without having to do clinical trials in those populations. (Generic drugs
are approved without the need for additional clinical trials.) Perhaps the best classification for Sandoz’s hard-won
approval is that it was a hybrid application.
Ultimately, while more “second generation” or follow on proteins based on expired patents will increasingly be
approved by the FDA, these drugs will have their own unique labeling and will not be able to be considered as
substitutes by pharmacists. Nevertheless, Sandoz plans to market Omnitrope as a generic drug even though it will
have to be specifically prescribed by name.
In short, biosimilar follow-on biologics with perhaps a somewhat abbreviated approval process is likely to be the
closest thing to a biogeneric the U.S. will see for the next several years. But while the cost of development for these
follow-on drugs is still much higher than typical small molecule generic drugs, the introduction of second
generation biotechnology therapeutics should create a bit more competition and price pressure.
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The following table lists the world’s top selling small and large molecule pharmaceuticals in 2005, as well as their
contribution to overall manufacturer sales.

The Global Pharmaceutical Industry's 30 Top Selling
Drugs in 2005
Rank

Drug
2005
Sales
($Billions)
% of
Co.
Sales

Company







1

Lipitor
$12.2
28%

Pfizer
2

Advair/Seretide
$5.7
17%

GlaxoSmithKline
3

Norvasc
$4.7
11%

Pfizer
4

Nexium
$4.6
19%

AstraZeneca
5

Zyprexa
$4.2
29%

Eli Lilly
6

Zocor
$4.0
18%

Merck
7

Plavix
$3.8
25%

Bristol-Myers Squibb
8

Antidiabetic products
$3.8
71%

Novo Nordisk
9

Diovan
$3.7
15%

Novartis
10

Risperdal
$3.6
16%

Johnson & Johnson
11

Prevacid
$3.5
41%

Takeda
12

Effexor
$3.5
23%

Wyeth
13

Eprex/Procrit
$3.3
15%

Johnson & Johnson
14

Zoloft
$3.3
7%

Pfizer
15

MabThera/Rituxan
$3.2
24%

Roche
16

Singulair
$3.0
14%

Merck
17

Cozaar/Hyzaar
$3.0
14%

Merck
18

Levoflaxacin
$2.8
92%

Daiichi
19

Seroquel
$2.8
12%

AstraZeneca
20

Kivenix
$2.5
8%

Sanofi-Aventis
21

Epogen
$2.5
20%

Amgen
22

Plavix
$2.4
7%

Sanofi-Aventis
23

Pravachol
$2.3
15%

Bristol-Myers Squibb
24

Gleevec/Gilvec
$2.2
9%

Novartis
25

Taxotere
$1.9
6%

Sanofi-Aventis
26

Rituxan
$1.8
33%

Genentech
27

Seloken/Topori-XL
$1.7
7%

AstraZeneca
28

Topomax
$1.7
8%

Johnson & Johnson
29

Protinix
$1.7
11%

Wyeth
30

Pantoprozole
$1.7
58%

Altana
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Regional Markets
The North American market for
pharmaceuticals, of which the U.S.
accounts for about 90%, was valued at
$266 billion in 2005.
12
Revenue was up
by only 5% from 2004 – the slowest rate
in years, and slower even than in the
mature economies of Europe and Japan,
where the pharmaceuticals market grew
about 7%.
13
In fact, all of the other
regions in the world outpaced the U.S.,
with the most rapid growth (albeit from a
small base) taking place in Latin
America.


Asia, however, is clearly the region with the greatest growth potential over
the coming years. Asia-Pacific pharmaceutical sales, excluding Japan, are
expected to skip along at an average 9-12% pace over the next five years
14
.
For one thing, India and China are home to more than one-third of the
world’s population, and the entire Asia-Pacific region currently only
represents 17% of global pharmaceutical sales.
15
In China alone, spurred by
rising standards of living and demand for healthcare, pharmaceutical sales
growth is expected to average roughly 17% annually. And, while Chinese
manufacturers currently dominate 65% of the domestic market, improved
patent protection and new laws enabling multinationals to operate in the
market without a domestic partner will undoubtedly cause an influx of
foreign firms.







12
Pharmaceutical Executive, May 2006
13
Ibid
14
IMS Asia Pacific, www.pharmafocusasia.com
15
Ibid
$265.7
$169.5
$60.3
$46.4
$24.0
$36.1
North America
Europe
Japan
Asia, Africa & Australia
Latin America
Rest of World
2005 Global Pharmaceuticals Sales b
y
Re
g
ion
($Billions)
Source: Pharmaceutical Executive, May, 2006
Country
2004
Sales
($Billions)
% of
Market
Japan $58.0 64.0%
China (hospital) $7.6 8.5%
Australia $5.8 6.6%
Korea $5.7 6.5%
India (retail) $4.5 5.1%
Taiwan $2.8 3.2%
Indonesia $1.9 2.2%
Philippines $1.3 1.5%
Thailand $1.1 1.3%
Hong Kong $0.4 5.0%
Malaysia $0.3 4.0%
Singapore $0.2 3.0%
Total $89.7 100%
Asia Pacific
Pharmaceutical Market
Source: IMS Asia Pacific
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Industry Structure
The global pharmaceuticals industry is dominated by 10 firms, which control nearly 45% of the market. The top 50
firms control 70% of the market, and Pfizer, the industry’s biggest firm, controls over 7% of the global market all
by itself.
The pharmaceutical industry is so heavily integrated on a global scale that, for the most part, competition has few
national boundaries. Competition is fierce amongst manufacturers in the top therapy classes where drugs with only
marginal differences are often easily substitutable. However, the most brutal competition facing Big Pharma is now
coming from generic drugs. The following table lists the world’s largest pharmaceutical companies.

The World's 25 Top Pharmaceutical Companies
2004
Rank
2005
Rank

Company
Headquarters
Global
Sales
($Billions)
Growth
from
2004
R&D
as %
of
Sales








1
1

Pfizer
New York, NY
$44.3
-4%
17%
2
2

GlaxoSmithKline
London, England
$34.0
8%
17%
3
3

Sanofi-Aventis
Paris, France
$32.3
-5%
15%
7
4

Novartis
Basel, Switzerland
$25.0
16%
18%
6
5

AstraZeneca
London, England
$24.0
12%
23%
4
6

Johnson & Johnson
New Brunswick, NJ
$22.3
1%
28%
5
7

Merck
Whitehouse Station, NJ
$22.0
2%
17%
9
8

Wyeth
Madison, NJ
$15.3
10%
8%
8
9

Bristol-Myers Squibb
New York, NY
$15.3
-1%
18%
11
10

Eli Lilly
Indianapolis, IN
$14.7
12%
20%
10
11

Abbott Labs
Abbott Park, IL
$14.0
16%
13%
12
12

Roche
Basel, Switzerland
$12.9
5%
29%
13
13

Amgen
Thousand Oaks, CA
$12.0
13%
19%
14
14

Boehringer-Ingelheim
Ingelheim, Germany
$10.8
2%
10%
15
15

Takeda
Osaka, Japan
$8.5
3%
15%
NA
16

Astellas
Tokyo, Japan
$8.0
NA
16%
16
17

Schering-Plough
Madison, NJ
$7.6
18%
25%
18
18

Bayer
Leverkusen, Germany
$7.7
18%
14%
17
19

Schering AG
Berlin, Germany
$6.3
3%
19%
22
20

Genentech
S. San Francisco, CA
$5.5
46%
24%
25
21

Novo Nordisk
Bagsvaerd, Denmark
$5.4
1%
15%
19
22

Eisai
Tokyo, Japan
$4.8
-5%
15%
20
23

Teva
Petach Tikva, Israel
$4.7
10%
9%
21
24

Merck KGaA
Darmstadt, Germany
$4.6
21%
15%
28
25

Sankyo
Tokyo, Japan
$4.3
46%
19%

Source: Pharmaceutical Executive; Advisen LTD




Profits & Cost Structure
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Pharmaceutical industry profits are almost ubiquitously perceived by the public as outrageous, particularly given
the outcry over high drug prices. The pharmaceutical industry, in response, cites the following statistics:
16

• It takes $800 million and an average of 12 to 15 years to discover and develop a new medicine;
• Only five of every 10,000 compounds investigated are tested in clinical trials;
• Of those five, only one is ever approved for patient use;
• Revenue from one successful medicine must cover the costs of the vast number of “dry holes;” and
• On average, only three of every 10 prescription medications available to treat Americans generate revenue
that meet or exceed average R&D costs.
The following table details the changes in revenue, profit, and R&D spending for the top 10 Pharmaceutical
companies over the past two years.


16
Pharmaceutical Research Manufacturers Association (PhRMA.org)
2005
Revenue
($Billions)
2005
Growth
2004
Growth
2005 Net
Income
($Billions)
2005
Growth
2004
Growth
2005 R&D
Cost
($Billions)
2005
Growth
2004
Growth
Pfizer $51.3 -2.3% 16.2% $8.1 -28.3% 292.0% $7.4 -3.9% 8.5%
Johnson & Johnson $50.5 6.8% 12.9% $10.4 22.4% 18.1% $6.3 21.2% 6.1%
Glaxosmithkline $37.3 -4.8% 2.3% $5.7 7.5% 12.0% $5.4 7.5% 23.5%
Novartis $32.5 15.0% 13.0% $4.8 14.0% 11.0% $5.2 4.0% 31.6%
AstraZeneca $24.0 9.0% 15.0% $3.4 -13.0% 11.0% $3.9 26.0% 30.0%
Merck $22.0 -3.9% 1.8% $3.8 -5.0% 25.0% $4.6 -21.0% -15.0%
Abbott Laboratories $22.3 13.2% 0.0% $1.8 5.9% 0.0% $3.4 6.3% 14.3%
Eli Lilly $14.6 5.8% 10.3% $3.0 11.1% 12.5% $2.0 11.1% -33.3%
Wyeth $18.8 8.0% 9.4% $2.7 4.0% 19.0% $3.7 308.0% -43.0%
Bristol-Myers Squibb $19.2 -1.0% -7.0% $2.7 8.0% 9.0% $3.0 25.0% -23.0%
Source: Company Reports; Advisen LTD
Top 10 Pharmaceutical Company Revenue, Profit, and R&D
Expenditure Trends
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Industry Consolidation
As is typical for any industry undergoing price pressure and struggling for greater revenue growth and profits, the
global pharmaceutical industry is undergoing a period of consolidation. However, the majority of mergers that were
chiefly motivated by cost cutting and the lure of better economies of scale over the last 18 months have taken place
in Japan, as the industry there reaches maturity.
Elsewhere, however, M&A activity has been far more strategic as Big Pharma takes aggressive steps to move into
the higher growth biotechnology and even generic segments of the marketplace, improve product pipelines, and, in
the case of Pfizer’s sale of its OTC products division to Johnson and Johnson, tighten focus on areas of core
competency.
Since most pharma companies haven't
invested in R&D for biologics, many are now
playing catch-up through acquisitions and
other collaborations. Johnson & Johnson
became one of the first pharma companies to
invest in this space in 1999, when it
purchased Centocor, the biologics company
that developed Remicade (infliximab). This
year, Merck acquired biotech shops GlycoFi
and Abmaxis. Even biotech companies are
boosting their biologics investments: Amgen
this year finalized its acquisition of Abgenix.
Pharmaceutical companies aren’t limited to
acquiring new firms to shore up flagging
pipelines, of course. According to a recent
study by Cutting Edge Information,
17
50% of
survey respondents admitted that filling gaps
in their therapeutic area pipelines was their greatest motivation in partnering with other firms. According to the
study, in top organizations, more than 25% of revenue comes from products brought in from elsewhere.
Mid Pharma companies, defined as pharmaceutical companies with annual revenue under $10 billion, currently
rely heavily on externally sourced products. In 2005, 43.8% of Mid Pharma revenue was derived from products
discovered outside of the in-house pipelines. Furthermore, even in the absence of any further external sourcing
between now and 2010, the dependence of revenue on products that come from external pipelines will continue to
increase, coming to stand at 48.6% by 2010.
18



17
www.PharmaDealMaking.com
18
Datamonitor, "Mid Pharma Sector: In-licensing and other externalization strategies"
$0
$50
$100
$150
$200
$250
1989 1991 1993 1995 1997 1999 2001 2003 2005
Source: Pharmaceutical Executive; Advisen LTD
Worldwide Pharmaceutical Industr
y
Ac
q
uisitions
($Billions)
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The follow table details some of the M&A deals in the industry over the last 18 months as well as the primary
strategy initiatives behind it.

The FDA’s Impact on the 2005 Pharmaceutical Industry
Industry observers are grumbling that the FDA “has also become risk-averse as a result of the debacle over Merck
& Co.'s painkiller, Vioxx”, according to a recent BusinessWeek article titled “Going From The Lab To Limbo” and
that the result has been the agency issuing “approvable” letters rather than approvals. Since the FDA must reach
some kind of decision within 6 to 10 months of a new drug filing; an approvable letter rather than an approval
presents the pharmaceutical company with some sort of minor hurdle (e.g. labeling) that must be overcome before
the drug is approved. Nevertheless, “a number of approvable letters ask for another round of clinical trials, which
can derail a drug completely. Bristol-Myers Squibb Co. announced in May that it is killing Pargluva, a diabetes
drug that received an approvable letter last October. The FDA was concerned about the drug's safety, and Bristol
said it would take five years to do the additional trials requested. Cephalon dropped Myotrophin for Lou Gehrig's
Disease after receiving an approvable letter in 1998 because it couldn't afford to conduct another clinical trial.”
19

The cost of accumulating additional evidence for FDA approval in addition to the lost sales due to delayed market
entry could reduce the value of companies’ pipelines by roughly 20%.
20



19

Going From The Lab To Limbo, BusinessWeek, June 12, 2006
20
IMS
Company Acquired Company Date*
Value
($Billions) Strategy
Top Deals in 2005
Yamanouchi Fujisawa Pharmaceuticals 04/01/05 $7.9 Industry Consolidation
Sankyo Daiichi 10/01/05 $6.6 Industry Consolidation
Novartis AG
Hexal AG 06/06/05 $5.3 Increase generic drug portfolio
Warren Acquisition Consortium Warner Chilcott 01/01/05 $3.0 Investor Acquisition
Novartis AG
Eon Labs, Inc.07/21/05 $2.4 Increase generic drug portfolio
Nordic Capital Nycomed A/S 10/10/05 $2.2 Investor Acquisition
Sumitomo Dainippon Sumitomo Pharma 10/01/05 $2.1 Industry Consolidation
Shire Pharmaceuticls Transkaryotic Therapies 07/28/05 $1.6 Increase biologics portfolio and expertise
Solvay SA
Fournia Pharma 07/28/05 $1.5 Expand cardiology drugs portfolio
GlaxoSmithKline
ID Biomedical 12/08/05 $1.4 Increase biologics portfolio and expertise
Selected Deals in 2006
AstraZeneca Cambridge Antibody Technology (CAT) 05/24/06 $1.30 Increase biologics portfolio and expertise
Novartis AG Chiron 10/05/05 $5.10 Increase biologics portfolio and expertise
Pfizer
Rinat Neuroscience Corp
04/06/06 NA Acquire combinatorial neuroscience theraputics portfolio
Merck GlycoFi 05/09/06 $0.40 Increase biologics portfolio and expertise
Merck Abmaxis, Inc.05/09/06 $0.08 Increase biologics portfolio and expertise
Novartis AG NeuTec Pharma Plc 6/7/2006 $0.57 Expand new drug pipeline
Novartis AG Chiron 04/20/06 $5.40 Increase vaccines and diagnostics portfolio
Johnson & Johnson Pfizer Consumer Healthcare Division 06/26/06 $16.60 Further promote each company's market focus
Source: Advisen LTD
Selected M&A Deals and Strategy in the Global Pharmaceutical Industry
* Announcement or completion date, whichever is most recently available.
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The following chart details the number of new FDA approvals for pharmaceuticals and biologics over the past ten
years.

0
5
10
15
20
25
30
35
40
45
50
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Pharmaceuticals/Therapeutics
Biologics
New FDA Approvals for Pharmaceuticals and Biologics
*
(1995 - 2005)
*Biologics includes therapeutic products, imaging agents and vaccines until 2004, when biologic theraputic product oversight was moved fro
m
CBER to CDER and the number was combined with that of the pharmaceuticals to form a composite "Therapeutics" category.
Source: FDA; www.phrma.org
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The following table presents selected new FDA approvals of pharmaceuticals in 2005.


Selected FDA Approvals of Biotechnology, Biotech-Related,
Small Molecule, and Related Products in 2005
Company

Product

Application

Approval
Date
American
Pharmaceutical Partners
Inc.

Abraxane - paclitaxel, first in
class protein bound particle

Treats breast cancer after failure of
combination therapy.

Jan 2005
Amylin Pharmaceuticals

Byetta - exenatide injection,
first in class incretin
mimetics

Treatment for Type II diabetes

Apr-05
Amylin Pharmaceuticals
Inc.

Symlin - pramlintide acetate
injection

Used in conjunction with insulin at
mealtime to treat Type I and Type II
diabetes in patients who have failed to
achieve desired glucose control despite
optimal insulin therapy

Mar 2005
Aventis Pasteur Inc.

Menactra - Meningococcal
Polysaccharide Serogroups
A, C, Y and W-135
Diphtheria Toxoid Conjugate
Vaccine

For active immunization of adolescents
and adults 11-55 years of age for the
prevention of invasive meningococcal
disease.

Jan 2005
Aventis Pasteur Limited

Adacel - Tetanus Toxoid,
Reduced Diphtheria Toxoid
and Acellular Pertussis
Vaccine, Absorbed

Booster immunization against tetanus,
diphtheria and pertussis.

Jun 2005
Baxter HealthCare Corp.

GAMMAGARD - Immune
Globulin Intravenous Human
Solution

Liquid dosage form of primary immune
deficiency

Apr 2005
BioMarin
Pharmaceuticals

Naglazyme - galsulfase

Enzyme replacement therapy for
mucopolysaccharidosis VI MPS VI

May 2005
BioMimetic Therapeutics
Inc.

GEM 21S - composed of the
tissue growth factor,
recombinant human Platelet-
Derived Growth Factor
rhPDGF-BB, and a synthetic
bone matrix, Beta-tricalcium
phosphate.

Treatment of peridontal bone defects
and associated gingival recession

Nov 2005
Bristol-Myers Squibb
Company

Orencia - abatacept, fully
human soluable fusion
protein

Reducing signs and symptoms of
rheumatoid arthritis

Dec 2005
Cangene Corp.

CNJ-016, Vaccinia Globulin
Intravenous - purified
antibody for specific vaccinia

Treatment and/or modification of
complications resulting from smallpox
vaccination.

May-05
Celgene Corp.

Revlimid - lenalidomide

For the treatment of patients with
transfusion-dependent anemia.

Dec 2005
DynPort Vaccine

VIGIV, Vaccinia Immune
Globulin Intravenous -
intravenous immune globulin

For the treatment and modifications of
aberrant infections induced by vaccinia
virus.

Feb 2005
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Company



Product



Application



Approval
Date

GlaxoSmithKline

Arranon - nelarabine
injection

A chemotherapy agent for the
treatment of patients with T-cell acute
lymphoblastic leukemia T-ALL and T-
cell lymphoblastic lymphoma T-LBL
whose disease has not responded to at
least two chemotherapy regimens

Oct 2005
GlaxoSmithKline

Boostrix - Tetanus Toxoid,
Reduced Diphtheria Toxoid,
Reduced Diphtheria Toxoid
and Acellular Pertussis
Vaccine, Absorbed

Booster immunization against tetanus,
diphtheria and pertussis as a single
dose in adolescents 10-18 years of age

May 2005
GlaxoSmithKline
Biologicals

Fluarix - influenza virus
vaccine

For active immunization of adults 18
years and older against influenza
disease caused by influenza virus types
A and B

Aug 2005
Halozyme Therapeutics
Inc.

Hylenex - recombinant
human hyaluronidase

Adjuvant agent to increase the
absorption and dispersion of other
injected drugs

Dec 2005
Insmed Inc.

IPLEX - mecasermin
rinfabate [rDNA origin]

Treatment of growth failure in children
with severe primary IGF-1 deficiency
primary IGF or with growth hormone
GH gene deletion who have developed
neutralizing antibodies to GH

Dec 2005
Merck & Co. Inc.

ProQuad - Measles, Mumps,
Rubella and Varicella Virus
Vaccine Live

Measles, mumps, rubella, and varicella
in children 12 months to 12 years

Sep 2005
NitroMed Inc.

BiDil - isosorbide dinitrate
and hydralazine

Fixed-dose combination of hydralazine
hydrochloride and isosorbide dinitrate
for heart failure in self-identified black
patients; first drug approved for a
specific racial group

Jun 2005
Novartis AG

Exjade - deferasirox, once-
daily oral iron chelator

Chronic overload due to blood
transfusions in adult and children age 2
or older

Nov 2005
Novo Nordisk

Levemir - insulin detemir
[rDNA origin] injection

Treatment of diabetes mellitus I and
Type II

Jun 2005
Onyx Pharmaceuticals
Inc. Bayer
Pharmaceuticals Inc.

Nexavar - sorafenib, tablets

For patients with advanced renal cell
carcinoma

Dec 2005
Tercica Inc. Genentech
Inc.

Increlex - mecasermin

Long-term treatment for growth failure
in children with severe primary IGF-1
deficiency

Aug 2005
Unigene Laboratories
Inc.

FORTICAL Nasal Spray -
calcitonin salmon

Nasal Spray treats postmenopausal
osteoporosis in women with low bone
mass

Aug 2005
Wyeth

Tygacil - tigecycline injection

Treatment of complicated skin structure
and intra-abdominal infections

Dec 2005







Source: FDA; Biotechnology Industry Organization; Advisen, LTD

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Economic Indicators
U.S. spending on healthcare and pharmaceuticals has had little correlation with economic growth over the past
couple of decades, as the graph below shows.
While U.S. economic growth
is not a strong independent
driver of U.S. spending on
healthcare products and
services, it does reflect the
nation’s ability to pay for
healthcare. And since the
turn of the new century,
growth in healthcare costs
has consistently outpaced
that of GDP. Moreover, the
trend will intensify as more
baby boomers become
senior citizens and move
into the demographic cohort
that consumes the bulk of
U.S. healthcare dollars.
From just over 7% in 1970,
healthcare expenditures as a
percent of GDP rose to
roughly 16% last year, and will hit the 20% mark by the end of the next decade. According to the Center for
Medicare and Medicaid Services (CMMS), average annual growth in national health spending, predicted at 7.2 %
over the next 10 years, will continue to outpace GDP growth by over two percentage points. Ultimately, the greater
the lag between healthcare expenditures and economic growth – and the longer the lag persists– the greater the
pricing pressure on U.S. healthcare providers and suppliers.
While the Medicare D prescription drug benefit plan that went into effect in January, 2006, will most likely
slightly boost overall annual U.S. pharmaceutical industry sales growth to 6-8% during its first year or two of
implementation due to the additional pharmaceutical end user base it provides, generics will continue to
aggressively cannibalize high-revenue branded drug markets and managed healthcare providers (including those
administering Medicare D) will tighten further the lid on drug costs. As such, U.S. pharmaceutical sales growth
might well peak in 2006, and soften thereafter.
2%
3%
4%
5%
6%
7%
8%
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Real GDP
Total Healthcare Spending
Annual U.S. GDP vs. Healthcare Spending Growth
Source: Centers for Medicare & Medicaid Services; U.S. Census Bureau
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Business Environment
If one were to capsulate the pharmaceutical industry’s business environment into one word, it would be “hostile.”
Pressure on prices and profit margins is becoming ever more brutal with the rise of generic drugs, pharmaceutical
price controls abroad, and domestic managed care providers’ ferocious efforts to put the brakes on healthcare
costs. Moreover, the FDA’s increasing regulatory stranglehold on pharmaceutical industry products and operations
continue to raise the administrative cost of compliance. However, it’s often in the court of public opinion where Big
Pharma perhaps faces its biggest challenges; negative perceptions of the industry are easily politicized and are
often the catalyst for developments in the regulatory, legislative, and legal arenas.
The pharmaceutical industry’s regulatory, legislative, and legal backdrop is a complex feedback mechanism
constantly in flux. The Food and Drug Administration (FDA) is responsible for regulatory oversight throughout
drug development, approval, production and marketing processes. Its primary mandate is to insure user safety
while at the same time enabling medical innovations to reach patients in need of them in a timely manner. At the
same time, new bills to amend and enhance FDA’s rules processes are constantly working their way through
Congress in response to developments and unforeseen consequences that expose perceived glitches in the system.
The intensely litigious legal environment for pharmaceutical firms, both in the intellectual property and product
liability domains, is both an outgrowth of and a catalyst for legislative initiatives. And at the very crux of this
ongoing interplay is most often the very public and highly contentious relationship between public opinion and a
very well financed and connected pharmaceutical lobby.
The first section in this discussion documents the regulatory process, the legislative initiatives that formed and are
being formed by it, and the intellectual property and product liability issues that arise from it. The second section
focuses on the political forces shaping the regulatory, legislative and legal environment, namely public vitriol
against the pharmaceutical industry on myriad fronts, and the pharmaceutical industry’s attempts to quell the
ruckus and promote its interests. The final section covers the fundamental demographic and economic issues that
shape market demand for pharmaceuticals.

Regulatory Environment
The FDA Drug Approval Process
The FDA approval process covers three major types of applications for permission to market pharmaceuticals:
• Investigatory New Drug Application (INDA);
• New Drug Application (NDA); and
• Abbreviated New Drug Application (ANDA) for generic drugs.
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The chart below details the overall drug discovery, development and approval process. The source of the
discussion of each type of application that follows is the fda.gov Web site.

The Drug Discovery, Development and Approval Process




Clinical Trials

















Discovery
&
Preclinical
Testing

Phase l
Phase ll
Phase lll

FDA

Phase
lV











Years

6.5

1.5
2
3.5

1.5

Test
Population

Laboratory
and animal
studies

20 - 100
healthy
volunteers
100 - 500
patient
volunteers
1,000 - 5,000
patient
volunteers


Purpose

Assess
safety,
biological
activity and
formulations

Determine
safely and
dosage
Evaluate
effectiveness,
look for side
effects
Confirm
effectiveness,
monitor
adverse
reactions
from long-
term use

Review
and
approval
process

Success
Rate

5,000
compounds
evaluated

5 enter trials

1
approved

Additional
post-
marketing
testing
required
by FDA











Source: Pharmaceutical Research and Manufacturers of America (www.phrma.org)

The Investigational New Drug Application Process (IND)
During a new drug's early preclinical development, the sponsor's primary goal is to determine if the product is
reasonably safe for initial use in humans, and if the compound exhibits pharmacological activity that justifies
commercial development. When a product is identified as a viable candidate for further development, the sponsor
then focuses on collecting the data and information necessary to establish that the product will not expose humans
to unreasonable risks when used in limited, early-stage clinical studies.
FDA's role in the development of a new drug begins when the drug's sponsor, usually the manufacturer or potential
marketer, having screened the new molecule for pharmacological activity and acute toxicity potential in animals,
wants to test its diagnostic or therapeutic potential in humans. At that point, the molecule changes in legal status
under the Federal Food, Drug, and Cosmetic Act and becomes a new drug subject to specific requirements of the
drug regulatory system.
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There are three IND types:
• An Investigator IND is submitted by a physician who both initiates and conducts an investigation, and
under whose immediate direction the investigational drug is administered or dispensed. A physician might
submit a research IND to propose studying an unapproved drug, or an approved product for a new
indication or in a new patient population.
• Emergency Use IND: allows the FDA to authorize use of an experimental drug in an emergency situation
that does not allow time for submission of an IND in accordance with 21CFR , Sec. 312.23 or Sec. 312.34.
It is also used for patients who do not meet the criteria of an existing study protocol, or if an approved study
protocol does not exist.
• Treatment IND: is submitted for experimental drugs showing promise in clinical testing for serious or
immediately life-threatening conditions while the final clinical work is conducted and the FDA review
takes place.
The IND application must contain information in three broad areas:
• Animal Pharmacology and Toxicology Studies - Preclinical data to permit an assessment as to whether the
product is reasonably safe for initial testing in humans. Also included are any previous experiences with
the drug in humans (often foreign use).
• Manufacturing Information - Information pertaining to the composition, manufacturer, stability, and
controls used for manufacturing the drug substance and the drug product. This information is assessed to
ensure that the company can adequately produce and supply consistent batches of the drug.
• Clinical Protocols and Investigator Information - Detailed protocols for proposed clinical studies to assess
whether the initial-phase trials will expose subjects to unnecessary risks. Also, information on the
qualifications of clinical investigators--professionals (generally physicians) who oversee the administration
of the experimental compound--to assess whether they are qualified to fulfill their clinical trial duties.
Finally, commitments to obtain informed consent from the research subjects, to obtain review of the study
by an institutional review board (IRB), and to adhere to the investigational new drug regulations.
• Once the IND is submitted, the sponsor must wait 30 calendar days before initiating any clinical trials.
During this time, FDA has an opportunity to review the IND for safety to assure that research subjects will
not be subjected to unreasonable risk.

The New Drug Application Process (NDA)
The NDA application is the vehicle through which drug sponsors formally propose that the FDA approve a new
pharmaceutical for sale and marketing in the U.S. The data gathered during the animal studies and human clinical
trials of an Investigational New Drug (IND) become part of the NDA.
The goals of the NDA are to provide enough information to permit FDA reviewer to reach the following key
decisions:
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Whether the drug is safe and effective in its proposed use(s), and whether the benefits of the drug outweigh
the risks.

Whether the drug's proposed labeling (package insert) is appropriate, and what it should contain.

Whether the methods used in manufacturing the drug and the controls used to maintain the drug's quality
are adequate to preserve the drug's identity, strength, quality, and purity.
The documentation required in an NDA is supposed to tell the drug's whole story, including what happened during
the clinical tests, what the ingredients of the drug are, the results of the animal studies, how the drug behaves in
the body, and how it is manufactured, processed and packaged.
Once an approval, approvable, or non-approvable recommendation is reached by the reviewers and their
supervisors, the decision must be evaluated and agreed to by the director of the applicable drug review division or
office. For the director's review, the consumer safety officer assembles an "action package" that contains the
action letter and any data, CDER reviews and memos, and other information supporting the reviewers'
recommendation.
Following the review of the action package, the division director may begin a dialogue with the reviewers and their
supervisors. The division director generally serves as the final FDA ruling. On the day the approval action letter is
signed, the product can be legally marketed in the U.S.

Abbreviated New Drug Approval Process for Generic Drugs (ANDA)
An Abbreviated New Drug Application (ANDA) contains data which, when submitted to FDA's Center for Drug
Evaluation and Research, Office of Generic Drugs, provides for the review and ultimate approval of a generic drug
product. Once approved, the generic drug can be marketed immediately.
A generic drug product is one that is comparable to an innovator drug product in dosage form, strength, route of
administration, quality, performance characteristics and intended use. All approved products, both innovator and
generic, are listed in FDA's Approved Drug Products with Therapeutic Equivalence Evaluations (Orange Book).
Generic drug applications are termed "abbreviated" because they are generally not required to include preclinical
(animal) and clinical (human) data to establish safety and effectiveness. Instead, generic applicants must
scientifically demonstrate that their product is bioequivalent to (i.e., performs in the same manner) the innovator
drug.
Using bioequivalence as the basis for approving generic copies of drug products was established by the "Drug
Price Competition and Patent Term Restoration Act of 1984," also known as the Waxman-Hatch Act. This Act
expedites the availability of less costly generic drugs by permitting FDA to approve applications to market generic
versions of brand-name drugs without conducting costly and duplicative clinical trials. At the same time, the
brand-name companies can apply for up to five additional years longer patent protection for the new medicines
they developed to make up for time lost while their products were going through FDA's approval process.

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Biotechnology Product Development
Biotechnology firms have an even lengthier process to traverse than conventional “small molecule”
pharmaceuticals. Before getting to the three research phases of clinical testing, biotechnology firms must go
through several screening processes. Steps 1 through 6 below can take up to 10 years:

21

1. Target identification. During target identification, researchers focus on identifying genes and their
respective products thought to be responsible or causing a particular disease. For infectious diseases,
microorganisms need to be characterized. The goal in this step is to find and isolate potential arenas for
therapeutic intervention.
2. Target validation. Once a prospective disease target is uncovered, its role in the disease in question must
be determined. Methods such as differential gene expression, tissue distribution analysis, and protein
pathway studies, are used to verify the target's significance in the illness.
3. Assay development. An assay, or drug candidate screening process, must be constructed to detect the
activity that potential treatments have on the target. Ideally, a drug development screen should be cost-
effective, fast,
accurate, easy to
perform,
quantitative, and
amenable to
automation.
4. Primary screening.
Once the assay is
ready for use, the
drug developer
will conduct tests
with a library of
chemical
compounds in an
attempt to
modulate a
validated target.
Researchers look
for a predefined
minimum level of
activity against the
target. Compounds that meet or exceed this criterion are included in subsequent screens.
5. Secondary screening. This procedure is focused on confirming the activity, measuring the potency, and
assessing the selectivity of hits from the primary screen. In doing so, a drug developer identifies the most
promising drug candidates in terms of pharmacological characteristics.


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"Biotechnology," Frank DiLorenzo, CFA Biotechnology Analyst. Standard & Poor's Industry Surveys, June 10, 2004.
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6. Lead optimization. By re-screening compounds several times through the secondary screen, researchers
attempt to zero in on candidates with the best chance of safety and efficacy. New libraries of compounds
that possess superior structure-activity relationships are generated. The optimization process can include
up to 10 or more iterations on previously optimized groups of compounds.
7. Preclinical studies. Prospective compounds that exhibit the greatest activity with the least chance of
toxicity are called leads. Leads move on to a set of FDA-mandated tests, which are necessary before human
clinical trials can be initiated. These pre-clinical tests primarily involve animal studies that must prove a
compound's safety in terms of potential carcinogenicity and other toxic consequences. Additionally, drug
developers use pre-clinical testing to assess preliminary effectiveness and other pharmacological
properties of a compound. A sponsoring drug company must submit the results of preclinical testing to the
FDA as part of an Investigational New Drug application (INDA), which is a formal request for permission
to begin human clinical testing.
In late 2003, the FDA transferred the oversight of a certain class of therapeutic biologics from the Center for
Biologics Evaluation and Research (CBER) to the Center for Drug Evaluation and Research (CDER). According to
the FDA, the purpose of this transition was to provide “greater opportunities to further develop and coordinate
scientific and regulatory activities between CBER and CDER, leading to a more efficient, effective, and consistent
review program for human drugs and biologics. FDA believes that as more drug and biological products are
developed for a broader range of illnesses, such interaction is necessary for both efficient and consistent agency
action. Under the new structure, the biologic products transferred to CDER will continue to be regulated as
licensed biologics”. This class is defined as follows:
• Monoclonal antibodies for in vivo use
• Proteins intended for therapeutic use, including cytokines (e.g. interferons), enzymes (e.g.
thrombolytics), and other novel proteins, except for those that are specifically assigned to CBER (e.g.,
vaccines and blood products). This category includes therapeutic proteins derived from plants,
animals, or microorganisms, and recombinant versions of these products
• Immunomodulators (non-vaccine and non-allergenic products intended to treat disease by inhibiting or
modifying a pre-existing immune response)
• Growth factors, cytokines, and monoclonal antibodies intended to mobilize, stimulate, decrease or
otherwise alter the production of hematopoietic cells in vivo

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Non-FDA Government Regulation and Oversight
The FDA may impose a heavy regulatory burden on the pharmaceutical industry, but the Office of the Inspector
General (OIG) in the Department of Health and Human Services (HHS) and the Department of Justice (DOJ) are,
arguably, more important overseers since they can impose monstrous fines on companies for their promotional
practices.
22
Medicare Part D was implemented as of January 1, so the marketplace will not only become more
competitive on a price basis, but the government will become by far the biggest source of revenue—further
increasing scrutiny. The OIG issues guidance to the pharmaceutical industry to help them comply with Federal
health care program requirements, including the statutes, regulations and other rules governing Medicare,
Medicaid, and all other Federal health care programs. In addition, most companies choose to comply with new
guidelines from PhRMA, and the Accreditation Council for Continuing Medical Education (ACCME).
According to the OIG latest guidance documents, there are three major potential risk areas (or areas under
particularly strict scrutiny) for pharmaceutical manufacturers:
• Integrity of data used by state and Federal governments to establish payment. Many Federal and state
health care programs establish reimbursement rates for pharmaceuticals, either prospectively or
retrospectively, using price and sales data directly or indirectly furnished by pharmaceutical
manufacturers. The government sets reimbursement with the expectation that the data provided are
complete and accurate. The knowing submission of false, fraudulent, or misleading information is
actionable. A pharmaceutical manufacturer may be liable under the False Claims Act if government
reimbursement (including, but not limited to, reimbursement by Medicare and Medicaid) for the
manufacturer s product depends, in whole or in part, on information generated or reported by the
manufacturer, directly or indirectly, and the manufacturer has knowingly (as defined in the False Claims
Act) failed to generate or report such information completely and accurately. Manufacturers may also be
liable for civil money penalties under various laws, rules and regulations. Moreover, in some
circumstances, inaccurate or incomplete reporting may be probative of liability under the Federal anti-
kickback statute
23
.
• Kickbacks and Other Illegal Remuneration. Pharmaceutical manufacturers, as well as their employees
and agents, should be aware of the Federal anti-kickback statute, and the constraints it places on the
marketing and promotion of products reimbursable by the Federal health care programs. The anti-kickback
statute is a criminal prohibition against payments (in any form, whether the payments are direct or indirect)
made purposefully to induce or reward referrals of Federal health care business. The anti-kickback statute
potentially implicates not only the offer or payment of anything of value for patient referrals, but also the
offer or payment of anything of value in return for purchasing, leasing, ordering, or arranging for or
recommending the purchase, lease, or ordering of any item or service reimbursable in whole or part by a
Federal health care program.
24

• Drug Samples. The provision of drug samples is a widespread industry practice that can benefit patients,
but can also be an area of potential risk to a pharmaceutical manufacturer. The Prescription Drug


22
Pharmaceutical Executive, PharmExec.com, reports that the pharmaceutical industry paid over $3 billion in fines over the last five
years.
23

DEPARTMENT OF HEALTH AND HUMAN SERVICES Office of Inspector General Draft OIG Compliance Program Guidance for
Pharmaceutical Manufacturers
24
Ibid
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Marketing Act of 1987 (PDMA) governs the distribution of drug samples and forbids their sale. A drug
sample is defined to be a unit of the drug ‘‘that is not intended to be sold and is intended to promote the
sale of the drug’’. Failure to comply with the requirements of PDMA can result in PDMA sanctions. In
some circumstances, if the samples have monetary value to the recipient (e.g., a physician) and are used to
treat Federal health care program beneficiaries, the provision of samples may also trigger potential False
Claims Acts or kickback liability.

Key Regulatory, Legal and Legislative Issues
Generic and Branded Pharmaceutical Makers Battle it Out
At the center of the ongoing drama between innovator drug makers and the companies that wish to produce their
generic equivalents is the 1984 Drug Price Competition and Patent Term Restoration Act (nicknamed Hatch-
Waxman after its sponsors) which spawned the Abbreviated New Drug Approval (ANDA) process that enables
generics firms to rely on findings of safety and efficacy of the original innovator rather than repeat expensive
clinical and pre-clinical trials. Hatch-Waxman stipulated that the generic firm can in effect infringe an innovator’s
patent by actively developing and testing the drug before patent expiry so that it may begin marketing the drug on
the day the patent expires. As a concession to innovator firms, the amendment also gave them, under certain
conditions, the ability to extend their patent for five years beyond its normal 20-year lifespan to make up for some
of the time lost during the long and onerous development and approval process.
Hatch-Waxman’s ANDA rules offer generics firms four possible routes to market. Three routes, Paragraph I,
Paragraph II, and Paragraph III certifications, apply to ANDA filings that don’t challenge innovator patents and
enable any number of companies to bring the generic drug to market once the patent has expired. The fourth route,
called Paragraph IV certification, applies when the generic drug maker claims either that the patent is invalid or
that its product does not infringe the patent. With a Paragraph IV certification, the first company to file an ANDA
becomes eligible for a 180-day period of marketing exclusivity during which remarkable profits can be made by
pricing the generic only slightly lower than the branded drug. During the 180-day period, the FDA may not
approve other ANDAs for the same product. The 180 days start on the earlier of two dates -that on which the
generic product goes on sale or the date of a court decision declaring the patent invalid or not infringed.
The exclusivity period was intended to motivate generic drug companies to innovate around patents for brand-
name drug products, but it also resulted in a near-rote litigation process where the generic company notifies the
innovator firm of its claim that their patent is invalid and the innovator firm promptly sues for patent infringement,
which, by default, triggers an automatic 30-month stay. At that point, innovator firms typically patented new and
largely trivial aspects not related to safety and efficacy--such as in a pill's shape or color in order to trigger
additional 30-month stays. Once the new patent was filed in the “Orange Book”, where all approved drugs and
their associated patents are listed, the FDA had no power to remove it. In mid-2003, however, the FDA announced
a new rule that limits a drug company to only one 30-month "stay" of a generic drug's entry into the market for
resolution of a patent challenge.
Innovator companies still retain an arsenal of techniques to try to keep generics off the market, however. One
commonly used approach is to file for a pediatric exclusivity period. By getting the drug approved for use in
children, the brand name drug gets an additional six months of exclusivity, and for blockbuster drugs, that six
months can mean billions of dollars. Another is continued litigation. While the FDA can grant generic approvals
once the 30-month stay has expired, it can’ t prevent innovator companies from suing generic competitors. The
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deep pockets of the pharmaceutical giants and the potential sums at stake if the innovator company wins are most
times incentive enough for generic companies to back off on marketing the new drug until the cases have been
resolved.

Backroom Settlements
Other strategies to keep generics from eroding innovator company market share include payments from the brand
manufacturer to generic drug makers who have won 180-day exclusivity to keep the drug off the market. In 1999,
the Federal Trade Commission (FTC) successfully prosecuted several of these types of patent settlements, and the
pharmaceutical industry took heed. However, appellate decisions last year held that two such settlements did not
violate antitrust laws. As a result, in the six months following the March 2005 decisions, more than two-thirds of
brand name-generic settlement agreements included such terms. The following is a summary of the FTC’ s 2005
Summary of Pharmaceutical Industry Settlement Agreements:
For the first time since 1999, brand and generic companies are entering settlements in which the
generic receives compensation from the branded manufacturer and there is a restriction on the
generic’s ability to market its product. Based on the information reported in the Commission’s 2002
study and on settlements reported between 1999 and 2004, no patent settlements included both
compensation to the generic and a restriction on the generic’s ability to market its product. In
contrast, three settlements submitted in FY 2005 included those terms.
On May 17, 2006, Senator Charles Schumer and Representative Henry Waxman publicly called on the PhRMA
and the Generic Pharmaceutical Association (GPhA) to express strong public opposition to such settlements, and
issued a press release titled:
Schumer, Waxman: Dramatic Rise in Collusion Between Pharma and Generic Drug Companies is
Increasing Drug Prices Across the Board. Lawmakers call on brand name and generic drug
companies to publicly condemn backroom settlements in which big pharmaceutical firms pay
millions to keep generic drug alternatives off the market. FTC report shows 67% increase in
settlements since 2004.
25

There is no reference or response to this press release on either of the associations’ websites, and at this writing, it
is not clear whether Congress will pursue legislative recourse.
Not only are pharmaceutical companies making hay with the apparent shift in the settlements climate, FTC
Commissioner Jon Leibowitz pointed out what he called “another interesting trend“ in an April 2006 speech at the
Second Annual In-House Counsel’s Forum on Pharmaceutical Antitrust:
26

“Brand firms are not stopping after settling with the first ANDA-filer; in some instances, they are
settling with most or all subsequent filers to guarantee no generic entry by anyone until a date
certain – one that’s usually near patent expiration.”
He cited Cephalon, the brand manufacturer of Provigil, a sleep-disorder medication that garnered more than $500
million in sales in 2005, which settled pending claims with four potential generic entrants in recent months. Each
of the four agreed to stay out of the market until October 2011 and will receive collective licensing payments of


25
Congress of the United States, House of Representatives, Committee on Government Reform, 05/17/2006
26
http://www.ftc.gov/speeches/leibowitz/060424PharmaSpeechACI.pdf
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$136 million. Cephalon’s CEO explained the rationale: by settling with the generics, “[w]e were able to get six
more years of patent protection. That’s $4 billion in sales that no one expected.” While decrying the impact of
such tactics on consumer drug pricing, Leibowitz offered no view on the legality of these settlements saying that
the payments may be appropriate for the licensed IP rights.
The FTC recently released a complete overview of FTC antitrust actions in pharmaceutical services and products,
which can be found at www.ftc.gov/bc/0604rxupdate.pdf.

Authorized Generics
Another increasingly popular route for pharmaceutical companies to stem generic drug encroachment on their turf
is to issue their own generic drug when the branded drug version goes off patent. An authorized generic, as it is
called, is defined by the FDA as “any marketing by an NDA holder or authorized by an NDA holder, including
through a third-party distributor, of the drug product approved under the NDA in a manner equivalent to the
marketing practices of holders of an approved ANDA for that drug.”4
In an authorized generic agreement, the branded manufacturer can either license its product to a generic
pharmaceutical company or the brand manufacturer can market the product through an in-house generic
subsidiary. (Novartis AG, one of the world’ s largest branded pharmaceutical manufacturers, through recent
acquisitions, is now the world’ s largest generic drug producer.)
27

The practice of authorizing generics allows the original brand manufacturer to market a competing product during
the 180-day exclusivity period of the generic drug manufacturer who successfully challenged its patent. In other
words, the generic drug firm’ s hard-won 180-day exclusivity, the period in which it can reap its best profits by
being the only generic of a branded drug on the market, is no longer exclusive. A recent study by IMS Consulting
commissioned by PhRMA
28
concluded that the introduction of an authorized generic to the marketplace during a
generic maker’ s 180-day exclusive marketing period is highly beneficial to the public interest because it can
greatly reduce the cost of the generic. IMS’s research suggested that without an authorized generic on the market,
the generic with six month exclusivity is priced an average of 23% below that of the branded drug. With an
authorized generic on the market, the generic discount to brand is roughly 38%.
29

“The launch of every paragraph-IV generic expected to be a blockbuster has been met with the availability of an
AG since the fall of 2003”, according to Fenwick & West LLP, and, naturally, the generic drugs industry is
screaming foul. The Generic Pharmaceutical Association charges PhRMA with obfuscating the true cost of
authorized generics both by using pricing at the manufacturer, not consumer level, in its analysis. It also charges
that authorized generics violate the intent of Hatch-Waxman, which was to create an incentive for generic firms to
challenge branded drug patents with a period of market exclusivity in order to bring less expensive generic drugs
to the market faster. And, it warns that by effectively taking away the lucrative 180-day exclusivity incentive,


27
Battle over authorized generics grows increasingly heated, Drug Topics, 04/01/2005
28

Assessment of Authorized Generics in the U.S., IMS Consulting, Spring 2006

29
Ibid
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much fewer questionable patents will be challenged by generics firms, and drug prices will remain higher than
they otherwise would.
30

The generic drugs industry has thus far the loser on this issue as a string of court cases and the FDA have come
out on the side of authorized generics based on the argument that multiple players foster more competition and
lower prices to the consumer. However, Congressman Waxman has publicly stated that authorized generics violate
the purpose of the 180-day exclusivity period, and at the end of March 2006, after much lobbying from a wide
range of constituencies accusing Big Pharma of trying to weaken the generic drug industry, the FTC announced it
will embark on a study of the competitive impact of authorized generic drugs.

Yet Another Salvo in the Big Pharma Assault on Generics?
When Zocor, Merck’ s $4 billion blockbuster cholesterol drug went off patent in June, 2006, Merck launched an
assault on the 180-day exclusivity held by generic producers Teva Pharmaceutical and India-based Ranbaxy for
different strengths of the pills by slashing the price of Zocor for two of the largest US health insurers – United
Health Group Inc and WellPoint Inc. Zocor was the biggest selling drug yet to be opened to generic competition
and the move sent shockwaves through the generic drug industry. While Merck’ s move affected only an
estimated 10-20% of the market,
31
it could herald future moves by other companies to undermine generic drug
industry strength. Ultimately, continued use of this tactic could deal another sharp blow to expected profits during
generic drug makers’ highly coveted 180-day exclusivity period, and would likely have the effect of dampening
the rate at which generic drug firms file Paragraph IV certifications that force branded drug firms to litigate in
protection of their patent. Teva is reportedly weighing legal action and NY Senator Charles Schumer has requested
an FTC investigation.

Canadian Drug Imports Redux
The letter of the law, when it comes to the Food and Drug Administration Act, is clear on the subject of Canadian
drug imports: even when manufactured by U.S. firms exporting into Canada, they don’t comply with FDA labeling
standards amongst others, are not under FDA oversight, and, simply, are illegal. Nevertheless, the brute force of
the multitude of constituencies clamoring for lower prescription drugs prices from across the border keep the issue
thriving in Congress. The dance is often the same: bills that arise in the Senate or the House subsequently die in
conference between the two and even should one survive, the Bush Administration has been adamantly opposed to
the re-importation of U.S. drugs from Canada.
The fact is that U.S.-made branded drugs are often significantly less expensive in Canada because of price controls
and the price differential is such that individuals and even municipalities seeking to lower healthcare costs have
been and continue to import drugs from Canada. The predominant legislative emphasis is not on challenging the
illegality of Canadian drug imports per se, but rather enforcement of the law. While importing drugs into the
United States is illegal, the FDA generally has not stopped small amounts purchased for personal use. However,


30

GPhA Statement on PhRMA Assessment of Authorized Generics, www.gphaonline.org

31
Merck's Zocor price cut a mixed bag for drug cos, India Times, 07/10/2006

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Customs and Border Protection began seizing controlled substances in September 2004, and expanded that
operation last November to include non-controlled substances. Since then, customs officials have reportedly seized
an estimated 34,000 packages of drugs coming into the country.
The latest Congressional attempt to enable individuals to bring less expensive Canadian drugs into the U.S. has
been slipped into the Senate’s $31.7 billion Homeland Security Department spending package. Arguing that
Customs and Border Protection should focus on the war on terror, the plan proposes to prohibit Customs and
Border Protection from stopping people with doctors' prescriptions for FDA-approved drugs from bringing the
medicine into this country from Canada. The proposal, which was approved 68-32, is vociferously attacked by
Senate Republican leaders and industry observers expect it, like others attempting to loosen enforcement of
Canadian drug re-importation, will ultimately be stripped from the spending package.
Safety, labeling, and drug counterfeiting issues aside, the sheer economics of Canadian drug re-importation en
masse are untenable; a country with a population of 30 million couldn’t conceivably supply a U.S. population 10
times that size with price-controlled pharmaceuticals without U.S. manufacturers limiting the quantity of drugs
they’re willing to sell Canada at the artificially depressed prices necessitated by the national Canadian health care
system. According to Robert Goldberg, director of the Manhattan Institute's Center for Medical Progress, "In the
past five years, Canadian Internet pharmacies have made a bundle arbitraging between the Canadian government's
set price on the handful (about 35-50) of drugs that are profitable and plentiful enough to sell back to the United
States (plus a hefty handling fee). As this business has grown, American companies have responded by holding