FORTUNE -- Big Pharma is still big, but its business model is dying. For years, the game in pharmaceuticals has been to research, discover and then fiercely defend billion-dollar drugs.
But several mighty drug companies are losing the rights to exclusively own the formulas for best-selling drugs. Take Pfizer (PFE), which made a killing off cholesterol medication Lipitor. In 2012, Pfizer lost the exclusive rights to the drug, opening it up to competition from companies that produce cheaper, generic versions.
That hurt. CEO Ian Read explained in the 2012 third-quarter earnings report, "Year-to-date we have absorbed approximately $5.5 billion in LOEs." An "LOE" is a loss of exclusivity to drug formulas, including Lipitor and others in this case, and $5.5 billion is no joke.
So how can drug companies prevent these kinds of losses? One way, Novartis CEO Joseph Jimenez suggested to Fortune, is to re-imagine what is known as a blockbuster, or a drug that earns the company at least $1 billion per-year. "The definition of a blockbuster is changing," Jimenez said.
The old concept of a blockbuster has generally been one drug to treat one disease that affects a large population. Because blockbusters are so profitable, companies scramble to squeeze as much money out of them as possible, arguably in a way that detracts from efforts to research and develop novel treatments.
For example, large pharmaceutical companies have invested in what's known as "me-too" drugs. Companies make drugs with the same basic formulas as some of their bestsellers, tweak them slightly, and re-package them as new treatments. That strategy won't work for much longer, says Jimenez, given that the Affordable Care Act will discourage me-too drugs. Previously, to get FDA approval, companies had to prove that new drugs performed significantly better than a placebo, but they didn't have to show that the treatment performed better than drugs already on the market. Under the ACA, "new" drugs that don't perform significantly better than current options won't be eligible for reimbursement from insurance companies.
This means Big Pharma has a couple of options. For one, they can fight to keep the rights to blockbusters. Pfizer has had some success with this; its hugely profitable drug Viagra was supposed to go off patent in 2012, but the company managed to extend its exclusivity rights until 2020.
But here's a crazy idea -- what about making new drugs? The catch is that competition is fierce in areas with big patient populations such as erectile dysfunction and heart disease. But Novartis has decided re-think the methodology behind drug development, Jimenez says.
It takes into account the fact that, in general, effective research and development doesn't come from targeting the most profitable problems. Basic research often takes many twists and turns. The discovery of Penicillin, famously, was a happy accident. Novartis (NVS) has a new strategy to try to generate that kind of serendipity. Instead of targeting a disease with a massive patient population, the company is instead targeting pathways, or the distinct biological mechanisms that cause a disease.
The company has seen some success with this method. It developed its drug Afinitor, for example, for with the idea to target a cluster of diseases. Afinitor was first approved to treat kidney cancer. But research demonstrated that it also works in patients with some lung and breast cancers. Sales of Afinitor for breast cancer do not add up to $1 billion, neither do sales of Afinitor as a kidney cancer or lung cancer treatment. But looking at the sales numbers combined, it makes a blockbuster.
There are pros and cons to this method. According to a February analyst report from Morningstar, Novartis is well positioned for good long-term growth. But investors need to understand that this kind of growth can take time. The old blockbuster-finding strategy hasn't been sustainable, but it's been profitable immediately. Novartis is taking a different route through drugs that treat smaller patient populations.
Investors aren't always willing to be patient. For example, in 2009, Novartis received approval for Ilaris, a drug that treats CAPS, a class of rare, potentially fatal autoinflammatory diseases that can cause fevers and chills, bone deformities, and loss of vision. "Many of our people said, 'Why are you designing a drug for only 6,000 people in the world; CAPS is so rare?'" No one else was making drugs to treat the disease.
But the idea is that cracking the code to treat CAPS will lead the way to treatment of other diseases caused by the same mechanism.
Using this strategy, Novartis will not bet the farm on finding the next massive breakthrough, such as an Alzheimer's drug, which is a tack its competitors have taken.
But there are clear pros to the company's plan. For one, Novartis will make treatments for rare diseases that could ultimately blossom into blockbusters by virtue of their application to multiple maladies. Even the drugs that don't materialize into great sales numbers will get the company into a new market.
And to chuck the business angle for a moment, the big-picture pro of this strategy is that it means Novartis will be making medicine for people who need it, despite the industry straying from that somewhat as an effective business strategy.
Making drugs, after all, is what drug companies are supposed to do.
Consumers are told that generics are just like their name-brand counterparts. More medical professionals are starting to say that's not the case.
By Katherine Eban, contributor
FORTUNE -- In October the Food and Drug Administration took a highly unusual step: It declared that a generic drug it had previously approved -- a version of the popular antidepressant Wellbutrin -- was not in fact "bioequivalent" to the name-brand version. The FDA withdrew MOREJan 10, 2013 5:00 AM ET
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