Can Innovation Reverse Declining
European Competitiveness?
Sir Tom McKillop speech at the Business Strategy Group
gala launch and Centenary Medal presentation
Held at Belgrave Square, London, on 30 November 2004
 Good
evening ladies and gentlemen and thank you very much for this
most prestigious award.
I am the son of a coal miner who ensured all five of his
children had outstanding opportunities through education.
Mathematics, science and engineering were extremely important
in our family. I trained as a chemist, my brother was a professor
of chemistry and I'm delighted to say my son is also a chemist
now working in the pharmaceutical industry but not in AstraZeneca
- no nepotism here. You will understand therefore that to
receive the Centenary Medal of the Society of Chemical Industry
and be appointed President of the Society is rather special
for me. So, once again, thank you for honouring me in this
way.
SLIDE 1
The SCI has always seen itself as "where science meets
business" and today's launch of a new Business Strategy
Group is, in my view, timely since science based companies
face tremendous challenges in planning for the future at a
time of unprecedented change and an increasingly hostile environment.
Business Strategy for me is about creating opportunities
and securing competitive advantage. Many factors can be important,
such as a preferred raw material position, scale and cost
advantage in manufacture, control in distribution, customer
service, or brand equity and the mix will vary from company
to company and by industry. However, for science-based industries,
innovation is almost always crucial. I am a passionate believer
in the importance of innovation. It is innovation that drives
progress in society and it is innovation that creates wealth.
The printing of pound notes or dollar bills is meaningless.
Wealth creation is the added value of taking goods and services
and, through the innovative use of our hands and brains, making
them more valuable to society. So innovation is a major determinant
of growth and of relative competitiveness. Companies, governments
and society in general should be in love with innovation,
but I am becoming increasingly troubled about the relationship
particularly in the more developed Western countries. Let's
look at what's been happening to the pharmaceuticals industry
in Europe, some emerging trends in North America and what
all this may mean in the future.
Europe was the cradle of the pharmaceutical industry and
dominated it for many decades
SLIDE 2 (EU trade balance)
Indeed, even today, it is Europe's most successful high technology
business sector. As you can see, it is contributing over 25
billion euros each year to the European balance of trade,
it dwarfs other technology sectors, and almost offsets the
huge deficit in IT and computing.
SLIDE 3 (Pharmaceutical R&D spend)
It's no surprise then that pharmaceuticals also represents
a very significant part of Europe's industrial research base
- over 10% of the total from the industry alone and over 13%
including industry and government spend. The position is even
more striking in a country like the UK where research in pharmaceuticals
and biotechnology makes up almost 40% of the nation's total
industrial research. So the state of the pharmaceutical industry
should be of considerable interest and importance to Europe.
But what is actually happening?
SLIDE 4 (Breakdown of world pharmaceutical market)
In 1990 the European market represented about 38% of the
total world market - bigger than the North American market
at 31%. But, by last year, this had dramatically altered.
North America had become nearly 50% of the world market and
Europe had declined to just over a quarter: a huge swing in
a relatively short period.
SLIDE 5 (Innovation and Market Penetration)
The position is even more striking if one looks at the share
of sales for new products introduced in the five-year period
1998 to 2002. Sales in the USA make up a staggering 70% of
the total global sales for these new products. These are the
innovative products of all that Research and Development and
it is clear the USA is adopting these new products faster
and rewarding innovation better.
SLIDE 6 (% of world pharmaceutical R&D spend)
So, guess what is happening to the pattern of R&D spend
in the industry. The R&D is increasingly going to the
United States. Although in absolute dollar or euro terms spend
is still going up in Europe, it is increasing much faster
in the USA than elsewhere so that the US has now overtaken
Europe in total spend with over 50% of the world total. As
a result, there is an enormous brain drain of Europe's scientists
to the USA with an estimated half a million of our best scientists
now located in North America.
SLIDE 7 (European research success is declining)
Of course, there is an inevitable consequence. In 1980, eight
of the top ten leading medicines had been discovered in Europe.
Today, eight of the top ten have come from the USA.
So Europe's most successful high technology industry is dramatically
losing competitiveness. The Pharmaceutical industry is exactly
the sort of industry Europe must succeed in, we have the talent
to succeed, and historically we have succeeded, so why is
this loss in competitiveness happening now?
SLIDE 8A (Why is Europe losing ground?)
I believe a number of factors are important, the first of
which is our attitude towards health. Europe has universal
health care coverage, the population feels entitled to healthcare,
there is little or no payment at the point of delivery in
most systems and costs to government have been rising. The
mindset among European politicians has been all about controlling
health costs with no focus on the value of health. A healthy
population is an economically productive one. The USA has
been investing progressively much more of its GDP in healthcare
compared to European countries for a long time. Although pharmaceutical
spend is only about 10% of total healthcare costs, the same
trends can be seen there. The US spends almost 2% of its GDP
on pharmaceutical products. The highest spending European
country is roughly two thirds of that level and the UK spends
less than half. Even worse, as the chart shows, the gap has
been getting worse over the last five years.
SLIDE 9 (Health R&D)
The differences in approach across the Atlantic are even
more striking if you look at the percentage of GDP governments
chose to spend in healthcare R&D. The US is investing
two and a half times more of its GDP than the UK and five
times more than the European average. Remember these are government
spends, not industry spends, and I am sure they reflect profoundly
different attitudes towards health and the value of innovation.
SLIDE 8B (Regulatory and reimbursement barriers)
A second reason for our loss of competitiveness concerns
regulatory and reimbursement barriers. Of course, all countries
require technical approval for pharmaceutical products covering
safety, efficacy and product quality, but in Europe most member
state governments have further barriers to market access including
often protracted pricing and reimbursement mechanisms.
SLIDE 10 (Delays from pricing)
As can be seen from this slide, the average delay after technical
approval is about one year and for some products in some countries
it can take much more than this. Add to these barriers Europe's
general fondness for regulation, such as the REACH proposals
for chemicals, and it is clear that Europe is much less innovation
friendly than the USA.
SLIDE 8C (Market distortions)
A propensity for intervention has led to a highly distorted
European market with many supply and demand side controls
and extensive, damaging parallel trade with the prospect of
the market deteriorating even further following enlargement
of the European community. In the USA, following technical
approval, there is a free market with all the usual characteristics
of a market. Prices are set competitively with rebates, discounts,
price/volume contracts and all the other features you would
expect to see in such a market. Innovation is rewarded with
good prices while purchasers benefit from the lowest prices
for generic products as soon as the intellectual property
has expired on innovative products. Contrast this to the market
in Europe riddled with governments' interventions on pricing
and with more and more organisations being set up to "control"
access to products thereby denying or delaying the availability
of the best treatments for patients.
This is bad enough but parallel trade is making the situation
even worse. Each member state in Europe has retained responsibility
for health matters, which is understandable since health is
an important political issue, but this responsibility extends
to the setting of pharmaceutical prices. As a result, every
country has its own mechanism to set prices and can and does
change the price quite arbitrarily. We could just about live
with this if these price impositions only affected product
bought in that country. But no, under the Treaty of Rome there
must be free movement of goods around Europe, so that, if
Portugal lowers its price for a product, arbitrageurs can
buy unlimited quantities of that product and ship it around
Europe to higher priced markets creating a downward spiral
in pricing.
Slide 11 (Parallel trade)
This parallel trade is now affecting about 15% of all pharmaceutical
sales costing the industry at least 4.5 billion euros of revenues
and an estimated 2 billion euros in lost profit, much of which
could have been reinvested in R&D in Europe. By the way,
the savings to governments are tiny, but this activity generates
huge profits for the parallel traders and pharmacists. Indeed,
the distortions to a proper market in pharmaceuticals have
created a profitable but completely worthless business activity
re-labelling and shipping product around Europe, increasing
the risk for patients through mislabelling and incorrect product
handling, and at the same time opening the door to the introduction
of counterfeit product entering the supply chain. A recent
WHO report suggests that as much of 10% of pharmaceutical
supply could be counterfeit, so this is no trivial matter,
and this crazy situation can only get worse following enlargement
unless European politicians take action. The industry is caught
in a clash of two dogma, the members states' accountability
for health matters versus the commission's insistence on free
movement of goods under the Treaty of Rome.
SLIDE 8D (Attitude to innovation)
But perhaps the most important reason why Europe has lost
competitiveness in pharmaceuticals is more profound than any
of the factors I have mentioned so far. I believe Europe has
lost confidence in science and innovation. I remember some
years ago visiting opinion leaders around the world to discuss
ideas we had for a range of new products. In the USA there
was immediate interest. New probably meant better and if these
products were better they wanted them because they were American
and they wanted the best. In Asia they were so excited you
had to be careful or they would steal the ideas. In Europe,
however, the response was cautious. Where were the problems,
what might go wrong, what would we need to do to get approval.
Europe has become ultra cautious and this is reflected in
the investment in R&D.
SLIDE 12 (R&D spend in EU and USA)
In 1982 both the USA and Europe invested 2.4% of GDP in Research
and Development but by 2002 the pattern had changed dramatically.
The USA increased its spend to 2.8% while in Europe it declined
to 1.9%. So the USA now spends roughly 50% more of GDP every
year than Europe.
SLIDE 13 (Share of total world R&D)
The enormity of this gap becomes clearer from this slide
derived from OECD data. The US share of world R&D investment
is 38%, well ahead of the EU share at 26%. With a world total
investment in R&D of about 760 billion dollars, this means
that the USA is investing roughly 90 billion dollars more
every year than the EU: and the gap has been widening year
on year. This is a colossal difference and, unless they make
a complete mess of the investment, the US should continue
to open up the wealth creation gap over Europe.
What a depressing picture for Europe; increasingly outspent
in R&D, seriously losing competitiveness in its most successful
high tech industry, and faced with a deep seated conservatism
towards innovation evident in its bureaucracy and fondness
for regulation and intervention.
Could the picture change? Is there any hope?
SLIDE 14A
The good news is that there is widespread recognition of
Europe's loss of competitiveness among policymakers. The Lisbon
Agenda laid out a vision to make the EU "the most competitive
and knowledge based economy in the world by 2010, capable
of sustained economic growth, with more and better jobs and
social cohesion". This has been followed by specific
targets such as raising the percent of GDP spent on R&D
to 3% by 2010. The direction is absolutely correct, but can
a structurally flawed Europe really deliver? Wim Kok's recent
review has clearly shown that we are well off track in delivery,
that the timetable is not achievable, but that this is so
important we must keep striving. It will take great courage
and leadership. Do we have it? Time will tell.
SLIDE 14B
Something else may be changing. There are signs that the
USA may be catching Europe's disease. Where previously the
US had an unquenchable thirst for new, innovative products,
we are now seeing demands for more and more evidence to support
their introduction. The American population may be becoming
more risk averse. Innovation will always carry uncertainty
and therefore some risk as well as the potential for great
benefit. I'm sure the people who discovered fire got their
fingers burnt. If society insists on the total absence of
risk before embracing new technology - the so-called precautionary
principle - it will stop innovation dead in its tracks. In
the case of my own industry, if people want new medicines
to be guaranteed as totally safe, there will be no new medicines.
It is only after the introduction and widespread use of medicines
in the real life setting that the full benefit/risk profile
becomes apparent. There are countless examples of medicines
being found to have important additional uses only after introduction
to the market. Sometimes studies following approval also reveal
flaws such as in the recent case of Vioxx. Loud demands are
being made in the USA for more and more evidence before the
approval of new products. Couple this with the litigious nature
of US society and you have the formula to end American domination
of innovation. If anything can undo America's economic success
sustained over many decades it is the culture of "someone
has to be blamed and someone sued". Their legal system
could be their Achilles Heel.
There is also a fierce debate going on in America about the
structure of the market for medicines with increasingly strident
calls for market intervention and importation of product from
other lower priced countries - lower prices, of course, imposed
on companies by governments. As I showed earlier, such measures
are exactly those, which have distorted and damaged the European
market. Perhaps the USA is, indeed, catching the disease and
will begin to suffer as a result, though I must say that the
country has shown incredible resilience and the belief in
competition and the market has almost always won out.
SLIDE 14C
Even if the US increasingly trends in the same direction
as Europe, we should not be unduly pessimistic about the prospects
for innovation because we are seeing the emergence of China,
India and other countries.
SLIDE15 (Emerging markets)
In the last few days a European Commission report has warned
of the enormous threat to Europe from these emerging economies
and no wonder. Economic growth in India and China is now three
times faster than that of Europe, their population and consumer
market is five times bigger. Their wages are on average a
tenth of that of the UK but it would be a terrible mistake
to assume that their success is based on only low wages and
the production of cheap, low quality commodity products. These
countries are investing heavily in the training of scientists,
are producing more engineers and technologists than the West,
and are rapidly moving up the value chain. Already China is
the third biggest spender in R&D behind only the USA and
Japan. What's more, these countries still seem passionately
in love with technology and innovation; no sign of the precautionary
principle stifling progress here.
So, Europe may be suffering from deep-seated conservatism
and fear of innovation, America may be catching the same disease
but I have no doubt that the governments of emerging countries
recognise the importance of innovation as a wealth creator.
It will be a huge challenge for the West to maintain its economic
leadership. This will only be achieved, in my opinion, if
we place innovation firmly at the centre of our planning,
support it with the right investments in science and education,
fight back the tide of bureaucracy, and strive for a proper
regulatory balance of benefit to risk. If, like me, you believe
innovation to be the main driver of progress in society, we
deserve nothing less.
Sir Tom McKillop
30 November 04
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