Internet Mini Case #1

A LEADING U.S. PHARMACEUTICAL COMPANY, ELI LILLY AND COMPANY (LLY) PRODUCED a wide variety of ethical drugs (approximately 94.2% of 2003 revenues) and animal health products (just over 5.8% of 2003 revenues). The company history began with Colonel Eli Lilly, a Union officer in the Civil War, who invented a process for coating pills with gelatin. Lilly’s principal activities were to discover, develop, manufacture, and market pharmaceutical-based health care solutions. The company’s two business segments are Pharmaceutical and Animal Health.

The company’s pharmaceutical product lines comprised neuroscience, endocrine, anti-infective, cardiovascular agents, oncology, and animal health. Lilly manufactured and distributed its products through owned or leased facilities in the United States, Puerto Rico, and 26 other countries; the company’s products were sold in approximately 160 countries. In the United States, Lilly’s pharmaceutical products were distributed through approximately 35 independent wholesalers that served physicians, pharmacies, hospitals, and other health care professionals.

Three wholesalers in the United States, AmeriSource Bergen Corporation, Cardinal Health, and McKesson, each accounted for between 19% and 23% of 2001 consolidated net sales. Products were promoted through sales representatives who called on physicians, wholesalers, hospitals, managed-care organizations, retail pharmacists, and other health care professionals. The company supported sales representatives’ efforts with advertising in medical and drug journals and distributed literature and samples of products to physicians at medical meetings.

Like its competitors, Lilly also advertised certain products directly to consumers, a practice coming under increased criticism from public health and cost-containment advocates. Marketing methods and product emphasis were adapted to meet local needs and regulations in markets outside the United States.

This case was prepared by Professor Maryanne M. Rouse, MBA, CPA, University of South Florida. Copyright ©2005 by Professor Maryanne M. Rouse. This case cannot be reproduced in any form without the written permission of the copyright holder, Maryanne M. Rouse. Reprint permission is solely granted to the publisher, Prentice Hall, for the books, Strategic Management and Business Policy–10th and 11th Editions (and the International version of this book) and Cases in Strategic Management and Business Policy–10th Edition by the copyright holder, Maryanne M. Rouse.

This case was edited for SMBP and Cases in SMBP–10th Edition. The copyright holder, is solely responsible for case content. Any other publication of the case (translation, any form of electronics or other media) or sold (any form of partnership) to another publisher will be in violation of copyright law, unless Maryanne M. Rouse has granted an additional written reprint permission.

Lilly’s patents were critical to maintaining its competitive position. Current patents for major products included:

DrugYear Introduced PurposeAlimta 2004 Malignant mesothelioma and advanced lungcancerSymbax 2004 Bipolar depressionCialis 2003 Erectile dysfunctionStraterra 2003 ADHDForteo 2002 OsteoporosisXigris 2001 Severe sepsisActos 1999 Type 2 diabetesEvista 1998 OsteoporosisZyprexa 1996 Schizophrenia, bipolar maintenanceHumalog 1996 Type 1 and type 2 diabetesGemzar 1995 Pancreatic, bladder, breast, and lung cancers ReoPro 1995 Prevention of cardiac ischemiaHumatrope 1987 Human growth hormoneHumulin 1982 Type 1 and type 2 diabetes

For a number of these products, in addition to the compound patent, the company held patents on the manufacturing process, formulation, or uses that may extend beyond the expiration of the product patent.

Although industry analysts had concerns about Lilly’s performance as it moved beyond the “Prozac era” (the company lost patent protection for its blockbuster antidepressant in August 2001, after a Federal Circuit Court reversed a part of a Federal Court decision upholding Lilly’s patents), the introduction of six major drugs between 2001 and 2004 plus a strong pipeline and solid performance had secured the company’s ranking as one of the top 10 global pharmaceutical firms, with most analysts rating the company’s stock as “outperform.”

As part of an inspection related to regulatory reviews of Lilly’s Zyprexa intramuscular and Forteo products in 2001, the Food & Drug Administration (FDA) found quality problems at several of the company’s manufacturing sites. Although Lilly appeared to be moving in the right direction in resolving these quality issues, they were still a concern several years later.

The bottom-line implication from this manufacturing mess was that several new product approvals, including Forteo and Straterra, were delayed. Lilly’s margins were likely to remain under pressure from lower volumes and costs associated with resolving its manufacturing problems. The company expected to resolve most manufacturing problems to the satisfaction of the FDA by year-end 2004.

Legislative-Related Activity and LitigationIn early October 2002, Lilly and Bristol-Myers Squibb settled over 300 lawsuits accusing them of failing to stop Kansas City pharmacist Robert Courtney from diluting cancer drugs over a period of years. Plaintiffs had maintained that both companies were complicit in the pharmacist’s actions, based on internal documents showing they knew as early as 1998, three years before the arrest, that cancer drugs were being diluted but failed to act.

In 2004, Lilly still faced a number of consumer lawsuits related to Prozac and was involved in patent litigation involving both Prozac and Zyprexa. Lilly was also expected to face charges of deceptive marketing in connection with its osteoporosis drug Evista. Critics noted that Lilly had attempted to position Evista as a means of lowering the risk of cardiovascular events (heart attack, heart-related chest pain, and other coronary events) based on data gathered in a study designed solely to assess Evista’s effects on osteoporosis. Questions were also raised about financial support provided byLilly to the authors of the study.

Financial Position/PerformanceThe loss of patent protection for Prozac had a significant effect on Lilly’s sales and profitability in both 2001 and 2002; however, worldwide sales for 2003 increased 14%, due primarily to the strong performance of more recently introduced drugs, including Zyprexa, Evista, and Gemzar, as well as growing sales of Cialis, Straterra, and Forteo. Net income for 2003 declined approximately 5.5%, from $2.71 billion in 2002, due to increased spending on research and development, revamping of manufacturing facilities, and an increase in marketing costs from 30.9% of revenue in 2002 to 32.23% of revenue in 2003. Impairments, restructurings, and other special charges (principally as a result of the Isis joint venture) resulted in a $382.2 million write-down for 2003. Complete financial information, including links to Eli Lilly’s annual and quarterly reports and SEC filings, is available via the company’s web site or

The IndustryIn the United States, the largest segment of the global pharmaceutical market, demographic trends, including the baby boom population bulge and longer average life spans, drove industry growth. At the turn of the 21st century, although approximately 12% of the U.S. population was over 65 years of age, over 33% of all U.S. prescriptions were written for those over 65. Patients generally considered prescription medicines necessary purchases which, together with a third-party payment system, tended to reduce the price elasticity of demand.

Despite near-term uncertainties with respect to pricing and patent expirations, the pharmaceutical industry was still one of the healthiest and widest-margin industries in the United States. U.S. prospects for the longer term were enhanced by demographic growth in the elderly segment of the population (accounting for about one-third of industry sales), as well as by new therapeutic products resulting from discoveries in genomics and biotechnology.

However, drugs generating over $40 billion of industrywide sales in 2001 were going to lose patent protection over the next four years. The flood of patent expirations offered major opportunities for the generic manufacturers, especially for those obtaining 180 days of “first to file” marketing exclusivity.

On the regulatory front, the FDA had become much tougher on new drug approvals. Regulatory compliance was costly both in out-of-pocket application, establishment, and product fees and in time required to gain approval. Major new drug therapies took an average of 14 years to develop, at an estimated cost of $500 million. Only about 1 applicant in 20 makes it through Phase 3 trials to FDA approval. The FDA was also cracking down on drug manufacturing, with some plants closed as a result of quality problems.

Three key developments were expected to act as a ceiling on profits for pharmaceutical firms: (1) Managed care plan buyers, who accounted for 70.4% of prescription drug purchases, had made drug cost containment a priority, (2) the Medicare Prescription Drug Improvement and Modernization Act was signed into law in December 2003, and (3) states had become very aggressive in pushing for new legislation aimed at obtaining greater drug discounts for Medicaid and other state-run programs.

Many HMOs used a three-tiered copay system to discourage the use of expensive drugs and encourage the use of generics. Outside the United States, the competitive landscape was quite different. Although the standardization of regulatory requirements among European Union member countries was expected to create a simpler operating environment, the EU imposed stringent price controls and banned most direct-to-consumer marketing; similar price controls and advertising bans existed in Japan.

The operating and competitive environments in developing nations were characterized by a high degree of uncertainty and, while they represented significant opportunities for revenue growth, they lacked the strong intellectual property protection pharmaceutical companies relied on to justify huge investments in R&D.

Recent DevelopmentsA growing challenge to U.S. pharmaceutical firms came from increased out-of-country purchases. On October 12, 2002, the largest U.S. health insurer informed members of the senior citizens lobbying group AARP that it would reimburse them for prescriptions filled in Canada and elsewhere abroad where governments cap drug prices. UnitedHealth Group, Inc., sent a letter to 97,000 people who bought insurance with a drug benefit through AARP about the coverage.

Although buying prescription drugs outside the United States for use in the country violated federal regulations, it was a growing practice among older Americans seeking relief from high-priced name-brand drugs.

UnitedHealth and AARP appeared to want to keep the announcement low key; however, thousands of AARP members, as well as other senior citizens, regularly purchased prescription medicines in Canada and Mexico—in person or via the Internet—where the drugs are significantly cheaper, even if not reimbursed. By October 2003, industry lobbyists, who had mounted a campaign against reimportation of prescription drugs based on purported safety concerns, were pressing Congress to set harsh penalties for those facilitating the practice.

In early October 2002, the U.S. Office of the Inspector General warned drug companies that offering incentives, such as concert tickets and vacations, to physicians could lead to civil or criminal charges.

The policy came after years of concern about drug industry marketing practices that critics said influenced doctors to prescribe certain drugs that led to higher costs for consumers. Although the policy did not bar nominal-cost gifts, golf balls, or bags emblazoned with company logos, meals other than those in conjunction with medical education, concert and other entertainment tickets, cash payments, and a wide range of other incentives were not allowed.

The policy also prohibited drug companies from reporting average wholesale prices that differed substantially from what was actually charged—and touting those prices in marketing. The government’s concern stemmed from the use of average wholesale prices in determining reimbursement for the drugs Medicare currently covered.

There had been some concern that if drugs were sold to doctors for less, doctors could bill for the higher amount and keep the difference. Critics said this was a tactic drug makers used to lure doctors to their products and further inflate consumer drug costs by more than $1 billion annually. To continue generating the returns enjoyed by the industry over the past decade, pharmaceutical companies would be forced to rethink how they identify and exploit opportunities to gain a competitive edge in an increasingly complex market.