Normally, competition in innovative industries is good for everyone. Consumers win, because it usually results in better products, and investors can win big if they can identify the superior product.
But for drug development, it's becoming increasingly clear that competition isn't always the best thing for the industry. When several companies research the same drug target, duplicate costs are inevitable. Considering how many compounds get thrown in the trash before ever becoming marketed drugs, overlapping searches waste a lot of research and development dollars. With growing pressure to lower health-care costs, companies will need a way to decrease the cost of developing drugs, or their operating margins will surely suffer.
Collaborations have always been a mainstay of drugmakers, usually with small development-stage drugmakers doing the research and early work in the clinic, and then pharmaceutical companies taking over the heavy lifting for phase 3 trials and marketing. Those deals will surely continue, but I think we're going to see pharmaceutical companies sticking their hand in the cookie jar earlier in development.
We're likely to see more development-stage deals like the ones GlaxoSmithKline
We may even see some rivals hook up to decrease risk and speed along development. Isis Pharmaceuticals
Making good drugs better
In addition to hooking up at the discovery level, companies will likely continue to collaborate to make current drugs even better. For instance, Bristol-Myers Squibb
The convenience factor for patients, something Gilead has worked hard on, should also play well for drugmakers that specialize in making extended-release drugs. Companies like Alkermes -- which has helped make extended-release formulas of Johnson & Johnson's
Some drugmakers have taken the collaboration efforts to even greater extremes, suggesting that companies pool their patents together to develop drugs. Johnson & Johnson and Glaxo have been most vocal about the idea, but it seems that most of the patent donations will come in areas where there's probably not much money to be made anyway, like tropical diseases.
I'm not convinced that this will be a major contribution to drugmakers' revenue, but it could help patients get drugs that wouldn't otherwise be developed, which could in turn help pharma's negative public relations rap. Plus, if big pharma sees this strategy working successfully, they could be motivated to extend the idea, moving toward a more "open source" model for R&D.
Foolish lesson for investors
As the government continues to pressure health-care companies to lower costs, investors will be left with two choices to deal with the lower margins: find an alternative industry to invest in, or find companies that can work with the new system.
Some drug companies will be able to keep margins up by developing drugs that knock the socks off the competition, but the rest will have to find a way to decrease R&D costs in order to compete. Keep your eye open for the ones that have what it takes.
Pfizer is a Motley Fool Inside Value selection. Johnson & Johnson is a current Income Investor pick, and GlaxoSmithKline is a former selection of the newsletter. Whether you like your companies big or small, dividend-laden or with multibagger written all over them, we've got a newsletter for you.