In researching yesterday's Rule Maker story on Schering-Plough (NYSE: SGP), it became clear how much the company relies on partnering and licensing to expand its drug pipeline.

This is a strength, not a weakness. In fact, licensing is a fast-growing and essential part of any big pharmaceutical company's strategy. To see how successful licensing can be, investors don't have to look farther than Pfizer's (NYSE: PFE) licensing agreement with Warner-Lambert  -- an agreement in place prior to Pfizer's eventual acquisition of Warner-Lambert -- to sell the blockbuster drug Lipitor. Lipitor had more than $5 billion in sales in 2000, and is the second-best-selling pharmaceutical product in the world.  

Based on the high valuations awarded the top pharmaceutical companies, licensing will be essential to ensure sales and profit growth. This is true for two reasons: There's no evidence, so far, that big companies with big research departments are more likely to discover groundbreaking drugs than smaller research outfits. In fact, the reverse may well be true. Second, big pharmaceutical companies -- with some exceptions, such as Amgen (Nasdaq: AMGN) and Genentech (NYSE: DNA) -- don't have research and development (R&D) divisions that have been focused on genomics-based research as long as newer biotechs. The genome-based approach, based on the human genome and its sequencing, can lead to a much more targeted drug discovery program.

How much will licensing expenditures grow? Researchers at McKinsey Consulting took a look at this issue in an article last year (free registration required). Five years ago, virtually none of the pharmaceutical companies that responded to a McKinsey study devoted more than 20% of R&D dollars to licensing. At the time of the story, the number had jumped to 30%, and McKinsey expects it to jump to 56% over the next four years. By 2002,  McKinsey researchers expect 10 of the top pharmaceutical companies will get 35% to 45% of revenues from externally sourced products.

It makes sense, therefore, for us to favor companies with experience in this area and a track record of success. Schering-Plough has a strong tradition of using licensing agreements to develop products in its specialty areas. Here's a short sample:

  • Schering has worked closely with drug maker Sepracor (Nasdaq: SEPR), a company that focuses on developing better forms of patented drugs, to develop Clarinex, the follow-up drug to Claritin. Claritin had sales that topped $3 billion last year, and the Claritin/Clarinex allergy stronghold is a key part of Schering-Plough's allergy/respiration franchise.
  • Schering has international marketing rights for Remicade, a rheumatoid arthritis drug developed by Johnson & Johnson's (NYSE: JNJ) Centocor, that could be a $1 billion product in Europe.
  • Since 1996, Schering has had a research partnership with Genome Therapeutics Corp. (Nasdaq: GENE) to discover new medications for the treatment of asthma. The two are working to identify asthma-susceptibility genes. The company also has a partnership with Celltech Group (NYSE: CLL) to develop oral medications for the treatment of asthma and inflammatory diseases.
  • Schering has exclusive marketing rights to Malacine, a treatment for malignant melanoma. The drug was developed by Ribi ImmunoChem Research Inc., which was bought by Corixa (Nasdaq: CRXA).
  • Schering has licensed Temodar, a chemotherapy drug, from Cancer Research Campaign Technology. Also, Schering has international marketing rights to cancer-fighting drug Caelyx from Sequus Pharmaceuticals, which merged with Alza Corp. (NYSE: AZA).
  • Schering has licensed Integrilin, which helps prevent blood clots, from Cor Therapeutics (Nasdaq: CORR). Integrilin became the most-used GP IIb-IIIa inhibitor in the U.S. in the second quarter of last year.
  • Schering is working with pharmaceutical bellwether Merck (NYSE: MRK) to use its drug Ezetimibe in combination with Merck's Zocor to help lower cholesterol. Data from Phase II trials indicated the two drugs in concert could lower cholesterol levels 17% to 18%.

Worth noting about Schering-Plough's licensing strategy is that it has a strong focus on areas where the company has expertise: allergy/respiration and anti-infective/anticancer medications. Focusing on these areas gives Schering-Plough the best chance to identify promising drugs and strike the best deals with developers since it's an area in which the company has knowledge and relationships. It benefits licensors because Schering-Plough has established production facilities, distribution lines, and a sales force to bring these products to market quickly.

More and more, the companies with the best partnerships and licensing deals, along with strong R&D programs, will move to the top of the heap. Schering-Plough is in a good position to work through its recent problems with the Food and Drug Administration. (The FDA found quality-control problems at Schering-Plough's manufacturing facilities in New Jersey and Puerto Rico.) We're looking past its troubles in 2001 and counting on strong growth over the next three to five years.

Have a great day.

Richard McCaffery lives in Laurel with his wife Linda. Neither owns any of the stocks mentioned in this article. Both Richard and Linda are still in Phase I trials. The Motley Fool is investors writing for investors.