To borrow a phrase from a certain fantasy series: "Winter is coming." Thankfully, however, the pharma industry is equipped with a thick coat.
"The expectation of our economists as well as the market seems to be that six to nine months of a mild recession is to be expected in 2023," said Arda Ural, EY Americas industry markets leader for health sciences and wellness. "But the coat that's protecting pharma from the big winter coming is the fundamentals."
A potential recession can be predicted using several factors, but this is a unique time in economic history, Ural said. Just last week, the U.S. Federal Reserve raised rates again in an aggressive move to curb inflation — meanwhile, unemployment remains historically low. And one of the key indicators of a coming recession is the inversion of the yield curve, or when 10-year yields drop below one-year yields — Ural counts six instances in which that happened since 1980 followed by an economic setback, and it is happening now.
And although these larger economic factors can affect businesses in any sector, the inelasticity of medical products tends to keep pharma and the overall healthcare sector afloat.
"Pharma is driven by its own dynamics as opposed to a more macroeconomic backdrop," Ural said.
According to Ural, the fundamentals — prescription dispensation, number of clinical trials, dollars spent in R&D, FDA approvals — are all solid.
Still, there are three priorities that leaders in the biopharma industry should make as they batten the hatches in what could be a meager year for the economy. As the fundamentals that make the pharmaceutical industry relatively recession-proof, Ural said, these priorities will be useful in the turbulent times to come.
Focus on driving growth
One way to look at the growth of the pharma industry is through the lens of its core product: dispensed prescriptions. Patients have been filling prescriptions at a compound annual growth rate of 3.4% since 1992, according to a report from EY — even through economic disrupters like the COVID-19 pandemic, subprime crisis and the dot-com bubble implosion. Furthermore, the engine behind growth is innovation, which biopharma companies have recognized and delivered for years, Ural pointed out.
The number of clinical trials surged 191% since 2012 with R&D as a percentage of sales rising 15% during that time. That led to more FDA approvals with a median of 43 per year from 2010 to 2021 compared to 26 per year in the previous decade, an EY analysis found.
But although the industry has seen consistent growth in this area, individual leaders need to keep an eye on their own progress, particularly on the products they have in the pipeline.
"Every company will have their differences, but if you look at No. 1, it's growth, and how you grow your (return on investment) for your current assets," Ural said. "Seventy percent of product launches do not live up to their expectation, which is a broadly accepted fact, so better commercial performance from existing products is priority No. 1."
This means pushing the needle forward on R&D, which Ural said is the foundation of the industry. In a recent EY survey, life sciences CEOs said they were more likely to increase investment in areas such as innovation and R&D — they also pointed to M&A as an important lever to pull, which brings us to priority No. 2.
Optimize the portfolio
When it comes to dealmaking, a recession can become an opportunity. Lower valuations allow companies with strong balance sheets and decent cash flow to access new platforms or technologies or businesses that could help grow their footprint.
"The sugar high of COVID is behind us," Ural said, referring to the end of 2021 when biotech stocks were at their peak, and then now when they are more than 50% off. "It was a sugar high because companies who were not ready for IPOs went public with valuations driven by COVID therapeutics and vaccines — and investors put a lot of value on biopharma stocks that lifted them up, and now they are coming back."
Now that valuations are lower and biotechs are running out of cash runway, the opportunity to buy is strong, Ural said. But like their R&D pipelines, the buyers need to be strategic about therapeutic areas and expertise to scale up in the right way.
"Pharma has to grow, and with winter coming, we need to put that coat on — we can afford that coat because we have the balance sheet," Ural said.
Growing product sales and making deals can only go so far to insulate a pharma company against the harsh recession winds without an eye toward keeping costs down, especially in a time of growing inflation. And rate increases from the Federal Reserve have ended the "era of free money," Ural pointed out.
That's where pharma companies need to look at their SG&A — or selling, general and administrative — expenses.
"The cost of capital has to be managed much more diligently, and that is something that pharma cannot control," Ural said. "But what it can control is SG&A — in pharma, it has hovered around 28% of revenue, and it hasn't changed over time even as digitalization, intelligent automation, robotic processes have been available."
Other industries have integrated these technologies more readily than pharma has, and cutting these costs will be crucial in a time when capital isn't as cheap.
"This is the time for financial resiliency, for back-office processes to be mapped out and digitalized to focus on raising that capital, which is no longer free," Ural said. "Take that capital and invest back into R&D and infrastructure building. It is a historical moment for pharma to be driven by growth and innovation."
For pharma to step back and address the fundamentals, leaders need to be thoughtful about where their strengths lie and what levers they can pull to take advantage of the inherent resiliency of the industry.
"I think these are all easier said than done, but they can be done," Ural said.