Drivers of Pharmaceutical Industry Investment July 20061

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Drivers of Pharmaceutical IndustryInvestment

Understanding Australias Competitive Position

September 2006

Final Report to Medicines Australia and Research Australia


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The Allen ConsultingGroup ii

The Allen Consulting Group Pty Ltd

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Disclaimer:

While The Allen Consulting Group endeavours to provide reliable analysis and believes thematerial it presents is accurate, it will not be liable for any claim by any party acting on suchinformation.

The Allen Consulting Group 2005


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The Allen ConsultingGroup iii

Contents

Executive summary 1

Important changes in the global industry 1

Investment drivers 2

Things that need to be done to improve the chance of attractinginvestment to Australia 4

The Australian situation 4

Key challenges for Australia 6

Possible actions for Australia 9

The payoff to Australia 10

Chapter 1

The pharmaceutical industry: key features and trends 12

1.1 Profile of the global pharmaceutical industry 12

1.2 Profile of the Australian pharmaceutical industry 17

1.3 The wider benefits of the pharmaceutical industry to Australia 20

Chapter 2

Drivers of investment across the value chain 25

2.1 Investment decisions general considerations 25

2.2 Investment decisions pharmaceutical industry specifics 282.3 Discovery R&D investment: trends and drivers 29

2.4 Clinical trial R&D investment: trends and drivers 35

2.5 Manufacturing investment: trends and drivers 38

Chapter 3

Australias competitive position 44

3.1 Key features of the Australian investment climate 44

3.2 Overall perception of Australian investment 45

3.3 Assessment of the competitiveness of the Australian environmentfor discovery R&D investment 48

3.4 Assessment of the competitiveness of the Australian environmentfor clinical trial R&D investment 54

3.5 Assessment of the competitiveness of the Australian environmentfor manufacturing investment 60


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The Allen ConsultingGroup iv

Chapter 4

The outlook for the Australian pharmaceutical industry 65

4.1 Maintenance of the status quo: industry erosion 65

4.2 The likely impact of the Action Agenda on the status quo 66

4.3 Interventions that are required to generate step changeimprovements in activity, outcomes 66

4.4 Mapping the socio-economic payoffs of decisive action 72

4.5 Conclusions and recommendations 80

Appendix A

Incentive programs in Australia 81

A.1 Past incentive programs 81

A.2 Current incentives 83

A.3 Future incentives? 85

Appendix BReferences 87


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D R I V E R S O F P H A R M A C E U T I C A L I N D U S T R Y I N V E S T M E N T

The Allen ConsultingGroup 1

Executive summary

The pharmaceutical industry is one of the most knowledge-intensive industries

in many ways it is the classic science-based industry with new products emerging

from research breakthroughs and general developments in scientific knowledge.Maintaining a supply pipeline of innovative drugs is an imperative for longer-term

success.

The leading companies devote around 18 per cent of their turnover to R&D and

employ large numbers of highly qualified research staff. For example, in 2004

Pfizer, the worlds largest pharmaceuticals company, spent approximately $US7.7

billion on R&D out of revenues of $US50 billion. The industry accounts for a

significant proportion of total business R&D globally. The market capitalisation of

the leading companies is very large, placing these companies among the biggest in

the world by this measure.

In the main, the innovative pharmaceutical companies have tended to locate their

corporate R&D labs in North America and Western Europe. For a number of

reasons, clinical trials, where scale economies do not play such an important role as

they do with discovery research, are conducted in many locations.

Large scale manufacturing of active ingredients tends to be concentrated on a

relatively small number of highly capital-intensive plants. The output of these

plants is provided to formulation and packaging plants, which are more

geographically dispersed in their location and generally speaking, operate at

somewhat smaller volumes than actives plants.

Important changes in the global industry

Over the last decade there has been a process of consolidation and rationalisationunder way in the global pharmaceutical industry. Mergers and acquisitions among

the leading companies are likely to continue to be driven by the economic realities

of the high costs of R&D, shortening product life cycles and large marketing field

forces, and by the increasing difficulty of generating blockbuster drugs. More

recently, the biotechnology revolution, especially in genomics and proteomics, has

caused the leading innovative pharmaceutical companies to go outside their

corporate labs in search of new drug candidates. This has resulted in a rise in extra-

mural R&D and the establishment of strategic alliances with small biotechnology

companies.

Generic drugs are becoming more important as large selling prescription drugs

come out of patent protection and governments around the world seek to contain

medical costs.

Reflecting the nature of the pharmaceutical industry, countries are competing

actively to attract investment in both R&D and manufacturing. Ireland and

Singapore in particular offer generous tax arrangements to attract major actives

manufacturing plants. Singapore is seeking to build up its biomedical research base

to attract R&D by the pharmaceutical companies.

The recent rise of biopharmaceuticals has also altered the research landscape and

opened a new field of competition in addition to traditional small molecule


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chemistry research. Biopharmaceutical manufacturing tends to be smaller in scale

and more complex in resources required than traditional manufacturing operations.

This represents a comparatively new area of research where young firms might be

able to gain a foothold in the future industry through alliances with large

pharmaceuticals that bring development and marketing expertise to small players

with innovative ideas.

New realities are also being created in the global market for pharmaceuticals as

China and India emerge as significant markets and manufacturing locations, and

have ambitions to develop their R&D capabilities. Similarly, the countries of

Central and Eastern Europe have emerged with India as potential new places to

conduct clinical trials.

Investment dri vers

The global pharmaceutical industry is dominated by foreign-owned multinational

enterprises. This is true in Australia as well, although there are some Australian

pharmaceutical companies, such as CSL and IDT. Nevertheless issues of

investment from the Australian perspective focus heavily on the attraction andretention of foreign direct investment in the pharmaceuticals industry. A major

focus of this report is to provide insight into the drivers of investment by the

innovative pharmaceutical industry in R&D and manufacturing and to get an up to

date reading of the attitudes of the multinational pharmaceutical companies to

investing in Australia.

The basis upon which decisions are taken

In industries in which there are many competing companies and R&D and patent

protection plays a limited role, investment decisions tend to be based on purely

economic factors. Companies will locate their R&D and production facilities

based on the consideration of economic factors, which loom large in determining

the rate of return expected from their investments, such as:

availability of key factors of production and other specialised resources;

costs of production;

ability to achieve necessary quality standards;

reliability of supply; and

access to key end user markets.

The literature on direct foreign investment suggests that the investing firm is

generally looking for one or a mix of three main types of advantages in making

foreign investment decisions:

access to low cost facilities;

access to specialised resources of one kind or another; and

access to markets.

Given that most developed countries, and many emerging countries, have low tariff

barriers, the need to invest in a particular country to access its market is much less

than it was in the past, although this consideration still plays a role in large


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emerging countries like China and India. Our focus in this report is on the first two

sources of advantage generally speaking, the worlds leading pharmaceutical

companies are able to access the Australian market without the need for local

production facilities.

Underlying the distinction between investments driven by the search for lower cost

locations (cost driven investments) and those driven by the search for specialisedresources (non-cost driven investments) is a difference between generalised and

specialised resources. The former are resources that can in principle be operated

equally well in a large number of countries. Specialised resources are by their

nature much more differentiated in terms of their quality and productivity and tend

to be much more country specific. Important examples for the innovative

pharmaceuticals companies are a high quality local science capability and a strong

clinical research base.

The importance of strategic factors in investment decisions

Prima facie, in industries such as pharmaceuticals where competition takes place

among the few, where R&D plays a large role, where patent rights are important

and where governments intervene heavily in end markets to determine entry

conditions and pricing, strategic factors can also come into play in investment

decision making as boards of global companies view countries for investment

purposes on how they contribute to their overall competitiveness. The importance

of strategic factors was clearly articulated by the British Pharma Group in its 2005

submission to the UK government:

Location decisions are increasingly taken from the perspective of their effect on the overall

competitiveness of the global firm.1

Just how important these kinds of factors are in practice is difficult to establish with

precision. On the other hand, it would be dangerous to assume they can be ignored

as they appear to influence perceptions held by the worlds leading innovative

pharmaceuticals companies about the attractiveness or otherwise of investing inparticular countries. For example, strategic factors clearly appear to have influenced

investment decisions in New Zealand, where its reimbursement scheme and small

market size have resulted in a significant reduction in pharmaceutical industry

activity.2

The influence of strategic factors can also be observed in Western Europe,

where rates of growth in R&D investment have slowed in Europe, with

reimbursement regimes cited as a significant contributing factor. This would

suggest that there is a nexus between the underlying economics of the prospective

project and other factors, such as market size and reimbursement schemes. As many

nations are competitive in economic terms, strategic factors become increasingly

important. Strategic factors can affect the general level of investment attention and

effort that a country receives from key decision makers within a firm and in some

cases may impact on decisions between competing investment locations.

1

The British Pharma Group is comprised of GSK and AstraZeneca, which represent a significant proportion ofthe UK market. In 2004, these two companies invested 1.8 billion in R&D in the UK, out of a total globalR&D spend of 4.7 billion. This level of investment made The British Pharma Group companies the first andsecond largest private sector contributors to R&D in the UK. As well as R&D, these companies also conduct asignificant amount of their manufacturing in the UK, generating exports worth 6.5 billion in 2004. Source:British Pharma Group, 2005, The British Pharma Group (BPG) on Competitiveness and Investment Criteria.

2

Clarke, Lesley, 2005, Lessons from the Kiwi Model, Researched Medicines Industry Association of NewZealand, Conference paper from The Future of the PBS, 24 August 2005, Sydney.


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Things that need to be done to improve the chance of attracting

investment to Australia

Faced with the reality that the leading innovative pharmaceutical companies

account for a very substantial part of R&D and manufacturing investment in the

industry, and understanding the basis upon which companies are thought to take

decisions, potential host governments have tended to take two kinds of action toimprove the prospects of attracting pharmaceutical investment.

First, reflecting the view that economic factors drive investment decisions, to

attract and retain investment, they have sought to use appropriate levers for

securing various types of investment. For example, with regard to attracting

discovery research investment, which is driven by the search for good ideas, host

countries have invested in their research related specialised resources and

capabilities that are most relevant to the interests of the pharmaceutical industry.

They have also in some cases offered generous R&D tax credits. To attract clinical

trials they have sought to improve the efficiency and effectiveness of their

regulatory systems governing the conduct of such trials, and have sought to align

their clinical practice with world standards. To attract and retain manufacturinginvestment, especially large scale investment in actives plants where cost drivers

predominate in importance, some governments have offered extremely generous

taxation arrangements.

Second, reflecting the view that strategic factors as well as economic factors

drive investment decisions, some countries have engaged with the innovative

pharmaceutical companies to strike balances between obtaining the lowest possible

price for pharmaceuticals and providing incentives for the development of

innovative drugs. Such incentives can come in the form of pricing behaviour, patent

life protection or direct subsidies for some products. Countries have also sought to

convey clear messages to the innovative pharmaceuticals companies at the highest

levels that they value their presence and will make every effort to understand their

investment drivers and take appropriate action to provide an attractive environmentfor them beyond issues of pricing and remuneration.

The Australian situation

Reflecting Australias small share of world GDP, the pharmaceutical industry in

Australia is a relatively small part of the global pharmaceutical industry.

Nevertheless, the industry contributes a significant proportion of total business

R&D in Australia and is one of Australias leading exporters of elaborately

transformed manufactured products.

The Pharmaceutical Industry Action Agenda is based on the proposition that the

potential for Australian industry to grow is substantial and that it could double itsshare of the global pharmaceutical industry by 2012.

Strengths

Australia has a number of strengths when competing for pharmaceutical investment

in R&D and manufacturing. Key strengths include:

the existing Australian operations of the leading innovative pharmaceuticalcompanies, plus some significant Australian owned companies;


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the presence of a strong bio-medical research capability;

a first world hospital and medical system; and

a growing number of emerging bio-medical companies with intellectualproperty relevant to the drug development process.

Looking at the different elements of pharmaceutical industry investment in R&Dand manufacturing the key strengths possessed by Australia in relation to them are:

Discovery Research

A strong bio-medical research base in both the medical research institutes

and the leading research based universities.

International recognition of the quality of Australian bio-medical

researchers.

An emerging set of bio-medical companies.

Clinical trials research

A first world hospital and medical system and a strong reputation for

carrying out high quality clinical trials.

An historically competitive cost base for conducting clinical trials.

Manufacturing

A number of formulation and packaging manufacturing plants that are able

to produce competitively a wide range of products at relatively small

volumes.

Weaknesses

At the same time that Australia possesses strengths in relation to pharmaceuticalsinvestment in R&D and manufacturing, it also suffers from some weaknesses in

relation to their respective elements. They are:

Discovery Research

Distance from the main corporate R&D laboratories of the worlds leading

innovative pharmaceuticals companies and the decision makers that

determine their targets and priorities. This creates difficulties in establishing

effective relationships with key decision makers.

The fragmentation of the research base across a large geographic area,

which can render commercialisation efforts more difficult and has in the

past limited some networking among Australian scientists.

Innovation gaps in infrastructure, funding and skills, in both medicinal

chemistry and biopharmaceutical R&D. These gaps are critical in that they

risk either the value of the idea being overlooked because it is perceived to

be too risky, or the intellectual property being purchased and

commercialised overseas, such that the benefits of the innovation are

captured by other parties.


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Clinical Trials Research

The number of different ethics bodies involved in granting approvals for

multi-site clinical trials to proceed (usually with different requirements for

format and content), which creates inefficiencies in the Australian

approvals process and increase the average times required for trial

completion.

Manufacturing

The lack of taxation and other incentives to match the offers being made by

competitors which means Australia cannot compete in attracting large scale

actives plants and risks losing competitiveness in other capital intensive

manufacturing plants.

Australias competitive position is also weakened by its current reimbursement

scheme. This study updated the 2001 survey of headquarter office perceptions of

Australia as an investment climate conducted by the Lewin Group. The findings of

this updated survey show that Australia overall ranks as About the same or

Worse as an investment location than the US, the UK, Singapore, the EU andCanada. Additional consultations with industry indicated that this negative

perception of Australia as an investment location by global company headquarters

is in the main due to the negative messages generated as a result of the

reimbursement environment.

Key challenges for Australia

Despite its considerable strengths, the global and domestic environments affecting

the pharmaceuticals industry mean that Australia is currently facing some major

challenges at key points in the value chain. Australias ability to tackle these

challenges will influence whether or not the Australian pharmaceuticals industry is

able to meet the goal in the Pharmaceuticals Industry Action Agenda of doubling its

share of the global industry by 2012.

Discovery Research

While Australia has a high quality biomedical research capability that punchesabove its weight in terms of contributing to global biomedical research, there

are very considerable challenges in ensuring that it is well connected to the

requirements of the multinational pharmaceuticals companies. This includes in

the main the need to ensure that the infrastructure, funding and skills are

available for Australian researchers to progress their research to commercially

viable stages of development.3

Clinical Trials Research

Australia has considerable advantages as a location for conducting high qualityclinical trials and until quite recently expenditure on clinical trials has grown

rapidly. The outlook is now more challenging as new cost competitive

locations to conduct clinical trials emerge in Asia Pacific and Central and

Eastern Europe. Also there are concerns about threats from possible changes in

3

In terms of small molecule development, there is currently a gap in skills and funding for medicinal chemistryresearch, which is required to bring small molecule projects beyond a proof of concept phase. From the

biologicals perspective there is currently a gap in scale-up biomanufacturing, which frustrates the commercialdevelopment of biological drugs.


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the regulatory system in Australia, flowing from the Bansemer Reports

recommendations to separate ethics and scientific approval processes4

, which

could introduce further costs and delays to the commencement of trials.

Manufacturing

There is a concern that with no incentives being provided to anchormanufacturing in Australia, let alone attract new manufacturing facilities, there

is the risk of a gradual run down in investment. This stems from the fact that

the technology of some Australian plants is becoming outdated, and there is

therefore an increasing likelihood of manufacturing moving to more attractive

locations offshore where pharmaceuticals investment is being actively sought.

The Pharmaceuticals Industry Action Agenda has identified a market failure inbiopharmaceutical manufacturing: demand for biomanufacturing facilities is

too lumpy and fragmented to be economic for any existing players to make a

unilateral investment in such facilities. However, without investment by either

a large pharmaceutical or an Australian government, this will continue to be a

gap in Australias infrastructure that could frustrate industry development.

The influence of the PBS negative head office perceptions of Australia, risks

arising from monopsonistic power

According to the survey conducted of perceptions by the headquarters of themultinational pharmaceuticals companies to investing in Australia,

5

the

Australian environment is not seen to be welcoming compared to those offered

by competitors in Asia Pacific and elsewhere. According to the updated

survey, the only country against which Australia compares well is New

Zealand, which has recently experienced disinvestment by the worlds leading

pharmaceuticals countries (See Figure ES.1).

Consultations with industry indicated that this overall negative perception of

Australia as an investment location by global company headquarters is in themain due to the negative messages generated as a result of the reimbursement

environment. During interviews with both local offices and headquarter

management, the clear message from industry was that key head office

decision makers receive a stream of negative messages from their Australian

affiliates, arising from reimbursement issues such as reference pricing

outcomes, time and costs required to list, PBS restrictions on volume, ad hoc

reimbursement policy changes (such as the 12.5 per cent price regulation), and

so on. The negative perceptions so created become the lens through which

Australia is viewed and, all other things being equal, exert a chilling effect on

potential investments in Australia.

4

Banscott Health Consulting Pty Ltd., 2005,Report of the Review of Access to Unapproved Therapeutic Goods,22 February, p16.

5

This updated the 2001 survey conducted by the Lewin Group for the Pharmaceutical Industry Action Agenda.See The Lewin Group, 2001, Analysis of Investment Decisions by the International Pharmaceutical Industryand the Competitive Position of Australia, presented to the Pharmaceuticals Industry Action Agenda, WorkingGroup 2, Strategic Factors and Decision Making for Investment, December.


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Figure ES.1

SURVEY OF HEADQUARTER PERCEPTIONS AUSTRALIAS OVERALL

INVESTMENT POSITION (2005)

Austra

liaco

mp

aredto

theUS

Austra

liaco

mp

aredto

theSingap

ore

Austra

liaco

mp

aredto

theUK

Austra

liaco

mp

aredto

theEU

Austra

liaco

mpa

redto

Canada

Austra

liaco

mp

ared

toNewZea

land

Much better

Better

About the same

Worse

Much worse

Moreover, the negative perception of Australia as an investment climate is also

linked to clear concerns about the long run impacts of growing monopsony

power by governments worldwide on innovation and the viability of the

pharmaceutical industry. In the situation of low margins across all

pharmaceutical products (the worst case scenario), in the long run this would

result in not only reduced output, but also reduced investment in R&D,

reduced innovation for consumers, and in turn threaten the viability of the

industry, as labour and capital would migrate into other, more profitable

industries.

To the extent that Australia is viewed to materially contribute to this long runrisk of untenable price reductions for the industry (due to global pricing

considerations, parallel import concerns and the export of its reimbursement

schemes overseas), Australia is in danger of being characterised by local and

head office managers as a country where investment should be limited where

alternatives exist.


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Possible actions for Australia

In order to position Australia to achieve the goal, articulated in the Pharmaceutical

Industry Action Agenda, of doubling Australias share of the global industry by

2012, a range of policy interventions should be considered. This report sets out four

broad areas for intervention that are required if significant industry growth is to be

achieved.

Reform the PBS to send a strong, positive signal to industry and improve headoffice perceptions of Australian market Several studies examining the link

between investment patterns of MNEs and reimbursement schemes have

shown that there is a discernable relationship between pricing arrangements

and pharmaceutical industry investment. Clear examples of reductions in

prices for patented products leading to reductions in industry investment

include New Zealand6

and Germany.7

Conversely, it has been argued that

Quebec stands out as a case where strong patent protection (via the 15-year

rule) has been rewarded with significant additional investment by the

pharmaceutical industry.8

Consultations with industry and the survey of

headquarter offices suggested that the current reimbursement arrangements inAustralia may already affecting industry decisions in the context of an

increasing adoption of pricing models (similar to the Australian PBS)

worldwide.

The strongest possible signal the Australian government could send to industry

would be to reform the pricing and listing environment for innovative

medicines to address the negative perceptions of the Australian market that

currently limit MNE interest in investing in Australia. This is in line with the

Action Agendas goal of raising the profile of the industry globally to increase

attention paid by MNEs. This reform would also support the National

Medicines Policy goal of fostering a vibrant medicines industry, and further

would result in coherence between Australias health policy actions and its

industrial policy aims.

Close the innovation gap and encouraging scale among researchers TheAction Agenda currently has a taskforce charged with bringing a mammalian

cell biopharmaceutical plant into Australia and the R&D Taskforce has also

been developing strategies for developing improved IP outcomes beyond the

skills of individual scientists. The Government should support all efforts to

bring this into the market if it is serious about developing Australia as a key

alliancing-opportunity region. In addition to these actions, to close the

innovation gap Government also needs to:

provide support for additional medicinal chemistry infrastructure and skills

development;

review current grant structures in light of adverse behaviours around patent

uptake and renewal; and

6

Data on company disinvestment is supplied in Chapter 2. See also Clarke, L., 2005,Lessons from the KiwiModel, Researched Medicines Industry Association of New Zealand, Conference paper from The Future of thePBS, 24 August 2005, Sydney and the Boston Consulting Group, 2004, Pharmaceutical Companies and

Biotechnology Cluster Development: New Zealand Case Study.7

Gilbert, J. and P. Rosenberg, 2005,Addressing the Innovation Divide, Annual Meeting 2004 Governors of theWorld Economic Forum for Healthcare, 22 January, Davos.

8

The Quebec Department of Finance, Economics and Research, 2003,An application of the computable generalequilibrium model for Quebec: Impacts of the abolishment of the 15-year rule, Canada.


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examine alternatives for funding proof-of-concept and other preclinical

research in light of low private venture capital involvement in Australia.

Address the current threats to clinical trials R&D The major threats toAustralias current strong clinical trials R&D track record are:

added regulatory requirements recommended in the Bansemer Report that

may delay trial completion times, such as those that may arise due to

separations of scientific and ethical evaluations;

lower cost competitors in trials and services, including Phase II and III

trials (where the majority of growth has been since the introduction of CTN

trials) and bio-informatics services; and

current reimbursement policies, which may reduce clinical trials activity

because companies will not want to conduct trials in countries where they

do not intend to apply for listing.

There are currently efforts underway to address existing inefficiencies as well

as potential future hurdles. These actions need to be supported. There should

not be any separation of scientific and ethics assessments and further, mutualrecognition of an accredited, lead HREC should become the model for

regulation of unapproved therapeutic goods in Australia. This should result in

lower average times to approval, without reducing the safety or ethicality of

trials. Moreover, it should result in a more consistent trials process.

In addition to the above efficiency improvements, the Government will need to

take action to address the growing impact of the disparity between labour costs

in Australia compared to other regional competitors such as India and China.

This may be accomplished through the successor program to the P3 scheme,

and should be a major consideration to the development of the design of this

industry program.

Develop competitive incentives for R&D and targeted manufacturinginvestments The current policy settings in Australia are demonstrably

uncompetitive by international standards. Existing support programs do not

drive the type of investment in R&D, manufacturing, services and partnerships

that will be required to meet the Action Agendas goal of doubling Australias

share of the global industry by 2012. Australias industry programs are too

small to alter the calculus of the manufacturing decision and arguably have not

resulted in additional R&D investment above what would have occurred in

their absence.

Having regard to global competition and the lessons learned from existing

programs, a set of incentive programs need to be created that is competitive in

terms of attracting R&D investments and manufacturing.

The payoff to Australia

The pharmaceuticals industry is one of the world's leading knowledge-based

industries and is currently being heavily impacted by the biotechnology revolution

that is changing the nature of the products it creates and the business models it uses.

Within Australia, the industry is active across the value chain from discovery R&D,

to clinical trials, to manufacturing and sales. Foreign direct investment, in addition

to the growth of domestic players, is important to the development of industry


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activity. Australias pharmaceuticals industry makes a significant contribution

through a variety of channels to the economy and, through the supply of innovative

drugs, to the community's health and standard of living.

Reflecting its value to the economy, the Governments of many countries are

seeking to make their environments attractive for investment by the world's leading

pharmaceuticals companies in R&D and manufacturing. They are seeking to ensurethat their environments for R&D and manufacturing are world class. Australia,

which already possesses a significant pharmaceutical industry, faces an increasingly

competitive global market to attract and retain pharmaceutical industry investment

in R&D and manufacturing.

If the environment facing the industry can be made world class, the value to the

community is potentially very large. The main benefits are:

the maintenance of a viable pharmaceuticals industry and continued supply ofinnovative pharmaceuticals, which provide quality health outcomes for

Australian consumers;

the provision of highly skilled and well paying jobs (the industry currentlyemploys around 36,000 people, at an average wage near double that of the

average wage for other manufacturing jobs), which in turn result in

productivity spillovers in other industries;

investment both directly in the industry and indirectly in its supplyingindustries;

growth in exports of elaborately transformed manufactures, which in turncontributes to Australia's reputation as an innovative country (the industry is

Australias third largest elaborately transformed manufacturer, with exports of

roughly $2.6 billion annually) as well as growth in GDP; and

partnerships with Australias world class biomedical researchers and hence anincreased return to the nation on the public sector investments in medical and

health research.

The pharmaceuticals industry is already one of the leading contributors to business

R&D in Australia and to exports of elaborately transformed manufactures.

However, as identified in the Pharmaceuticals Industry Action Agenda the potential

exists to double the share of the pharmaceuticals industry in the global industry by

2012. If appropriate actions are taken this ambitious goal can be achieved. If they

are not, the risk is that pharmaceutical industry R&D and manufacturing capability

will be run down and a major opportunity for growth in a knowledge-based industry

well suited to Australia will be lost.


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Chapter 1

The pharmaceutical industry: key features andtrends

This chapter provides an overview of the pharmaceutical industry. It first discusses

the industry in the global context identifying the market players, their traditional

business model and how this has influenced investment patterns, as well as the

recent trends shaping current and future decision-making. The chapter then draws

out the Australian experience from this global backdrop.

1.1 Profile of the global pharmaceutical industry

Key players

The global pharmaceutical industry is dominated by large multinational enterprises

(MNEs) based in the United States and Europe. In 2000, the US contributed US$60billion to value-added in pharmaceuticals, surpassing Western Europes US$40

billion and Japans US$22 billion.9

This relationship has grown starker since that

time, with the US increasingly becoming the dominant centre for pharmaceutical

production activity.10

Global sales of pharmaceuticals in 2004 reached $591 billion and grew

approximately nine per cent between 2002 and 2003.11

Table 1.1

THE BIG TEN

Company Headquarters Annual R&D

expenditure

Annual Sales

Pfizer New York, USA US$ 7.4 billion US$ 51.2 billion

GlaxoSmithKline London, UK US$ 5.8 billion US$ 40.4 billion

Novartis Basel, Switzerland US$ 4.8 billion US$ 32.2 billion

Sanofi-Aventis Paris, France US$ 5.1 billion US$ 34.6 billion

Merck & Co New Jersey, USA US$ 3.8 billion US$ 22.0 billion

AstraZeneca London, UK US$ 3.4 billion US$ 23.9 billion

Johnson & Johnson New Jersey, USA US$ 6.3 billion US$ 22.3 billion

Bristol-Myers Squibb New York, USA US$ 2.7 billion US$ 19.2 billion

Wyeth New Jersey, USA US$ 2.7 billion US$ 15.3 billion

Roche Basel, Switzerland US$ 4.9 billion US$ 15.3 billion

Source: Based on 2005 figures from the individual companies websites.

9

Messinis, G., 2002, Working Paper No. 7: The Australian Pharmaceutical Industry in its Global Context, The

Centre for Strategic Economic Studies, Victoria University.10

See for example, Gilbert, J. and P. Rosenberg, 2004, Addressing the Innovation Divide: ImbalancedInnovation, Annual Meeting 2004 Governors of the World Economic Forum for Healthcare, Davos, 22January.

11

German Association of Research Based Pharmaceutical Companies, www.vfa.de/en.


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The fifty largest firms are responsible for approximately 83 per cent of total global

pharmaceuticals sales, and the ten largest companies (Table 1.1) account for

approximately 50 per cent of global sales.

Recent trends indicate that the larger companies are consolidating their strong

market position. For instance, sales growth for the top 50 companies was 12 per

cent between 2002 and 2003 compared to an industry average of nine per cent.12

Relatedly, the last decade has also been a decade of mergers and acquisitions, in an

attempt to release operational efficiencies. Mergers and acquisitions activity rose

steadily from 292 deals in 1999 to 568 in 2003 and 703 in 2004.13

The pharmaceutical value chain and traditional business model

The pharmaceutical industry pivots on innovation innovation that is costly, time-

consuming and highly regulated by authorities such as the Australian Therapeutic

Goods Administration (TGA) and the US Food and Drug Administration (FDA). It

is one of the largest contributors to privately funded R&D in the world. Global

R&D expenditure in the pharmaceutical industry has been estimated at $57 billion

per annum,14

which represents a high proportion of re-investment of sales in R&D

activities. For instance, MNEs were estimated to reinvest 18 per cent of their sales

revenue into R&D in 2002.15

According to conservative estimates, the average time from drug discovery to

market is estimated to be 16.5 years and the average cost of bringing a drug to

market is approximately $1 billion (Figure 1.1).16

Figure 1.1

DRUG DEVELOPMENT AVERAGE TIME AND COSTS

10,000Compounds

1Approved

Drug

250

Compounds

5 Compounds

Phase I20-100

volunteers

Phase II100-500

volunteers

Phase III1,000-5,000volunteers

5 Years 1.5 Years 6 Years 2 Years 2 Years

Drug Discovery Pre-cl inical Clinical TrialsRegulatoryReview

Large ScaleManufacture

$1 billion

Source: PhRMA, 2005, Pharmaceutical Industry Profile 2005, From Laboratory to Patient: Pathways toBiopharmaceutical Innovation, Washington DC, p 4-5.

12

Department of Industry Tourism and Resources website. www.industry.gov.au.13

PricewaterhouseCoopers, 2004, Corporate Finance Insights: Pharmaceutical Sector Annual Report 2004, p 3.14

Medicines Australia.15

Department of Industry Tourism and Resources Website, www.industry.gov.au.16

See the Tufts Centre for the Study of Drug Development and the Department of Industry Tourism and

Resources website, and PhRMA, 2005, Pharmaceutical Industry Profile 2005, From Laboratory to Patient:Pathways to Biopharmaceutical Innovation, Washington DC.


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In terms of drug discovery, only one in ten drug targets identified will be brought to

market, and of all drugs brought to market only two in five provide returns in

excess of their risk adjusted cost of capital.17

The drug development process

(clinical trials R&D) is marked by similarly high costs and even longer time

commitments. This presents such high barriers to entry that generally only large

MNEs can afford to develop compounds.

Historically, counter-balancing the risks and costs associated with development was

the potential for substantial revenues from so-called blockbuster drugs, or drugs

with annual sales of over US$500 million.

These factors the high costs and risks of product development, the potential for

blockbuster drug development, the requirements of international regulatory regimes

and need for collaboration among quality researchers over long periods of time

shaped the development within the pharmaceutical industry of a vertically

integrated, linear business model.18

The key features of the traditional

pharmaceutical business model were strategically located, centralised discovery

R&D facilities, a small number of large manufacturing plants, and globally

dispersed clinical trials and sales offices:

Discovery R&D The traditional business model was built on large,centralised discovery R&D laboratories located near company headquarters in

either the US or Western Europe. Research was concentrated to capture

economies of scale and facilitate collaboration among researchers. Historically,

R&D has been tightly guarded within the firm and collaboration with external

research organisations has been rare. However, as discussed below,

collaboration has been increasing since the 1990s.

Clinical trials R&D The large R&D labs of MNEs have beencomplemented by globally dispersed clinical trials. Factors influencing the

greater global dispersion of clinical trials were that they did not benefit from

the same economies of scale as discovery R&D, the requirement forheterogenous populations for testing and the diversity of regulatory regimes

across jurisdictions.

Manufacturing Typical pharmaceutical manufacturing facilities are capitalintensive, R&D intensive and require skilled employees. There are two distinct

stages to pharmaceutical manufacturing: primary and secondary manufacture.

Primary manufacture involves the production of active chemical and

biopharmaceutical ingredients. Secondary manufacturing involves formulation

and packaging of the end product and usually occurs in smaller factories that

are geographically proximate to their market.

Supplementing key needs along all points of the value chain were also

pharmaceutical services. Historically, the services sector provided inputs andassistance to the industry from discovery R&D to the distribution of the final

product, with a focus on the latter stages of drug development and distribution.

Examples of services offered by the sector include marketing services; management

services; training and staff development services; transport and distribution

17

Rasmussen, B., 2003, Aspects of the Pharmaceutical Business Model: Implications for Australia, DraftWorking Paper No. 15, Final Draft, Pharmaceutical Industry Project Working Paper Series, Centre forStrategic Economic Studies, Victoria University of Technology, p 2.

18

The Walter and Eliza Hall Institute, 2005, CRC IID submission, unreleased draft.


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services; and architectural and engineering services, for example the designers and

builders of pharmaceutical manufacturing facilities.

Industry changes and the evolution of the pharmaceutical business model

During the 1990s a proportionally higher number of blockbuster molecules came to

market than in preceding decades, and approximately 80 per cent of pharmaceuticalrevenue growth over this period was attributed to the rise of the blockbuster.

However, as the patents on these blockbusters have expired, or are nearing their

patent expiry date, these drugs have come under intense competition from generic

and me-too variants. In turn, sales have fallen, leaving firms searching for new

drugs to refresh the pipeline.

The key factor shaping the industry is the lack of future blockbuster drugs in the

pipeline. Technological and other changes have meant that the drugs in

development increasingly target smaller patient populations. With fewer

blockbusters forecast to emerge from the pharmaceutical pipeline in forthcoming

years, despite increasing expenditure on R&D (Figure 1.2), it is anticipated that

pharmaceutical industry revenues and profits will fall.19

Figure 1.2

DRUG DISCOVERY AGAINST CURRENT AND PREDICTED PHARMACEUTICAL R&D

EXPENDITURE

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 20070

10

20

30

40

50

60

70

Forecast

Global pharmaceutical R&D Expenditure, $US billion

New molecules by year of first launch

Source: CMR International and The Economist, 2005, 'Pharmaceutical Industry Survey', TheEconomist, 16 June 2005.

This has forced the industry to rethink their approaches to all aspects of the

traditional business model (Figure 1.3).

19

The Boston Consulting Group, 2004, Rising to the Productivity Challenge: A Strategic Framework forBiopharma, May.


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Figure 1.3

THE EVOLUTION OF THE PHARMACEUTICAL BUSINESS MODEL

Productdevelopment

cycle

ONE INTEGRATED COMPANY

Productdevelopment

cycle

ContractResearchOrgs

MANY DISTRIBUTED COMPANIES

Traditionalpharmaceuticalbusiness model

Evolvingpharmaceuticalbusiness model

ContractManufactures

Toolcompanies

Testingservices

Source: Collaborative Economics, 2000, Networks of Innovation: Regions Collaborating to Compete inthe Global Market National Gathering of Biotech/Life Science Innovation Regions, BIO2000Conference.

As illustrated above, the fundamental shift by industry in response to the decline of

the blockbuster business model has been the movement away from vertical

integration. Increasingly, pharmaceutical manufacturers have sought to outsource or

in-license some aspects of their operations:

Changes in innovation models In contrast to the traditional pharmaceuticalmodel, pharmaceutical companies have been looking more and more to

external parties such as research-intensive biotechnology companies,

universities and medical research institutes (MRIs) for R&D innovations.

The rise of genomic-based technology has been a key driver of this trend and it

is anticipated that these technologies and these smaller players will be some of

the most important sources of new pharmaceutical molecules. Depending ontheir corporate strategy, large pharmaceuticals have either forged alliances

(such as in-licensing IP arrangements) with these firms or acquired them.

Pharmaceutical companies offer development expertise and funding, without

which the smaller firms would be unable to bring the drug to market.

It is important, however, to put this trend in perspective. While pharmaceutical

companies have been increasingly turning to external parties for innovation

alliances, they will continue to back their own in-house research. It is expected

that the ratio of in-house to external research will shift from 90:10 as observed

in the 1990s to perhaps a ratio of in-house to external research of 70:30 by

2010.20

Changes in development models As revenues and profits have been forecastto fall, pharmaceutical companies have increased their scrutiny of the cost sideof their business. There has been a growing trend towards pharmaceutical

companies outsourcing to contract research organisations (CROs) resource-

draining clinical trial work. Where large numbers of sites are required or

patients are expected to be difficult to identify, pharmaceutical companies will

20

Industry consultations; Department of Industry, Tourism and Resources, 2003,Australias Preclinical andScale-Up Manufacturing Capabilities, A Comparative Analysis, December; and The Grant Committee, 2004,Sustaining the Virtuous Cycle: For a Healthy Competitive Australia, Investment Review of Health and Medical

Research, Final Report, Canberra, December, p 99.


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tend to contract this work out to an organisation that can more efficiently

complete the work. Companies will also locate the clinical trial in the most

cost-competitive site, provided there are sufficient medical research

capabilities available to conduct the work.

Investing according to incentives Another key feature affecting

pharmaceutical industry development in the past few years is the considerablecompetition between governments to attract industry investment. Countries

such as Ireland and Singapore as well as several US states have offered

significant incentive packages to attract capital-intensive pharmaceutical

investment. These packages have been shown to critically impact on some

types of investment decisions, especially manufacturing investment or re-

investment decisions. It is predicted that they will remain part of the

pharmaceutical industry investment landscape.

The changes in the industry resulting from the decline of the blockbuster business

model have been reflected in changing investment patterns. It has lead to the reality

that capital, in particular manufacturing and clinical trial investments, could in

principle be put in many locations globally. It has also facilitated a continued

consolidation of major, in-house discovery R&D investments in the US, in parallel

to some increasing opportunities for third party organisations to partner with large

pharmaceutical firms on some research.

1.2 Profile of the Australian pharmaceutical industry

As set out in the National Medicines Policy, Australia is committed to the

development of an industry that participates in the global value chain:

It is essential that industry policy and health policy be coordinated, providing a consistent and

supportive environment for the industry, and appropriate returns for the research and

development, manufacture, and supply of medicines. International competitiveness will only be

achieved if Australian industry can operate in a global environment.21

In the past several decades, and influenced by several investment incentive

packages for the pharmaceutical industry, Australia has built up a presence along all

points of the value chain.

Key players in Australia

There are approximately 120 locally and foreign owned companies participating in

the Australian pharmaceutical industry, which comprises both local and

multinational subsidiary organisations.

The majority of industry players in Australia are subsidiary organisations. The

multinational manufacturers with subsidiaries in Australia include Merck, Pfizer,

GSK, Bristol-Myers Squibb and Novartis. Local manufacturers include CSLLimited, Institute for Drug Technology (IDT), Mayne, Sigma and Alphapharm.

Some of these firms have significant secondary manufacturing infrastructure in

Australia, while others specialise in clinical trials R&D. There is little large-scale

manufacturing of active ingredients apart from some alkaloid production by GSK

and Janssen-Cilag.

21

Department of Health, 2000, National Medicines Policy, Commonwealth of Australia, Publication Number2654, p 4.


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Australia also has a number of research orientated biomedical science companies

and biomedical institutes. IDT, Zenyth Therapeutics and Cerylid Biosciences are

examples of these organisations. These organisations often work in collaboration

with hospitals, universities and other government organisations, which all play a

critical role in biomedical discovery R&D and clinical trials R&D in Australia.

Significant players include The Walter and Eliza Hall Institute, The Peter

MacCallum Cancer Centre, CSIRO and the Australian Nuclear Science andTechnology Organisation (ANSTO).

More recently, Australia has seen the growth of a young biotech industry, based

around small firms. According to the Department of Industry Tourism and

Resources (DITR), in December 2005, there were 2794 employed in 420 core

biotechnology companies of which 74 were listed on the Australian Stock

Exchange (ASX), of which 39 per cent were listed in the last three years.22

Most of

these firms were spun out of research institutions and universities, and their

products focus on the development of new drugs, especially human therapeutics,

and human diagnostics. These firms are highly R&D intensive operations, and

operate using a business model based around proving the concept of their

technology and licensing the IP to larger companies to commercialise.

Austral ian involvement in the global value chain

The Australian pharmaceuticals industry is an important contributor to business

R&D in Australia, which is currently running at under 1 per cent of GDP. It is

estimated that investment by the pharmaceuticals industry in R&D represents about

5 per cent of total sales by the industry. Recent estimates suggest that the industry

spends around $520 million on R&D per annum.23

This is small by world standards,

and reflects the traditional business model of the worlds leading innovative

pharmaceuticals companies, which until very recently has dictated that most major

discovery research is conducted in-house in large corporate laboratories located in

the US or Western Europe. Thus, a high proportion of the expenditure on R&D by

the multinational pharmaceutical companies in Australia is on clinical trials R&D,which tends to be less capital intensive than discovery R&D investments.

The Australian industry plays a minor role in the manufacture of active

pharmaceutical ingredients (APIs), however, there is significant local secondary

manufacturing in formulation and packaging. Small scale API manufacturing in

Australia is largely focused on the synthesising of alkaloids, such as morphine and

codeine, from Tasmanias licit poppy crop. Participants in Australian API

production from Tasmanian poppies include GSK and Tasmanian Alkaloids. Other

API production in Australia is generally small scale and specialised. Australian

participants include CSL and the Institute for Drug Technology Australia.

Secondary manufacturing is conducted in Australia on a much larger scale than APImanufacturing. There are at least ten large secondary manufacturing plants,

including GSKs facility at Boronia.

A pharmaceutical services industry has also grown up alongside of these activities,

but is not generally regarded as a hub for any one type of service. Because of the

wide and varied nature of the types of services provided at different points along the

22

Department of Industry, Tourism and Resources, 2006,Biotech Business indicators. June.23

According to Melbourne Universitys 2005 R&D and Intellectual Property Scoreboard, three pharmaceuticalcompanies were among the 10 largest spenders on R&D in 2003-04.


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value chain, this report discusses these services as related to discovery R&D,

clinical trials R&D and manufacturing within the context of these primary

activities.

Austral ian responses to global trends

The changes in the global environment have had the greatest impact on the existingmanufacturing sector in Australia. For instance, the global consolidation of

secondary manufacturing plants has led to the closure of several manufacturing

plants in Australia as new investments or re-investments have been generally

located in countries offering more competitive tax incentives.

An exception to this trend has been GSKs investment in manufacturing, which has

increased by roughly $60 million over the past five years. GSK has two significant

manufacturing operations at Port Fairy and Boronia, which have very different

purposes. The Port Fairy plant specialises in producing active pharmaceutical

alkaloid products, including morphine and codeine, based on processing poppies

grown in Tasmania. The plant accounts for about one-quarter of the worlds

medicinal opiate requirements. The Boronia plant is a secondary manufacturing

facility, which formulates and packages a range of prescribed pharmaceuticals.

GSK at Boronia has developed a specialised and flexible workforce able to produce

a wide range of products in a very flexible way the products are exported to

many countries. Part of the expansion of the Boronia plant, which is now the 8 th

biggest plant in the GSK world, is due to picking up production that was dropped

due to the closure of smaller scale, less economic plants elsewhere in Asia-Pacific.

Similarly, other firms with specialised manufacturing capabilities, such as CSLs

adjuvant manufacturing facilities and IDTs niche, small scale production

facilities,24

have been insulated from the same rationalisation of manufacturing

capacity observed by other players in the Australian market, who generally compete

with other international plants to supply global manufacturing requirements.

The general picture for R&D has been brighter than the manufacturing story.

Global trends towards growing numbers of alliances by pharmaceutical companies

with external organisations have resulted in some increased investment in discovery

R&D in Australia. The growth of, and alliances with, the Australian biotechnology

sector is perhaps the most significant example of Australia leveraging investments

from new global pharmaceutical industry trends. However, in Australia there has

been less interest in biotechnology alliances from the big pharmaceutical industry

participants than in other countries,25

and it is generally expected that the big

battalion R&D investments will remain offshore, particularly within the US.

Nevertheless, with the growth of genomics and proteomics, the biotechnology

sector could potentially see increased growth in investment in the Australian

pharmaceutical industry, albeit from a small base.In the past several decades, the Australian Government has launched several

incentive programs to attract pharmaceutical industry investment. The first

incentive program to directly target the pharmaceutical industry was the Factor (f),

24

IDT has small scale production facilities for APIs for human and veterinary use, including production ofanticancer (cytotoxic) APIs; finished dosage forms for clinical trial use; highly toxic or active materials such ascytotoxics and cephalosporins; small scale non-toxic materials; and viral vaccines.

25

Rasmussen, B., 2004, Alliance Opportunities for Aus Biotech, Working Paper no. 23, Pharmaceutical

Industry Project Working Paper Series, Centre for Strategic Economic Studies, Victoria University ofTechnology.


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which ran from 1988 to 1994, and was followed by the Pharmaceutical Industry

Investment Program (PIIP). Many industry participants credit these programs as the

catalyst for the current levels of involvement by their company within Australia.

The current P3 program was developed with a view to build on the lessons from

previous programs, and commits $150 million from 2000 to 2005 to support

incremental investment in R&D by the industry in Australia. Several

pharmaceutical companies have utilised the program to fund some R&Dinvestments within Australia since its commencement, however, critics have

questioned whether this has attracted additional investment or merely subsidised

activities that would have otherwise occurred. There were concerns that the

incremental nature of funding results in too little money being spread over too

many parties. In August 2006, after consultation with the industry, the Government

implemented changes to the P3 program to allow larger companies to apply for the

support of their R&D initiatives. Currently there is no incentive program in

Australia aimed at increasing manufacturing investment.26

1.3 The wider benefits of the pharmaceutical industry to Australia

Beyond the direct contribution that the industry makes due to the scale of itsactivities, the characteristics of the pharmaceutical industry allow it to produce long

term and profound economic benefits that go beyond the direct benefits associated

with industry investment and activity. As noted by the DITR, industries which are

highly innovative should be cultivated because they stimulate further economic

growth, over and above the production they entail.27

For example, it has been

estimated that the rate of return to Australia was between two and five times the

actual expenditure.28

The sources of this return to the Australian economy and the

range of spillovers from industry investment include:

the development of export capabilities;

improvements in productivity in other areas of medical research through

knowledge of new techniques and treatment strategies, and the wider, flow-onimpacts of that labour in the economy;

increases in the supply of skilled R&D professionals, and the wider, flow-onimpacts of that labour in the economy;

quality improvements in research outcomes, and the wider, flow-on impacts ofthat labour in the economy;

increased demand for Australian research outcome from higher quality pre-clinical candidates;

spillovers from new partnerships;

spillovers from new technologies; and

contributions towards National Research Priority Goals.

26

See Appendix B for an overview of past and present incentive programs.27

Department of Industry, Tourism and Resources, 2001, Discussion Paper, Pharmaceutical Industry ActionAgenda, Commonwealth of Australia, p. 44.

28

Access Economics, 2003,Exceptional Returns: The Value of Investing in Health R & D in Australia, Canberra,p. 65


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Together, these serve to increase demand for Australian output. Taken together,

each of these impacts can contribute to Australia achieving the status of a first-tier

innovator nation.

Export opportunities

Australian firms with a higher degree of foreign ownership generally have a higherthan average export propensity.29

This can be attributed to the fact that companies

with a higher degree of foreign ownership are likely to have a more global or

outward focus, and are able to compete in the global market. This may be through

better understanding of international standards and best practice, access to markets,

or a knowledge of overseas supply networks. This is not to say that domestic firms

lack this knowledge. However, the costs of gathering this information for a firm

with a significant degree of foreign ownership is likely to be far less than for a fully

domestic firm.

Pharmaceuticals are Australias third largest elaborately transformed manufactured

export after automobiles and wine, totalling almost $2.6 billion annually. While

Australias exports of elaborately transformed manufactures represent a relatively

small part of Australias total exports of goods and services, they are significant as

they tend to embody significant inputs of R&D, design and engineering and other

knowledge-based elements where spillover benefits are likely to be important. The

production of such products is skill intensive and employees tend to be paid higher

than average wages. The competition worldwide to attract investments involving

the production of elaborately transformed manufactures reflects the value that is

placed on them by governments.

Moreover, there are significant reputation benefits to be gained from strong export

performance in elaborately transformed manufactures. Such exports tend to be seen

as a reflection of a nations innovative capacity and contribute to Australias

reputation as a modern, knowledge-based economy and society.

Improved living standards

The average wage paid to employees in the pharmaceutical industry in Australia is

well above the average working wage. In 2000-2001 the pharmaceutical industry

average wage was $53,000, well above the average wage for the manufacturing

industry of $32,000.30

Higher wages flow through to higher household income and

in turn, consumption, which is a proxy for consumer welfare as it is assumed that

individuals derive benefits (utility) from higher levels of consumption. This also

results in GDP growth, which in turn may result in later rounds of investment in

basic research by government, and so on.

Spillover activity and knowledge benefits other industr ies

The introduction of new companies, or a significant degree of foreign control into

an existing domestic company can bring with it new management techniques, new

product lines, new methods of delivery or benefits which are even more intangible

such as a new work culture or corporate ethic. These benefits can be passed on

horizontally, through the movement of employees between foreign and

29

Access Economics, 2004, The Benefits of Inward Foreign Direct Investment to the Australian Economy Areport for Invest Australia, Canberra, Canberra, p. 19.

30

Econtech, 2002, The Economic Contribution of the Australian Prescription Pharmaceutical Industry: Reportto APMA, quoted inMedicines and Health, 1(6), 1 June 2002.


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domestically owned companies, or through competitor firms adopting international

best practice; or vertically through the implementation of change throughout a

supply or distribution chain.

Both the R&D and manufacturing of pharmaceuticals require highly skilled and/or

educated workforce whose pay is commensurate to their skills. Developing highly

skilled workforce can bring considerable long-term economic benefits as it providesa skills base for future investment and innovation. Their expertise can be used to

attract additional investment, train future employees and be directed at other

biomedical research. These knowledge spillovers are also expected to benefit other

industries. Many economic studies have shown that highly skilled workforces have

driven the economic growth and prosperity enjoyed by developed countries.

Industries such as the pharmaceuticals are a key source of such a workforce.

In particular, a strong pharmaceutical industry presence can provide a major

platform for the development of Australias biotech sector. The number of

biotechnology companies grew from almost none in 1981 to 1982 to over 300 in

2001 to 2002. The rapid growth in biotech firms has been coupled with a high

attrition rate.31

The growing number of small biotech companies rely on larger firms

with significant capital pools and development expertise to bring their ideas into the

market and fund continued research. These small firms can also tap into the critical

mass of skills and support services that the presence of major pharmaceutical

companies provides.

Infrastructure development

Pharmaceutical R&D investment is also a driver of improved biomedical research

infrastructure. Investment from pharmaceutical companies in small biomedical

companies, research institutes and public universities can increase the research

capabilities of those organisations both in the field of pharmaceutical research as

well as in other research areas. Similarly in clinical trials, patients benefit from

gaining access to innovative drugs, and physicians benefit by gaining anunderstanding of new treatments as well as providing input into the trial

methodology, especially in early phase trials.

Realising benefits from publ ic sector i nvestments in basic research

Australias level of government-financed expenditure on R&D is high by

international standards. In 2000 it was 0.71 per cent of GDP, compared to an OECD

average of 0.64 per cent.32

Following the 1999 Wills Review, Commonwealth

expenditure for health and medical research was doubled over five years through

the injection of $614 million, while Backing Australias Ability increased

Australian Government funding for science and innovation by $8.3 billion for the

period 2001-02 to 2010-11.33

The Commonwealths support for science and innovation has been more focused

and strategic than in the past. Backing Australias Ability represented a strategic,

whole of government approach. Similarly, the establishment of the Ministerial

31

Consultations with government experts indicated that Australia might have four times as many biotechs being

launched as in the US but that the majority of these would fail in Australia whereas firms in the US were farmore likely to succeed.

32

Department of Education Science and Training, 2003, Mapping Australian Science and Innovation,Commonwealth of Australia, p 18.

33

http://backingaus.innovation.gov.au/, accessed September 2006.


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Science and Innovation Committee points to the high priority given to science and

innovation issues by the Australian Government. The setting of National Research

Priorities exemplifies a trend to identify priorities to guide investment.

The states and territories, too, are taking an increasingly active role through the roll-

out of strategies and initiatives such as Queenslands Smart State, Victorias

Science, Technology and Innovation Initiative, New South WalesBioFirst Strategyand Western AustraliasInnovate WApolicy.

In contrast to public expenditure on R&D, Australias BERD as a share of GDP is

0.95 per cent,34

whereas the OECD average is 1.53 per cent in 2004-05. Moreover,

in 2004 Australia ranked 12th in the OECD, up from 16thin 2000, in the share of

gross expenditure on R&D undertaken by business (48.8 per cent) compared to the

OECD average of just under 62 per cent.35

Thus, attracting pharmaceutical

investment remains a significant opportunity for injecting commercial funding into

realising returns on public sector investments.

Contributing to Australia becoming a first -tier innovator nation

There has been recent improvement in Australias position in the internationalleague table as an innovative economy. A recent study by Gans and Stern

36

argues

that over the last two decades Australia has been transformed from a classical

imitator to a second-tier innovation economy. However, Australia has not yet

lifted itself to the level of performance achieved by first-tier innovator nations.

A vibrant and growing pharmaceutical sector can contribute to Australia further

increasing performance to first-tier innovator levels. Achieving first-tier

innovator levels would see economic changes and benefits such as:

Strengthened growth in small, emerging technology-based businesses.

An increasing proportion of small, technology-based businesses breaking

through to become emerging globals. Australia has over the last two decadesproduced some companies that have achieved such a breakthrough, with

Cochlear and ResMed being the outstanding examples. These companies

illustrate the potential upside in terms of value creation that such businesses

can contribute to the economy.

As a result of the increase in technology-based businesses and the greaterproportion of those that are able to become emerging globals, the aggregate

impact of technology-based companies emerging from the commercialisation

process in terms of contribution to economic value, well paid jobs and exports

will be highly significant.

Success in achieving recognition for Australia as becoming a first-tier

innovator nation will assist the process of attracting innovation intensiveactivities by leading research-based multinational companies to Australia. It

will also assist the position of Australia in attracting and retaining highly

qualified researchers and innovators in all areas of activity.

34

http://www.abs.gov.au/Ausstats/[email protected]/39433889d406eeb9ca2570610019e9a5/bae5fb25d2121f6dca2568a9001393ef!OpenDocument, accessed September 2006.

35

OECD, 2006, Main Science and Technology Indicators, June.36

Gans, J., Stern, S., 2003,Assessing Australias Innovative Capacity in the 21stCentury.


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A virtuous cycle established in which greater investment in the generation ofideas, will directly lead to the creation of greater value and jobs for the

economy which in turn will increase Australias capacity to invest in the

generation of ideas. Achieving a self sustaining virtuous cycle like this will be

vital to increasing living standards in Australia in the 21stcentury.


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Chapter 2

Drivers of investment across the value chain

This chapter considers each key component of the value chain to analyse specifictrends and drivers in the global context.37

2.1 Investment decisions general considerations

Economic theory and studies of location decisions of foreign investment suggest

that the primary consideration for the investing company is to ensure that the

expected rate of return on an investment in the favoured location exceeds the

expected rate of return from competing locations. This means in general that the

investing company is making the investment in order to access:

low cost locations;

specialised resources and skills; and market demand.

In practice, given the opening of markets around the world to international markets

trade, with the exception of gaining access to very large emerging countries and

markets such as China and India, investors tend to be driven either by the search for

low cost locations and/or accessing specialised resources and skills.

Typically investment decisions involve a mix of two kinds of resources:

general resources; and

specialised resources.

By general resources are meant resources whose nature is invariable across

different locations. An example of such resources is a capital-intensive production

facility using a relatively small amount of labour in order to produce a limited range

of standardised products in high volumes. The knowledge to operate the plant is

essentially codified and hence the plant could be potentially located in many places.

Specialised resources are by their nature likely to vary across locations as the tacit

knowledge of skilled people varies and underlying systems also vary. An example

of such resources is teams of researchers.

Between the polar cases, there are likely to be investments that require a mix of

general and specialised factors and hence involve more complex approaches to

determine investment location decisions that take account of both cost and non-cost

investment drivers.

The implications of these cases for the investing company and potential host

governments, based on the mix of general and specialised resources employed, are

quite different. In the case of investments dominated by general resources, the

37

It should be noted that the discussions of investment patterns and decisions in each section of the value chaincould be easily expanded into their own respective analyses. Indeed, many studies have been completed thatfocus in on only one narrow elements of the value chain. It is not possible for this report to provide the same

level of detail for every type of investment. The aim is to identify the drivers to a sufficient extent such thatlevers for increasing general areas of investment can be identified.


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investing company will look for ways of minimising cost including tax paid, which

from the investing companys point of view is a cost of doing business.

Fundamentally in the case of investments dominated by general resources, which

could, in principle, be located in many countries, the investments are cost driven.

The implication for governments wishing to attract such investments is that their

taxation systems need to be world competitive.

In the case of investments dominated by specialised resources, the investing

company will necessarily focus on characteristics such as the availability, quality

and productivity of specialised resources. While costs are important, unlike

investments dominated by general factors, costs are not the prime investment

driver. From the viewpoint of actual or potential host countries, investing and

building capability in the key specialised resources required by industry is central to

effective investment attraction and retention.

There will be a class of investments that will involve a mix of general and

specialised resources where the investing company will have to carry out a decision

making process which gives appropriate weight to both sets of resources.

Investment decisions will be driven by a mix of cost and non-cost factors.

The importance of strategic factors in investment decisions

A further aspect is likely to be involved in investment decision making where

strategic factors come into play. Such factors are unlikely to be significant in

industries where there are many competitors, where R&D and patent rights are

unimportant and where governments are not heavily involved in determining the

operating environment. But where competition takes place among the few, R&D

and patent rights are important and governments strongly influence the business

environment for the industry concerned strategic factors are at least potentially of

significance.

Just how important these kinds of factors are in practice is generally very difficult

to establish with precision. On the other hand, it would be dangerous to assume theycan be ignored as they appear to influence perceptions held by the worlds leading

innovative pharmaceuticals companies about the attractiveness or otherwise of

investing in particular countries. For example, strategic factors clearly appear to

have influenced investment decisions in New Zealand, where its small market size

and reimbursement scheme have resulted in a significant reduction in

pharmaceutical industry activity:38

In May 1998, Bristol-Myers Squibb announced it will no longer invest inclinical research and development in New Zealand. At the time BMS was

investing on average NZD$4 million per annum in research in NZ.

In 1995, Pfizer Laboratories withdrew its manufacturing operation from NewZealand.

In January 2000, Lundbeck withdrew its antidepressant product from the NewZealand market, blaming PHARMAC's policies for its withdrawal.

38

Company activity supplied by Medicines Australia, 29 November 2005. See also Clarke, L., 2005, Lessonsfrom the Kiwi Model, Researched Medicines Industry Association o

Documents

Drivers of Pharmaceutical Industry Investment July 20061