Pharmaceuticals – Opportunities From Inefficiencies and Self-Destruction

“America's healthcare system is second only to Japan, Canada, Sweden, Great Britain, well ... all of Europe. But you can thank your lucky stars we don't live in Paraguay!” Homer Simpson, Cartoon legend

The US healthcare system is frequently criticized and often the butt of jokes, but there is no denying that it is enormous, expensive, inefficient, and fragmented.

According to the Commonwealth Fund (CF), US healthcare spending accounts for around 20% of GDP – around double that of Australia and 50% more than Switzerland, which is widely recognized as having one of the world’s most comprehensive healthcare systems. CF’s latest official performance rankings of 11 developed nations reveal that the US is last overall, also having the lowest ranking in four of the five categories analyzed.

The US healthcare industry can be broadly classified into four major sub-segments:

• Services and facilities

• Medical devices, equipment, and hospital supplies

• Medical insurance, services, and managed care

• Pharmaceuticals

For the purposes of this article, we will be focusing on the latter segment and the opportunities to profit from creative disruption.

Opioid carnage…

The US pharmaceutical industry has a very poor reputation and is largely untrusted by consumers. The distrust mainly stems from the opioid crisis, which unfolded over the first two decades of the 21st century.

Purdue Pharma was the early villain of the piece for its part in creating and driving an opioid epidemic, with its aggressive marketing and lobbying of its high-strength drug OxyContin. The company campaigned to make pain management the default treatment for long-term chronic conditions rather than attempting to address the symptoms, thus increasing prescriptions for OxyContin and driving up profits.

The most high-profile element of the scandal involved the two-month trial of the giant Johnson & Johnson (JnJ) in 2019. Evidence was presented that JnJ’s marketing department had not only used high-pressure tactics, including the targeting of doctors who were already prescribing large quantities of opioids, to advance the sales of its drugs, but had worked in tandem with Purdue to influence medical practice, federal regulators and politicians to promote the mass prescribing of opioids.

Oklahoma’s attorney general described the scheme, which purportedly claimed the lives of more than 400,000 Americans through opioid addiction, as “cunning, cynical, and deceitful”.

However, the buck did not stop with Purdue and JnJ - also tainted were the household names of Walmart and CVS, as well as the lesser-known drug distributor McKesson. The latter’s CEO was vilified for being the highest-paid executive in the US just as opioid deliveries reached their peak.

Small margins for legacy distributors…

The US accounts for around 40% of the global home healthcare market (45%1 of the global pharmaceuticals market). Even the 45% figure is massively shy of the North American share of global equity market capitalization (US equities command a weighting of around 71% of the benchmark MSCI Global Index).

In comparison, the European weighting in the MSCI World Index is less than 10%, yet the continent accounts for around 30% of the global healthcare market. This suggests that US healthcare is not only expensive but inadequate.

US healthcare: expensive and inadequate

Source: The Commonwealth Fund.

There are also fears that pharmaceutical supply chains will become less efficient due to recent legislation, which is likely to be uncontested with the Democrats maintaining control of the Senate following the recent midterm elections.

While sales are being driven by the continuation of vaccination roll-outs, which has resulted in soaring margins for brand-name drug producers, the wholesalers and distributors, upon which “big pharma” is reliant, continue to trade on thin margins, despite growing sales. Some distributors still have payments to make in connection with opioid-related lawsuits and litigations, but many also lack the technical nous to prosper in the digital age.

This opens the door for innovative and potentially holistic pharma businesses to seize the initiative and disrupt both the production and distribution frameworks. While legacy incumbents are ripe for market-share stripping in many industries, it is particularly true of pharma.

The way forward…

A recent article published by Andreessen Horowitz suggests that the future biggest company in the world could well be a consumer health tech company. The authors point out that US healthcare is a $4 trillion industry (and growing), and the likes of Google, Apple, Facebook, and Amazon are all looking to grab a share of the market in recognition of the size of the opportunity.

It is worth reiterating that the incumbent pharmaceutical companies have a damaged reputation, and they are also very weak in terms of consumer engagement. This suggests that an untarnished company clearly placing the interests of the consumer at the forefront of its business model and fostering good relationships with the other parties in the value chain, including providers and payors, will be able to grow at warp speed.

Since the growth potential is exponential, we believe that the prospective disruptors of the US pharmaceutical industry do not necessarily need the financial muscle of Google and Amazon, but a proprietary digital platform is a prerequisite. This will easily allow for the vertical and horizontal integration of value-added services, enabling a company to rapidly scale up and become a holistic healthcare services provider.

In our view, Alto Pharmacy, which was founded in 2015 by two former Facebook engineers who initially bought a small independent pharmacy in San Francisco, is a perfect example of a company that is well-placed to seize the opportunities created by the tarnished reputation of and poor engagement by the incumbents, as well as the inefficiencies of the broader industry.

1. Source: Altradius (March 2022)