In the concluding ii weeks, I bring started writing most epic autumn of Valeant as well as the unraveling of the Theranos story, but I bring held dorsum because all iii stories bring to live on laid upward against the backdrop of the changing wellness tending business. While at that topographic point are numerous stories beingness told most how this is changing, I decided that it made feel to get past times looking at the evolution of the wellness tending draw of piece of job concern over the concluding 25 years and how changes inwards its inwardness characteristics may explicate all iii stories.
The Story
To empathise the drug business, I went dorsum to 1991, towards the starting fourth dimension of a surge inwards spending inwards the U.S. on wellness care. The pharmaceutical companies at the fourth dimension were cash machines, built on a platform of substantial upward front end investments inwards enquiry as well as development. The drugs generated past times R&D that made it through FDA approving as well as into commercial production were used to comprehend the aggregated cost of R&D as well as to generate important excess profits. The commutation to this procedure was the pricing mightiness enjoyed past times the drug companies, the outcome of a well-defended patent system, important increment inwards wellness tending spending, splintered wellness insurance companies as well as lack of accountability for costs at every degree (from patients to hospitals to the government). In this model, non surprisingly, investors rewarded pharmaceutical companies based on the amounts they spent on R&D (secure inwards their belief that the costs could live on passed on to customers) as well as the fullness as well as residual of their production pipelines.
So, how has the story changed over the concluding decade? The rising inwards wellness tending costs seems to bring slowed downwards as well as the pricing mightiness of drug companies has waned for many reasons, amongst Obamacare beingness solely i of many drivers. First, nosotros bring seen more consolidation inside the wellness insurance business, potentially increasing their bargaining mightiness amongst the pharmaceutical companies on drug prices. Second, the regime has used the buying clout of Medicaid to deal for amend prices on drugs, as well as patch Medicare nevertheless industrial plant through insurance companies, it tin lay pressure level on them to negotiate for lower costs. Third, the pharmacies that stand upward for the distribution networks for many drugs bring too been corporatized as well as consolidated, as well as are gaining a vox inwards the pricing process. The internet effect of all of these changes is that R&D has much to a greater extent than uncertain payoffs as well as has to evaluated similar whatever other large uppercase investment, that it is goodness solely when it creates value for a business. Consequently, investors bring had to transcend to a greater extent than measured inwards their judgment of R&D spending at drug companies, rewarding companies for spending to a greater extent than on R&D solely if it is productive as well as punishing them when it is not.
The diminished pricing mightiness story is non a novel i as well as others bring made the points that I bring but it is nevertheless but a story. The existent enquiry is whether the numbers dorsum the story as well as to respond that question, I looked at commutation operating metrics for publicly traded drug companies from 1991 to 2014, amongst the intent of eking out trends inwards the numbers.
The Revenue Growth Story: The Rise of Biotech
The increment inwards wellness tending costs continued into the concluding decade, albeit at levels much to a greater extent than moderate than inwards the 1990s, but the large story was the rising of biotechnology companies inwards the space. At inception, the distinction betwixt pharmaceutical as well as biotech companies wass the method past times which they produced drugs, amongst pharmaceutical firms working amongst chemicals as well as biotechnology companies using alive organisms (bacteria, cells or yeast) to generate their drugs. Given that both R&D processes are designed to generate drugs that transcend through similar FDA approving processes as well as teach sold through the same distribution channels, this departure is i that solely scientists tin relate to, as well as i that is becoming meaningless every bit R&D departments at both groups poach on the other's territory. The repose of the differences that people request to betwixt the two, i.e, that biotech companies pass to a greater extent than fourth dimension on research, tend to lose coin as well as are riskier than pharmaceutical firms bring less to arrive at amongst draw of piece of job concern differences than life cycle differences.
In the painting demo below, I human face at the aggregate revenues reported past times pharmaceutical as well as biotechnology companies from 1991 to 2014.
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| Source: Classification past times S&P Capital IQ |
Note that past times the concluding decade, as well as peculiarly since 2010, almost all of the increment inwards the drug draw of piece of job concern has come upward from the biotech companies, amongst pharmaceutical companies reporting apartment revenues betwixt 2010 as well as 2014. In 2014, biotech companies accounted for 30.63% of total revenues at drug companies, upward from 19.23% inwards 2010.
Tech versus Non-tech
Before nosotros start on a tidings of how tech companies are different from non-tech companies, nosotros direct hold to recall near what separates the ii groups, in addition to that separation becomes hazier past times the day. In the 1980s, at the start of the tech revolution, the distinction was a uncomplicated one. If a company’s products or services were computer-related (either personal or concern computers), it was classified equally a applied scientific discipline firm. That distinction allowed us to position Microsoft, Apple in addition to Atari equally applied scientific discipline firms, in addition to convey inwards HP, IBM in addition to Digital Equipment equally the onetime guard. That definition no longer works, equally almost every production nosotros purchase (from appliances to automobiles) has a computerized element to it, in addition to it has meant that deciding whether a companionship is a tech companionship is a judgment call. Given that reality, I would suggest that rather than describe hard lines of distinction betwixt tech in addition to non-tech, nosotros consider applied scientific discipline on a continuum, where at i halt yous direct hold companies whose products in addition to services are exclusively applied scientific discipline driven (Google, Facebook) in addition to at the other, yous direct hold companies that almost no applied scientific discipline element to them (consumer products in addition to cosmetics companies, for instance). With this continuum, yous tin combat that Tesla in addition to Ford are both auto companies, but that Tesla has a larger applied scientific discipline element than Ford.
Why practice nosotros tending near these distinctions? First, they direct hold practical implications for analysts in addition to portfolio managers. Sell-side equity question analysts are unremarkably lay into sector silos in addition to asked to move on their focus on the companies that they are assigned. With companies similar Amazon, Netflix in addition to Tesla, high profile names to follow, I direct hold noticed that at that spot are large differences across banks. Some assign these companies to the applied scientific discipline analysts, only about to the businesses that these companies operate inwards (Tesla inwards autos, Netflix inwards amusement in addition to Amazon inwards retail) in addition to only about create novel sector groupings only for these grayness expanse companies. Second, for ameliorate or worse, the categorization of a companionship tin acquit on its pricing. Tesla, classified equally an auto company, volition await expensive, compared to other auto companies, but classified equally a immature tech company, it may await cheap. That is mayhap why companies seek out the tech label for themselves, fifty-fifty if applied scientific discipline is only a little element of their offerings.
The Tech Life Cycle
If yous select my declaration that applied scientific discipline is a continuum, so yous tin mayhap alive alongside my definition of “tech” companies equally those that larn the predominant part of their value from technology. With that definition, I tin revisit the corporate life bike in addition to its determinants in addition to build the next generalizations (and I am certain that yous tin recall of exceptions alongside each one):
- Scaling upward is easy: Tech companies oft operate inwards businesses where entry is non restricted, the upward front end investment is minimal in addition to scaling upward inwards easy. If marketplace atmospheric condition are favorable, they are aided in addition to abetted past times access to capital in addition to past times less viscous client preferences inwards their markets. Not surprisingly, tech companies tin grow quickly.
- Holding on is tough: Once tech companies accomplish the mature phase, they don't larn to direct hold long harvest periods. Their competitive advantages are fleeting in addition to chop-chop deplete.
- Decline is rapid: The same forces that allow applied scientific discipline companies to grow, i.e., unrestricted entry, ease of scaling upward in addition to client switching, also build them vulnerable to novel entrants seeking to select their concern away from them.
- And at that spot is niggling left inwards the halt game: Unlike other businesses, which accumulate physical assets equally they grow in addition to hence direct hold a liquidation potential, alongside applied scientific discipline companies, at that spot is niggling of essence to autumn back, i time earnings ability is exhausted.
Is at that spot evidence that this is what happens inwards the market? I could utilisation Blackberry equally an example, but I would so live guilty of using anecdotal evidence to advance my theory. Instead, I volition combat that the evidence exists, albeit inwards scattered form. First, at that spot is evidence that the little tech firms (that move the start tests) are able to scale upward faster inwards price of revenue increase (at least) than little non-tech firms. The fact that they oft lose coin spell doing so is equally much a business office of the accounting inconsistency of treating question in addition to production evolution costs equally operating expenses, equally it a business office of operating weakness. The mo is that these tech firms, i time established, direct hold a to a greater extent than hard fourth dimension maintaining growth. The 3rd is that decline, i time it starts at tech firms, is to a greater extent than hard to opposite in addition to quicker to accelerate. All of these points are made inwards this McKinsey article on increase at tech companies.
A Life Cycle Perspective on Disruption
Disruption is the novel buzz tidings inwards corporate strategy, a ground that I listed it equally on my listing of words that operate equally weapons of majority distraction, in addition to is oft used to cutting off debate or non beak specifics. From my perspective, the essence of disruption is a that it is a novel means of doing concern that radically changes the fundamentals of on established business. In the context of technology-driven disruption, it a company, alongside a tech model, coming into a non-tech business, characterized past times long increase periods, extended mature phases in addition to elongated declines.
Consider auto service, i.e., the taxi cab in addition to limo business. The onetime non-tech model for this concern required regulatory approving (making entry difficult) in addition to substantial investment (in cars) inwards a marketplace governed past times client inertia. Uber in addition to the other ride sharing companies direct hold upended the model past times bypassing regulatory approval, non investing inwards cars in addition to breaking through inertia past times reaching out to customers through their smart phones. The results speak for themselves. Not only direct hold Uber, Lyft in addition to Didi Kuaidi grown at rates different whatever seen past times traditional auto service companies, but each has a marketplace accomplish that is beyond the onetime model. No traditional cab companionship tin afford to operate inwards 300 cities, similar Uber does.
The lawsuit of disruption is that it upends the fortunes of mature companies from the onetime concern model, coasting inwards their mature phase, convinced that alter is slow. Unprepared for the speed of alter emanating from the tech entrants, these onetime players hold off likewise long to respond, looking to regulators in addition to dominion makers for protection, in addition to non surprisingly, confront an implosion. That, inwards a nutshell, is what has happened to the taxi cab in addition to limo concern inwards many cities. The novel entrants, though, should non celebrate likewise quickly, since their tech model disruption comes alongside its dangers. Their models are hard to mine for cash flows in addition to are themselves susceptible to competition. As I noted inwards my post on the hereafter of the ride sharing business, disruption is easy, but making coin on disruption is hard.
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Tech Life Cycle Series
