Coming into focus

Coming into focus

Yesterday Lilly (NYSE:LLY) reported first quarter results and behind the numbers there was a clear, unmistakable message – Lilly is back in the diabetes business. Yes this company which once was one of the most dominate forces in diabetes that lost their way in the late 90’s and early portion of the new century has regained its mojo and returned to their roots. Yet this latest reincarnation of the franchise has more potential and vigor than previous efforts at reinvention.

The cornerstone of the new Lilly is not a reliance on insulin but a comprehensive portfolio of diabetes medications that run the gamut from orals to injectable’ s. To their credit Lilly was one of the first diabetes drug companies to recognize how the landscape was changing. How innovation was not being rewarded, how the FDA was becoming even more conservative, how payors were favoring single source contracting and most importantly of all how price would trump performance. While the company would never acknowledge this publicly, like Diabetic Investor they anticipated the diabetes drug market becoming a commodity market.

Now before everyone starts thinking that the company has completely turned the corner remnants of the old Lilly remain. While the company has done an excellent job of building their product portfolio, they have yet to restructure their sales and marketing teams to reflect new market dynamics. These efforts appear to be underway but change comes slowly at Lilly.

While Diabetic Investor once criticized Lilly for this me-too copycat late to market strategy today we lavish praise on the company for doing something we once loathed. What changed? Several dynamics but two that stand out above the rest, healthcare reform and the FDA. Now when we say healthcare reform we are not specifically referring to ObamaCare although this did have an impact. When we mention healthcare reform our angle is directly related to cost, cost containment has become the order of the day and drug companies are just not being rewarded with premium reimbursement for innovative new therapies.

Why should a company spend billions to develop innovative new therapies when payors have the attitude that the existing therapy options are just fine plus they are cheaper? The fact is drug companies have contributed to this perception by rolling out new therapy options which really aren’t new at all. Therapies which are just incrementally better than the drug they are designed to replace, i.e. Toujeo and Lantus. Lilly has done the same with Tradjenta in the crowded DPP4 category. The difference now is Lilly reconfigured their strategy to match the needs of payors not patients.

A reconfiguration that was also driven by the FDA. For all the talk about reform, for all banter about the need to bring drugs to market faster the simple fact is when it comes to diabetes drugs the regulatory process has gotten worse and not better. Take a look at the problems Novo Nordisk (NYSE:NVO) is having with Tresiba. The fact is thanks to that crusading cardiologist Dr. Steven Nissan, the regulatory risk has increased tenfold. Just ask the folks at AstraZeneca (NYSE:AZN) the most recent company to come under the microscope for their DPP4 Onglyza.  Think about how the folks at Merck (NYSE:MRK) must be sweating bullets right now as they await the CV data to be released for their blockbuster Januvia.

This double whammy of payor cost control combined with the adverse regulatory environment not only made the me-too copycat late to market strategy workable but also essential. In their own way AstraZeneca is trying to compete with Lilly yet lacks any insulin products. Novo on the other hand seems to be steering clear of bringing in any oral offerings preferring instead to find new applications for existing drugs, i.e. Victoza becoming a treatment for obesity. Looking over the remainder of the field Diabetic Investor for obvious and well documented reasons sees Sanofi (NYSESNY) as the company in the worst position less so for Merck or Johnson and Johnson (NYSE:JNJ).

As we have stated consistently the beauty of the new Lilly strategy is it forces the competition to pick their battles, keeping them playing defense. Again as we have mentioned before the diabetes drug market is no place for the timid. This has turned into a knock down no holds barred street fight, a fight that a mixed martial arts fighter would shy away from. In their quest to maintain share the companies have played into the hands of payors. These tactics are quickly transforming the diabetes drug market into exactly what these companies say they don’t want; a commodity market where price trumps performance.

The simple fact is Lilly has prepared for this and the completion has not. They know that the performance of their me-too copycat drugs does not have to beat the competition, it merely has to match the competition. Lilly can basically walk into a payor and state their drugs are just as good as the competitions and if you buy the whole package there cheaper too. Lilly isn’t trying to hit a Lantus or Januvia style grand slam as they are perfectly content hitting singles and doubles. As long as they have more runs at the end of the game that’s all that matters.

Since it’s springtime we’ll stick with the baseball analogue think of Lilly as the Oakland Athletics and their moneyball approach to building a winner. Or perhaps think of them as the Chicago Cubs who have undergone a painful yet very necessary rebuilding process. Today under new leadership these once lovable losers have a team rich in young talent developed down on the farm. Throw in a few choice free agents and hope rains eternal on the north side of Chicago. In many respects Lilly has followed a similar path, the drugs that were under development are coming to the market and like the Cubbies it’s time to see if these kids can play at the major league level.

The real question is will this strategy work or will the competition turn the tables on Lilly. Will Novo, Sanofi, AstraZeneca or Merck play their version of hardball and do whatever it takes to retain share. Will they become so aggressive with pricing and rebates that it is Lilly who must then play defense? Will a company like AstraZeneca decide to go to toe to toe with Lilly buying their way into the insulin market? Will Novo stray from their roots and add orals to their portfolio? What about Sanofi, can they remain a viable player? Will any of these companies be bold enough to partner with or aligned themselves with a diabetes device company? Can anyone fully leave the past behind and begin selling diabetes management solutions?

Whether these drug companies realize it or not, when outcomes determine reimbursement, they will need devices that help patients better use the drugs they sell. And we’re not just talking about patients who use insulin but all patients with diabetes. In the future payors will favor companies who not only bring them all the drugs they need but companies that bring along a diabetes management system which helps patients use these drugs effectively.

As it stands today Lilly is halfway to the future with their drug portfolio. The question now is can they get the other half they need to stay ahead of the competition? While we don’t see Lilly acquiring their way into the device arena we can easily imagine a strategic alliance/partnership in their future. A partnership which as we have noted in the past which becomes the ultimate win-win scenario. Lilly sells more drugs while the device company, whoever that might be, sells more devices. All because together they help the patient achieve better outcomes which is the ultimate winning formula.