A Well-Oiled Generic Pharma Machine
A radically different business and operating model in the generic pharmaceutical industry
Business Model
Bpharma is a small (<$100M in revenue) specialty generics pharmaceutical company that, in my opinion, has done a good job of aligning its operating model with its business value proposition. The business model of Bpharma differs significantly from that of other branded and even generic pharmaceutical companies. Bpharma’s strategy is to target off-patented drugs that have small market sizes and are difficult to formulate or manufacture (examples include topical ointments or gels; these contrast with easy-to-manufacture oral tablets). The rationale for focusing on these drugs is 1) given the small market opportunity, most large generic manufacturers have no incentive to enter; 2) the focus on more niche, complex formulations (like topicals or patches) creates higher barriers to entry; and 3) because of points 1 and 2, these markets have fewer competitors, allowing for more favorable pricing dynamics than are normally experienced by the generic pharmaceutical industry.
Operational Alignment
Implementing such a business strategy, however, requires a fundamentally different operating model than peers’. Given that generic drugs are by definition commodity products, the winners in this industry have tended to be the largest players (often based in India) who are able to deliver the lowest cost through massive economies of scale. However, if your strategy is specifically to target small niche markets, then achieving meaningful scale is almost impossible. For this reason, Bpharma has chosen to utilize an “asset-lite” operational strategy, in which all manufacturing is outsourced to a third-party (known as a contract manufacturing organization or CMO). This arrangement allows Bpharma to leverage the CMO’s manufacturing scale, thereby enabling the viability of its commercial strategy.
In addition to this manufacturing issue, there are several other operational decisions that Bpharma has made in order to support its business strategy, especially in the areas of human capital and organizational design. One of the lynchpins of Bpharma’s success is its ability to recruit and retain talented R&D scientists. Given the niche nature of Bpharma’s drug formulations, there exist very few scientists with the expertise and know-how to develop these products. Bpharma has addressed this issue both from the recruitment side by building strong relationships with the few university PhD programs which focus on these types of formulations, and also from the retention side by offering scientists meaningful equity stakes within the company.
Bpharma’s organizational design is another key enabler of its business strategy. In order to successfully execute its business model, it is important for Bpharma to 1) have a high success rate on development projects, and 2) be quick to market. Given Bpharma’s smaller size and limited resources compared to other larger competitors, the company cannot afford to have many failed projects. One of the primary ways that Bpharma has tackled this issue is by promoting strong cross-functional collaboration. Unlike other pharmaceutical companies where Research, Development, and Commercial often operate in siloes, Bpharma has espoused a much more integrated approach—the rationale being that greater collaboration will enable issues to be raised earlier on in the process when it is far less expensive to solve them. Specifically, Bpharma has accomplished this integration by co-locating all departments in the same facility and by creating cross-functional teams for a given development project. These cross-functional teams include representatives from Commercial, R&D, and Regulatory and meet on a periodic basis to discuss development progress. Bpharma has seen real value from this approach, especially on the regulatory side, as the company has been able to resolve issues on its own before regulatory filing, avoiding very costly delays from a prolonged back-and-forth with the FDA.
Company Performance
A well-chosen business strategy supported by strong operational alignment has resulted in impressive company performance. Bpharma has more than tripled revenue over the past 3 years and its lean, “asset-lite” approach combined with its strategic market selection has translated into EBIT margins in excess of 40%. Furthermore, the company’s operations are incredibly scalable, as each new drug launch requires very little capital investment or additional personnel. Of course, Bpharma’s strategy is not without risks. The business model hinges on the company’s ability to continue to find drugs that fit its niche, and its operational strategy of outsourcing manufacturing does increase its exposure to drug quality issues (which have been a headache for the pharmaceutical industry in the past). These risks notwithstanding, I believe that the alignment between Bpharma’s business and operating models provides a strong platform for future profitable growth.
Note: For confidentiality reasons, I have chosen to use a cloaked name for the company. All other facts and figures are accurate.
Sources: Internal company documents; interviews with company employees
I have heard of companies that try to operate similar businesses, though Bpharma’s revenue is definitely the largest I’ve seen. This company’s business model is not unique in pursuing off-patent drugs targeted at small markets, though this company’s rapid success is unique, which sounds like is due to its operating model. It’s very interested that the company’s most valuable asset is the R&D scientists. I’ve see companies that outsource both R&D and manufacturing, where the main value of these companies is the ability to identify and pursue specific projects/drugs. I’d be curious to find out how this company handles potential competition from smaller companies or start-ups that aren’t going for the $50-100 million drugs but rather the $5-10 million ones.