Case study example: Pharmaceutical company owned by a PE firm
Our client is a PE firm which has just bought out a profitable orphan pharmaceutical drug manufacturer that has a market leading drug for acute involuntary eye spasm or commonly known as dancing eye syndrome. The company has a pattern for their drugs which expires in 10 years. The company has an average annual revenue growth rate of 5% but the PE firm has set a target for at least 10% in order to justify their investment. Also, the client has stated that their R&D spend is falling and is below what has been allocated for the R&D department and they have little insight into how the R&D department works.
The client has asked you, what are your initial thoughts on the issues facing the company from decrease R&D spend to how should they approach increasing revenue?
Step 1: Get clarification
First, get clarification on what is an orphan drug company?
Answer: it’s a pharmaceutical company that specialise in treating rare diseases which affects less than 200,000 individuals and they develop and sell prescription drugs only.
Also, get clarification on how realistic are the growth rates set by the PE firm within the orphan drug pharmaceutical space?
Answer: It seems realistic and in line with comparable companies.
Third clarification question is do they operate nationally or internationally? as this is important because the pharmaceutical industry is heavily regulated in different jurisdictions and if you are an American company, then health insurance firms have barging power, but in the European Union regulators and governments have bargaining power which will influence the pricing of the drugs and ergo the profitability potential for this firm.
Answer: Currently the firm operates in the U.S. only.
Now, for arguments case and to keep this scope of this case manageable within the time frame we are going to assume they only sell within the US only for now. Also, they can not increase the price of their drugs anymore without the risking bad press since they are already charging at the higher end.
The final clarifying question is what is the company’s product offering and how to they differ from the competitors?
Answer: The company main drug is a market leading drug for the treatment of dancing eye syndrome and this particular drug currently has no competition.
Questions 1: What do you suspect is the client key issues and problem for our client?
Firstly, to summarise I see that our client the PE firm has bought an orphan drug pharmaceutical company which a track record of 5% year-on-year sales growth but wants to double revenue before the patent expires and the market is flooded with cheaper generic drugs.
Second, I believe their more significant problem is not adequately preparing for the future. By not spending the appropriate amount on R&D to fund the development of new drugs to support the company’s growth after their current pattern expires. I suspect after the recent acquisition of this pharmaceuticals company by this PE firm that there have been R&D issues internally, possibly with staff leaving? this is obviously a serious issue because without appropriate investment into new R&D immediately, this will slow down getting regulatory approval from the FDA to begin trails of new drugs and to eventually lunch the product. Unless significant changes occur within the R&D department it looks like R&D spend will remain flat or even continue decreases.
Third, I suspect that the head of R&D might have left the company after the acquisition and this lack of skill, leadership and communication by the head of R&D to communicates to the board of directors on future product development is what might be fulling concerns of the pharmaceutical firm new owner, hence why they have approached us. Given the board of directors would normally get assurance over where the future product development and revenue will come from and without a good understanding of R&D and knowing what is affecting the drug pipeline will continue to put downward pressure on revenue growth.
Question 2: What initial suggestion do you have to improve revenue growth and addressing the R&D issue.
To answer the initial question concerning revenue we can use the profit framework to just analyse the revenue section by creaking down the simple formula of Revenue = Price X quantity.
To use the formula and analyse the firm’s profit, let’s begin by looking at price and since this is an orphan pharmaceuticals company then we can assume prices are already pretty high given the limited pool of recipients to recuperate the cost of manufacturing and profit. Also, as mentioned in the brief, the company cannot increase prices higher without negative media attention which would be bad for the future of the company. This leaves us with finding a way to expand quantity in order to boost revenue.
Ways to increase quantity would be to sell more to existing customers and sell to new customers via M&A.
- The company can organically increase the overall market share by addressing relatable disease to the current one.
- Inorganic growth via M&A, the firm can acquire another pharmaceutical drug company within either a related field or completely different to access a new market to sell to or a relatable market where we can cross sell
- In the long run we can develop version 2 of the market leading drug so when the IP runs out the firm can pattern V2 with new added benefits to the original and plus from the original manufacturer of the market leading drug
- In terms of organic international growth, we assume we cannot expand into new geographical areas such as the EU or ASIA without taking a significant price cut or having to jump through significant paperwork and approval
Next, addressing the R&D issue of failing R&D spend and not maximizing budgets. It seems something has happened for the R&D department to not use all of the allocated funds at their disposal. I suspect when the PE firm acquired the pharma company there might have been some disagreements between the head of R&D.
Question: do we know if anything has changed within the R&D department at the firm?
Answer: Yes, the head of R&D left.
Well this might have come about because of the following problem
- Post-acquisition of the firm, the R&D head did not get any compensation or was not happy with the level of incentives offered and thus decided to leave
- Also, budget controls was not agreed after acquisition by the head of R&D which meant it was hard for the head of R&D to continue normal and thus decided to leave.
- Alternatively, the Head of R&D was not up the task of developing another bread breaking super drug
- Another reason why the head of R&D could have left maybe because of a lack of R&D talent within the department or lack of talent to support or retain talent or not enough good projects to spend the cash on
Clearly the company will not be able to function without appointing a new head of R&D either by promoting internally or hiring externally. This is time sensitive, as future cashflow will depend on the success of R&D which we all know takes a lengthy time from development to product lunch and will be critical for the long term viability of this firm so the sooner this gets done the sooner the company can get on track to meting future cash flow and profitability targets.
In terms of the more immediate revenue generation needs, and considering the restrictions on price control. I believe the most efficient way to expand market share would be to acquire more market share, the PE firm might want to consider an M&A and acquire another pharmaceutical company within a different field with the capacity to take on this company’s R&D needs if we are struggling to find talent. This will allow the PE firm to consolidate the R&D department, sales force and backend office and office space cost, which will all create cost synergy. I believe this can be achieved well within 3 years.
