Drivers of Pharmaceutical Industry Investment July 20061

Drivers of Pharmaceutical Industry
Investment
Understanding Australias Competitive Position
September 2006
Final Report to Medicines Australia and Research Australia
The Allen Consulting Group Pty Ltd

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material it presents is accurate, it will not be liable for any claim by any party acting on such
information.
The Allen Consulting Group 2005
The Allen Consulting Group
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Contents
Executive summary
Important changes in the global industry
Investment drivers
Things that need to be done to improve the chance of attracting

investment to Australia
The Australian situation
Key challenges for Australia
Possible actions for Australia
The payoff to Australia
10
Chapter 1
The pharmaceutical industry: key features and trends
12
1.1 Profile of the global pharmaceutical industry
12
1.2 Profile of the Australian pharmaceutical industry
17
1.3 The wider benefits of the pharmaceutical industry to Australia
20
Chapter 2
Drivers of investment across the value chain
25
2.1 Investment decisions general considerations
25
2.2 Investment decisions pharmaceutical industry specifics
28
2.3 Discovery R&D investment: trends and drivers
29
2.4 Clinical trial R&D investment: trends and drivers
35
2.5 Manufacturing investment: trends and drivers
38
Chapter 3
Australias competitive position
44
3.1 Key features of the Australian investment climate
44
3.2 Overall perception of Australian investment
45
3.3 Assessment of the competitiveness of the Australian environment

for discovery R&D investment
48
for clinical trial R&D investment
54
for manufacturing investment
60
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Chapter 4
The outlook for the Australian pharmaceutical industry
65
4.1 Maintenance of the status quo: industry erosion
65
4.2 The likely impact of the Action Agenda on the status quo
66
4.3 Interventions that are required to generate step change

improvements in activity, outcomes
66
4.4 Mapping the socio-economic payoffs of decisive action
72
4.5 Conclusions and recommendations
80
Appendix A
Incentive programs in Australia
81
A.1 Past incentive programs
81
A.2 Current incentives
83
A.3 Future incentives?
85
Appendix B
References
87
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DRIVERS OF PHARMACEUTICAL INDUSTRY INVESTMENT
Executive summary
The pharmaceutical industry is one of the most knowledge-intensive industries
in many ways it is the classic science-based industry with new products emerging
from research breakthroughs and general developments in scientific knowledge.
Maintaining a supply pipeline of innovative drugs is an imperative for longer-term
success.
The leading companies devote around 18 per cent of their turnover to R&D and
employ large numbers of highly qualified research staff. For example, in 2004
Pfizer, the worlds largest pharmaceuticals company, spent approximately $US7.7
billion on R&D out of revenues of $US50 billion. The industry accounts for a
significant proportion of total business R&D globally. The market capitalisation of
the leading companies is very large, placing these companies among the biggest in
the world by this measure.
In the main, the innovative pharmaceutical companies have tended to locate their
corporate R&D labs in North America and Western Europe. For a number of
reasons, clinical trials, where scale economies do not play such an important role as
they do with discovery research, are conducted in many locations.
Large scale manufacturing of active ingredients tends to be concentrated on a
relatively small number of highly capital-intensive plants. The output of these
plants is provided to formulation and packaging plants, which are more
geographically dispersed in their location and generally speaking, operate at
somewhat smaller volumes than actives plants.
Important changes in the global industry
Over the last decade there has been a process of consolidation and rationalisation
under way in the global pharmaceutical industry. Mergers and acquisitions among
the leading companies are likely to continue to be driven by the economic realities
of the high costs of R&D, shortening product life cycles and large marketing field
forces, and by the increasing difficulty of generating blockbuster drugs. More
recently, the biotechnology revolution, especially in genomics and proteomics, has
caused the leading innovative pharmaceutical companies to go outside their
corporate labs in search of new drug candidates. This has resulted in a rise in extramural R&D and the establishment of strategic alliances with small biotechnology
companies.
Generic drugs are becoming more important as large selling prescription drugs
come out of patent protection and governments around the world seek to contain
medical costs.
Reflecting the nature of the pharmaceutical industry, countries are competing
actively to attract investment in both R&D and manufacturing. Ireland and
Singapore in particular offer generous tax arrangements to attract major actives
manufacturing plants. Singapore is seeking to build up its biomedical research base
to attract R&D by the pharmaceutical companies.
The recent rise of biopharmaceuticals has also altered the research landscape and
opened a new field of competition in addition to traditional small molecule
chemistry research. Biopharmaceutical manufacturing tends to be smaller in scale

and more complex in resources required than traditional manufacturing operations.
This represents a comparatively new area of research where young firms might be
able to gain a foothold in the future industry through alliances with large
pharmaceuticals that bring development and marketing expertise to small players
with innovative ideas.
New realities are also being created in the global market for pharmaceuticals as
China and India emerge as significant markets and manufacturing locations, and
have ambitions to develop their R&D capabilities. Similarly, the countries of
Central and Eastern Europe have emerged with India as potential new places to
conduct clinical trials.
Investment drivers
The global pharmaceutical industry is dominated by foreign-owned multinational

enterprises. This is true in Australia as well, although there are some Australian
pharmaceutical companies, such as CSL and IDT. Nevertheless issues of
investment from the Australian perspective focus heavily on the attraction and
retention of foreign direct investment in the pharmaceuticals industry. A major
focus of this report is to provide insight into the drivers of investment by the
innovative pharmaceutical industry in R&D and manufacturing and to get an up to
date reading of the attitudes of the multinational pharmaceutical companies to
investing in Australia.
The basis upon which decisions are taken
In industries in which there are many competing companies and R&D and patent
protection plays a limited role, investment decisions tend to be based on purely
economic factors. Companies will locate their R&D and production facilities
based on the consideration of economic factors, which loom large in determining
the rate of return expected from their investments, such as:
availability of key factors of production and other specialised resources;
costs of production;
ability to achieve necessary quality standards;
reliability of supply; and
access to key end user markets.
The literature on direct foreign investment suggests that the investing firm is
generally looking for one or a mix of three main types of advantages in making
foreign investment decisions:
access to low cost facilities;
access to specialised resources of one kind or another; and
access to markets.
Given that most developed countries, and many emerging countries, have low tariff
barriers, the need to invest in a particular country to access its market is much less
than it was in the past, although this consideration still plays a role in large
emerging countries like China and India. Our focus in this report is on the first two
sources of advantage generally speaking, the worlds leading pharmaceutical
companies are able to access the Australian market without the need for local
production facilities.
Underlying the distinction between investments driven by the search for lower cost
locations (cost driven investments) and those driven by the search for specialised
resources (non-cost driven investments) is a difference between generalised and
specialised resources. The former are resources that can in principle be operated
equally well in a large number of countries. Specialised resources are by their
nature much more differentiated in terms of their quality and productivity and tend
to be much more country specific. Important examples for the innovative
pharmaceuticals companies are a high quality local science capability and a strong
clinical research base.
The importance of strategic factors in investment decisions
Prima facie, in industries such as pharmaceuticals where competition takes place

among the few, where R&D plays a large role, where patent rights are important
and where governments intervene heavily in end markets to determine entry
conditions and pricing, strategic factors can also come into play in investment
decision making as boards of global companies view countries for investment
purposes on how they contribute to their overall competitiveness. The importance
of strategic factors was clearly articulated by the British Pharma Group in its 2005
submission to the UK government:
Location decisions are increasingly taken from the perspective of their effect on the overall
1
competitiveness of the global firm.
Just how important these kinds of factors are in practice is difficult to establish with
precision. On the other hand, it would be dangerous to assume they can be ignored
as they appear to influence perceptions held by the worlds leading innovative
pharmaceuticals companies about the attractiveness or otherwise of investing in
particular countries. For example, strategic factors clearly appear to have influenced
investment decisions in New Zealand, where its reimbursement scheme and small
market size have resulted in a significant reduction in pharmaceutical industry
2
activity. The influence of strategic factors can also be observed in Western Europe,
where rates of growth in R&D investment have slowed in Europe, with
reimbursement regimes cited as a significant contributing factor. This would
suggest that there is a nexus between the underlying economics of the prospective
project and other factors, such as market size and reimbursement schemes. As many
nations are competitive in economic terms, strategic factors become increasingly
important. Strategic factors can affect the general level of investment attention and
effort that a country receives from key decision makers within a firm and in some
cases may impact on decisions between competing investment locations.
The British Pharma Group is comprised of GSK and AstraZeneca, which represent a significant proportion of
the UK market. In 2004, these two companies invested 1.8 billion in R&D in the UK, out of a total global
R&D spend of 4.7 billion. This level of investment made The British Pharma Group companies the first and
second largest private sector contributors to R&D in the UK. As well as R&D, these companies also conduct a
significant amount of their manufacturing in the UK, generating exports worth 6.5 billion in 2004. Source:
British Pharma Group, 2005, The British Pharma Group (BPG) on Competitiveness and Investment Criteria.
Clarke, Lesley, 2005, Lessons from the Kiwi Model, Researched Medicines Industry Association of New
Zealand, Conference paper from The Future of the PBS, 24 August 2005, Sydney.
Things that need to be done to improve the chance of attracting

investment to Australia
Faced with the reality that the leading innovative pharmaceutical companies
account for a very substantial part of R&D and manufacturing investment in the
industry, and understanding the basis upon which companies are thought to take
decisions, potential host governments have tended to take two kinds of action to
improve the prospects of attracting pharmaceutical investment.
First, reflecting the view that economic factors drive investment decisions, to
attract and retain investment, they have sought to use appropriate levers for
securing various types of investment. For example, with regard to attracting
discovery research investment, which is driven by the search for good ideas, host
countries have invested in their research related specialised resources and
capabilities that are most relevant to the interests of the pharmaceutical industry.
They have also in some cases offered generous R&D tax credits. To attract clinical
trials they have sought to improve the efficiency and effectiveness of their
regulatory systems governing the conduct of such trials, and have sought to align
their clinical practice with world standards. To attract and retain manufacturing
investment, especially large scale investment in actives plants where cost drivers
predominate in importance, some governments have offered extremely generous
taxation arrangements.
Second, reflecting the view that strategic factors as well as economic factors
drive investment decisions, some countries have engaged with the innovative
pharmaceutical companies to strike balances between obtaining the lowest possible
price for pharmaceuticals and providing incentives for the development of
innovative drugs. Such incentives can come in the form of pricing behaviour, patent
life protection or direct subsidies for some products. Countries have also sought to
convey clear messages to the innovative pharmaceuticals companies at the highest
levels that they value their presence and will make every effort to understand their
investment drivers and take appropriate action to provide an attractive environment
for them beyond issues of pricing and remuneration.
The Australian situation
Reflecting Australias small share of world GDP, the pharmaceutical industry in

Australia is a relatively small part of the global pharmaceutical industry.
Nevertheless, the industry contributes a significant proportion of total business
R&D in Australia and is one of Australias leading exporters of elaborately
transformed manufactured products.
The Pharmaceutical Industry Action Agenda is based on the proposition that the
potential for Australian industry to grow is substantial and that it could double its
share of the global pharmaceutical industry by 2012.
Strengths
Australia has a number of strengths when competing for pharmaceutical investment

in R&D and manufacturing. Key strengths include:
the existing Australian operations of the leading innovative pharmaceutical

companies, plus some significant Australian owned companies;
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the presence of a strong bio-medical research capability;
a first world hospital and medical system; and
a growing number of emerging bio-medical companies with intellectual

property relevant to the drug development process.
Looking at the different elements of pharmaceutical industry investment in R&D

and manufacturing the key strengths possessed by Australia in relation to them are:
Discovery Research
A strong bio-medical research base in both the medical research institutes
and the leading research based universities.

International recognition of the quality of Australian bio-medical
researchers.
An emerging set of bio-medical companies.
Clinical trials research

A first world hospital and medical system and a strong reputation for
carrying out high quality clinical trials.

An historically competitive cost base for conducting clinical trials.
Manufacturing
A number of formulation and packaging manufacturing plants that are able
to produce competitively a wide range of products at relatively small

volumes.
Weaknesses
At the same time that Australia possesses strengths in relation to pharmaceuticals

investment in R&D and manufacturing, it also suffers from some weaknesses in
relation to their respective elements. They are:
Discovery Research
Distance from the main corporate R&D laboratories of the worlds leading
innovative pharmaceuticals companies and the decision makers that

determine their targets and priorities. This creates difficulties in establishing
effective relationships with key decision makers.
The fragmentation of the research base across a large geographic area,
which can render commercialisation efforts more difficult and has in the
past limited some networking among Australian scientists.
Innovation gaps in infrastructure, funding and skills, in both medicinal
chemistry and biopharmaceutical R&D. These gaps are critical in that they
risk either the value of the idea being overlooked because it is perceived to
be too risky, or the intellectual property being purchased and
commercialised overseas, such that the benefits of the innovation are
captured by other parties.
Clinical Trials Research

The number of different ethics bodies involved in granting approvals for
multi-site clinical trials to proceed (usually with different requirements for

format and content), which creates inefficiencies in the Australian
approvals process and increase the average times required for trial
completion.
Manufacturing
The lack of taxation and other incentives to match the offers being made by
competitors which means Australia cannot compete in attracting large scale

actives plants and risks losing competitiveness in other capital intensive
manufacturing plants.
Australias competitive position is also weakened by its current reimbursement
scheme. This study updated the 2001 survey of headquarter office perceptions of
Australia as an investment climate conducted by the Lewin Group. The findings of
this updated survey show that Australia overall ranks as About the same or
Worse as an investment location than the US, the UK, Singapore, the EU and
Canada. Additional consultations with industry indicated that this negative
perception of Australia as an investment location by global company headquarters
is in the main due to the negative messages generated as a result of the
reimbursement environment.
Key challenges for Australia
Despite its considerable strengths, the global and domestic environments affecting
the pharmaceuticals industry mean that Australia is currently facing some major
challenges at key points in the value chain. Australias ability to tackle these
challenges will influence whether or not the Australian pharmaceuticals industry is
able to meet the goal in the Pharmaceuticals Industry Action Agenda of doubling its
share of the global industry by 2012.
Discovery Research
While Australia has a high quality biomedical research capability that punches
above its weight in terms of contributing to global biomedical research, there
are very considerable challenges in ensuring that it is well connected to the
requirements of the multinational pharmaceuticals companies. This includes in
the main the need to ensure that the infrastructure, funding and skills are
available for Australian researchers to progress their research to commercially
3
viable stages of development.
Clinical Trials Research
Australia has considerable advantages as a location for conducting high quality

clinical trials and until quite recently expenditure on clinical trials has grown
rapidly. The outlook is now more challenging as new cost competitive
locations to conduct clinical trials emerge in Asia Pacific and Central and
Eastern Europe. Also there are concerns about threats from possible changes in
In terms of small molecule development, there is currently a gap in skills and funding for medicinal chemistry
research, which is required to bring small molecule projects beyond a proof of concept phase. From the
biologicals perspective there is currently a gap in scale-up biomanufacturing, which frustrates the commercial
development of biological drugs.
the regulatory system in Australia, flowing from the Bansemer Reports

4
recommendations to separate ethics and scientific approval processes , which
could introduce further costs and delays to the commencement of trials.
Manufacturing
There is a concern that with no incentives being provided to anchor

manufacturing in Australia, let alone attract new manufacturing facilities, there
is the risk of a gradual run down in investment. This stems from the fact that
the technology of some Australian plants is becoming outdated, and there is
therefore an increasing likelihood of manufacturing moving to more attractive
locations offshore where pharmaceuticals investment is being actively sought.
The Pharmaceuticals Industry Action Agenda has identified a market failure in

biopharmaceutical manufacturing: demand for biomanufacturing facilities is
too lumpy and fragmented to be economic for any existing players to make a
unilateral investment in such facilities. However, without investment by either
a large pharmaceutical or an Australian government, this will continue to be a
gap in Australias infrastructure that could frustrate industry development.
The influence of the PBS negative head office perceptions of Australia, risks
arising from monopsonistic power
According to the survey conducted of perceptions by the headquarters of the

5
multinational pharmaceuticals companies to investing in Australia, the
Australian environment is not seen to be welcoming compared to those offered
by competitors in Asia Pacific and elsewhere. According to the updated
survey, the only country against which Australia compares well is New
Zealand, which has recently experienced disinvestment by the worlds leading
pharmaceuticals countries (See Figure ES.1).
Consultations with industry indicated that this overall negative perception of
Australia as an investment location by global company headquarters is in the
main due to the negative messages generated as a result of the reimbursement
environment. During interviews with both local offices and headquarter
management, the clear message from industry was that key head office
decision makers receive a stream of negative messages from their Australian
affiliates, arising from reimbursement issues such as reference pricing
outcomes, time and costs required to list, PBS restrictions on volume, ad hoc
reimbursement policy changes (such as the 12.5 per cent price regulation), and
so on. The negative perceptions so created become the lens through which
Australia is viewed and, all other things being equal, exert a chilling effect on
potential investments in Australia.
Banscott Health Consulting Pty Ltd., 2005, Report of the Review of Access to Unapproved Therapeutic Goods,
22 February, p16.
This updated the 2001 survey conducted by the Lewin Group for the Pharmaceutical Industry Action Agenda.
See The Lewin Group, 2001, Analysis of Investment Decisions by the International Pharmaceutical Industry
and the Competitive Position of Australia, presented to the Pharmaceuticals Industry Action Agenda, Working
Group 2, Strategic Factors and Decision Making for Investment, December.
Figure ES.1
SURVEY OF HEADQUARTER PERCEPTIONS AUSTRALIAS OVERALL

INVESTMENT POSITION (2005)
Much better
Better
About the same
Worse
Much worse
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Au
Au
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Moreover, the negative perception of Australia as an investment climate is also

linked to clear concerns about the long run impacts of growing monopsony
power by governments worldwide on innovation and the viability of the
pharmaceutical industry. In the situation of low margins across all
pharmaceutical products (the worst case scenario), in the long run this would
result in not only reduced output, but also reduced investment in R&D,
reduced innovation for consumers, and in turn threaten the viability of the
industry, as labour and capital would migrate into other, more profitable
industries.
To the extent that Australia is viewed to materially contribute to this long run
risk of untenable price reductions for the industry (due to global pricing
considerations, parallel import concerns and the export of its reimbursement
schemes overseas), Australia is in danger of being characterised by local and
head office managers as a country where investment should be limited where
alternatives exist.
Possible actions for Australia
In order to position Australia to achieve the goal, articulated in the Pharmaceutical

Industry Action Agenda, of doubling Australias share of the global industry by
2012, a range of policy interventions should be considered. This report sets out four
broad areas for intervention that are required if significant industry growth is to be
achieved.
Reform the PBS to send a strong, positive signal to industry and improve head
office perceptions of Australian market Several studies examining the link
between investment patterns of MNEs and reimbursement schemes have
shown that there is a discernable relationship between pricing arrangements
and pharmaceutical industry investment. Clear examples of reductions in
prices for patented products leading to reductions in industry investment
6
7
include New Zealand and Germany. Conversely, it has been argued that
Quebec stands out as a case where strong patent protection (via the 15-year
rule) has been rewarded with significant additional investment by the
8
pharmaceutical industry. Consultations with industry and the survey of
headquarter offices suggested that the current reimbursement arrangements in
Australia may already affecting industry decisions in the context of an
increasing adoption of pricing models (similar to the Australian PBS)
worldwide.
The strongest possible signal the Australian government could send to industry
would be to reform the pricing and listing environment for innovative
medicines to address the negative perceptions of the Australian market that
currently limit MNE interest in investing in Australia. This is in line with the
Action Agendas goal of raising the profile of the industry globally to increase
attention paid by MNEs. This reform would also support the National
Medicines Policy goal of fostering a vibrant medicines industry, and further
would result in coherence between Australias health policy actions and its
industrial policy aims.
Close the innovation gap and encouraging scale among researchers The
Action Agenda currently has a taskforce charged with bringing a mammalian
cell biopharmaceutical plant into Australia and the R&D Taskforce has also
been developing strategies for developing improved IP outcomes beyond the
skills of individual scientists. The Government should support all efforts to
bring this into the market if it is serious about developing Australia as a key
alliancing-opportunity region. In addition to these actions, to close the
innovation gap Government also needs to:
provide support for additional medicinal chemistry infrastructure and skills
development;
review current grant structures in light of adverse behaviours around patent
uptake and renewal; and

6
Data on company disinvestment is supplied in Chapter 2. See also Clarke, L., 2005, Lessons from the Kiwi
Model, Researched Medicines Industry Association of New Zealand, Conference paper from The Future of the
PBS, 24 August 2005, Sydney and the Boston Consulting Group, 2004, Pharmaceutical Companies and
Biotechnology Cluster Development: New Zealand Case Study.
Gilbert, J. and P. Rosenberg, 2005, Addressing the Innovation Divide, Annual Meeting 2004 Governors of the
World Economic Forum for Healthcare, 22 January, Davos.
The Quebec Department of Finance, Economics and Research, 2003, An application of the computable general
equilibrium model for Quebec: Impacts of the abolishment of the 15-year rule, Canada.
examine alternatives for funding proof-of-concept and other preclinical
research in light of low private venture capital involvement in Australia.
Address the current threats to clinical trials R&D The major threats to
Australias current strong clinical trials R&D track record are:
added regulatory requirements recommended in the Bansemer Report that
may delay trial completion times, such as those that may arise due to
separations of scientific and ethical evaluations;
lower cost competitors in trials and services, including Phase II and III
trials (where the majority of growth has been since the introduction of CTN
trials) and bio-informatics services; and
current reimbursement policies, which may reduce clinical trials activity
because companies will not want to conduct trials in countries where they
do not intend to apply for listing.
There are currently efforts underway to address existing inefficiencies as well
as potential future hurdles. These actions need to be supported. There should
not be any separation of scientific and ethics assessments and further, mutual
recognition of an accredited, lead HREC should become the model for
regulation of unapproved therapeutic goods in Australia. This should result in
lower average times to approval, without reducing the safety or ethicality of
trials. Moreover, it should result in a more consistent trials process.
In addition to the above efficiency improvements, the Government will need to
take action to address the growing impact of the disparity between labour costs
in Australia compared to other regional competitors such as India and China.
This may be accomplished through the successor program to the P3 scheme,
and should be a major consideration to the development of the design of this
industry program.
Develop competitive incentives for R&D and targeted manufacturing

investments The current policy settings in Australia are demonstrably
uncompetitive by international standards. Existing support programs do not
drive the type of investment in R&D, manufacturing, services and partnerships
that will be required to meet the Action Agendas goal of doubling Australias
share of the global industry by 2012. Australias industry programs are too
small to alter the calculus of the manufacturing decision and arguably have not
resulted in additional R&D investment above what would have occurred in
their absence.
Having regard to global competition and the lessons learned from existing
programs, a set of incentive programs need to be created that is competitive in
terms of attracting R&D investments and manufacturing.
The payoff to Australia
The pharmaceuticals industry is one of the world's leading knowledge-based

industries and is currently being heavily impacted by the biotechnology revolution
that is changing the nature of the products it creates and the business models it uses.
Within Australia, the industry is active across the value chain from discovery R&D,
to clinical trials, to manufacturing and sales. Foreign direct investment, in addition
to the growth of domestic players, is important to the development of industry
10
activity. Australias pharmaceuticals industry makes a significant contribution

through a variety of channels to the economy and, through the supply of innovative
drugs, to the community's health and standard of living.
Reflecting its value to the economy, the Governments of many countries are
seeking to make their environments attractive for investment by the world's leading
pharmaceuticals companies in R&D and manufacturing. They are seeking to ensure
that their environments for R&D and manufacturing are world class. Australia,
which already possesses a significant pharmaceutical industry, faces an increasingly
competitive global market to attract and retain pharmaceutical industry investment
in R&D and manufacturing.
If the environment facing the industry can be made world class, the value to the
community is potentially very large. The main benefits are:
the maintenance of a viable pharmaceuticals industry and continued supply of

innovative pharmaceuticals, which provide quality health outcomes for
Australian consumers;
the provision of highly skilled and well paying jobs (the industry currently
employs around 36,000 people, at an average wage near double that of the
average wage for other manufacturing jobs), which in turn result in
productivity spillovers in other industries;
investment both directly in the industry and indirectly in its supplying

industries;
growth in exports of elaborately transformed manufactures, which in turn

contributes to Australia's reputation as an innovative country (the industry is
Australias third largest elaborately transformed manufacturer, with exports of
roughly $2.6 billion annually) as well as growth in GDP; and
partnerships with Australias world class biomedical researchers and hence an

increased return to the nation on the public sector investments in medical and
health research.
The pharmaceuticals industry is already one of the leading contributors to business

R&D in Australia and to exports of elaborately transformed manufactures.
However, as identified in the Pharmaceuticals Industry Action Agenda the potential
exists to double the share of the pharmaceuticals industry in the global industry by
2012. If appropriate actions are taken this ambitious goal can be achieved. If they
are not, the risk is that pharmaceutical industry R&D and manufacturing capability
will be run down and a major opportunity for growth in a knowledge-based industry
well suited to Australia will be lost.
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Chapter 1
The pharmaceutical industry: key features and

trends
This chapter provides an overview of the pharmaceutical industry. It first discusses
the industry in the global context identifying the market players, their traditional
business model and how this has influenced investment patterns, as well as the
recent trends shaping current and future decision-making. The chapter then draws
out the Australian experience from this global backdrop.
1.1
Profile of the global pharmaceutical industry
Key players
The global pharmaceutical industry is dominated by large multinational enterprises

(MNEs) based in the United States and Europe. In 2000, the US contributed US$60
billion to value-added in pharmaceuticals, surpassing Western Europes US$40
9
billion and Japans US$22 billion. This relationship has grown starker since that
time, with the US increasingly becoming the dominant centre for pharmaceutical
10
production activity.
Global sales of pharmaceuticals in 2004 reached $591 billion and grew
11
approximately nine per cent between 2002 and 2003.
Table 1.1
THE BIG TEN

Company
Headquarters
Annual R&D
expenditure
Annual Sales
Pfizer
New York, USA
US$ 7.4 billion
US$ 51.2 billion
GlaxoSmithKline
London, UK
US$ 5.8 billion
US$ 40.4 billion
Novartis
Basel, Switzerland
US$ 4.8 billion
US$ 32.2 billion
Sanofi-Aventis
Paris, France
US$ 5.1 billion
US$ 34.6 billion
Merck & Co
New Jersey, USA
US$ 3.8 billion
US$ 22.0 billion
AstraZeneca
London, UK
US$ 3.4 billion
US$ 23.9 billion
Johnson & Johnson
New Jersey, USA
US$ 6.3 billion
US$ 22.3 billion
Bristol-Myers Squibb
New York, USA
US$ 2.7 billion
US$ 19.2 billion
Wyeth
New Jersey, USA
US$ 2.7 billion
US$ 15.3 billion
Roche
Basel, Switzerland
US$ 4.9 billion
US$ 15.3 billion
Source: Based on 2005 figures from the individual companies websites.
10
11
Messinis, G., 2002, Working Paper No. 7: The Australian Pharmaceutical Industry in its Global Context, The
Centre for Strategic Economic Studies, Victoria University.
See for example, Gilbert, J. and P. Rosenberg, 2004, Addressing the Innovation Divide: Imbalanced
Innovation, Annual Meeting 2004 Governors of the World Economic Forum for Healthcare, Davos, 22
January.
German Association of Research Based Pharmaceutical Companies, www.vfa.de/en.
12
The fifty largest firms are responsible for approximately 83 per cent of total global
pharmaceuticals sales, and the ten largest companies (Table 1.1) account for
approximately 50 per cent of global sales.
Recent trends indicate that the larger companies are consolidating their strong
market position. For instance, sales growth for the top 50 companies was 12 per
12
cent between 2002 and 2003 compared to an industry average of nine per cent.
Relatedly, the last decade has also been a decade of mergers and acquisitions, in an
attempt to release operational efficiencies. Mergers and acquisitions activity rose
13
steadily from 292 deals in 1999 to 568 in 2003 and 703 in 2004.
The pharmaceutical value chain and traditional business model
The pharmaceutical industry pivots on innovation innovation that is costly, timeconsuming and highly regulated by authorities such as the Australian Therapeutic
Goods Administration (TGA) and the US Food and Drug Administration (FDA). It
is one of the largest contributors to privately funded R&D in the world. Global
R&D expenditure in the pharmaceutical industry has been estimated at $57 billion
14
per annum, which represents a high proportion of re-investment of sales in R&D
activities. For instance, MNEs were estimated to reinvest 18 per cent of their sales
15
revenue into R&D in 2002.
According to conservative estimates, the average time from drug discovery to
market is estimated to be 16.5 years and the average cost of bringing a drug to
16
market is approximately $1 billion (Figure 1.1).
Figure 1.1
DRUG DEVELOPMENT AVERAGE TIME AND COSTS

Drug Discovery
Pre-clinical
Phase I
20-100
volunteers
10,000
Compounds
Regulatory
Review
Clinical Trials
Large Scale
Manufacture
Phase III
1,000-5,000
volunteers
1
Approved
Drug
250
Compounds
Phase II
100-500
volunteers
5 Compounds
5 Years
1.5 Years
6 Years
2 Years
2 Years
$1 billion
Source: PhRMA, 2005, Pharmaceutical Industry Profile 2005, From Laboratory to Patient: Pathways to
Biopharmaceutical Innovation, Washington DC, p 4-5.
12
13
14
15
16
Department of Industry Tourism and Resources website. www.industry.gov.au.

PricewaterhouseCoopers, 2004, Corporate Finance Insights: Pharmaceutical Sector Annual Report 2004, p 3.
Medicines Australia.
Department of Industry Tourism and Resources Website, www.industry.gov.au.
See the Tufts Centre for the Study of Drug Development and the Department of Industry Tourism and
Resources website, and PhRMA, 2005, Pharmaceutical Industry Profile 2005, From Laboratory to Patient:
Pathways to Biopharmaceutical Innovation, Washington DC.
13
In terms of drug discovery, only one in ten drug targets identified will be brought to
market, and of all drugs brought to market only two in five provide returns in
17
excess of their risk adjusted cost of capital. The drug development process
(clinical trials R&D) is marked by similarly high costs and even longer time
commitments. This presents such high barriers to entry that generally only large
MNEs can afford to develop compounds.
Historically, counter-balancing the risks and costs associated with development was
the potential for substantial revenues from so-called blockbuster drugs, or drugs
with annual sales of over US$500 million.
These factors the high costs and risks of product development, the potential for
blockbuster drug development, the requirements of international regulatory regimes
and need for collaboration among quality researchers over long periods of time
shaped the development within the pharmaceutical industry of a vertically
18
integrated, linear business model. The key features of the traditional
pharmaceutical business model were strategically located, centralised discovery
R&D facilities, a small number of large manufacturing plants, and globally
dispersed clinical trials and sales offices:
Discovery R&D The traditional business model was built on large,

centralised discovery R&D laboratories located near company headquarters in
either the US or Western Europe. Research was concentrated to capture
economies of scale and facilitate collaboration among researchers. Historically,
R&D has been tightly guarded within the firm and collaboration with external
research organisations has been rare. However, as discussed below,
collaboration has been increasing since the 1990s.
Clinical trials R&D The large R&D labs of MNEs have been
complemented by globally dispersed clinical trials. Factors influencing the
greater global dispersion of clinical trials were that they did not benefit from
the same economies of scale as discovery R&D, the requirement for
heterogenous populations for testing and the diversity of regulatory regimes
across jurisdictions.
Manufacturing Typical pharmaceutical manufacturing facilities are capital

intensive, R&D intensive and require skilled employees. There are two distinct
stages to pharmaceutical manufacturing: primary and secondary manufacture.
Primary manufacture involves the production of active chemical and
biopharmaceutical ingredients. Secondary manufacturing involves formulation
and packaging of the end product and usually occurs in smaller factories that
are geographically proximate to their market.
Supplementing key needs along all points of the value chain were also
pharmaceutical services. Historically, the services sector provided inputs and
assistance to the industry from discovery R&D to the distribution of the final
product, with a focus on the latter stages of drug development and distribution.
Examples of services offered by the sector include marketing services; management
services; training and staff development services; transport and distribution
17
18
Rasmussen, B., 2003, Aspects of the Pharmaceutical Business Model: Implications for Australia, Draft
Working Paper No. 15, Final Draft, Pharmaceutical Industry Project Working Paper Series, Centre for
Strategic Economic Studies, Victoria University of Technology, p 2.
The Walter and Eliza Hall Institute, 2005, CRC IID submission, unreleased draft.
14
services; and architectural and engineering services, for example the designers and
builders of pharmaceutical manufacturing facilities.
Industry changes and the evolution of the pharmaceutical business model
During the 1990s a proportionally higher number of blockbuster molecules came to

market than in preceding decades, and approximately 80 per cent of pharmaceutical
revenue growth over this period was attributed to the rise of the blockbuster.
However, as the patents on these blockbusters have expired, or are nearing their
patent expiry date, these drugs have come under intense competition from generic
and me-too variants. In turn, sales have fallen, leaving firms searching for new
drugs to refresh the pipeline.
The key factor shaping the industry is the lack of future blockbuster drugs in the
pipeline. Technological and other changes have meant that the drugs in
development increasingly target smaller patient populations. With fewer
blockbusters forecast to emerge from the pharmaceutical pipeline in forthcoming
years, despite increasing expenditure on R&D (Figure 1.2), it is anticipated that
19
pharmaceutical industry revenues and profits will fall.
Figure 1.2
DRUG DISCOVERY AGAINST CURRENT AND PREDICTED PHARMACEUTICAL R&D

EXPENDITURE
70
60
50
Forecast
40
30
20
10
0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
New molecules by year of first launch

Global pharmaceutical R&D Expenditure, $US billion
Source: CMR International and The Economist, 2005, 'Pharmaceutical Industry Survey', The
Economist, 16 June 2005.
This has forced the industry to rethink their approaches to all aspects of the
traditional business model (Figure 1.3).
19
The Boston Consulting Group, 2004, Rising to the Productivity Challenge: A Strategic Framework for
Biopharma, May.
15
Figure 1.3
THE EVOLUTION OF THE PHARMACEUTICAL BUSINESS MODEL
Traditional
pharmaceutical
business model
Evolving
pharmaceutical
business model
Contract
Research
Orgs
Product
development
cycle
Product
development
cycle
Tool
companies
ONE INTEGRATED COMPANY
Contract
Manufactures
Testing
services
MANY DISTRIBUTED COMPANIES
Source: Collaborative Economics, 2000, Networks of Innovation: Regions Collaborating to Compete in

the Global Market National Gathering of Biotech/Life Science Innovation Regions, BIO2000
Conference.
As illustrated above, the fundamental shift by industry in response to the decline of

the blockbuster business model has been the movement away from vertical
integration. Increasingly, pharmaceutical manufacturers have sought to outsource or
in-license some aspects of their operations:
Changes in innovation models In contrast to the traditional pharmaceutical

model, pharmaceutical companies have been looking more and more to
external parties such as research-intensive biotechnology companies,
universities and medical research institutes (MRIs) for R&D innovations.
The rise of genomic-based technology has been a key driver of this trend and it
is anticipated that these technologies and these smaller players will be some of
the most important sources of new pharmaceutical molecules. Depending on
their corporate strategy, large pharmaceuticals have either forged alliances
(such as in-licensing IP arrangements) with these firms or acquired them.
Pharmaceutical companies offer development expertise and funding, without
which the smaller firms would be unable to bring the drug to market.
It is important, however, to put this trend in perspective. While pharmaceutical
companies have been increasingly turning to external parties for innovation
alliances, they will continue to back their own in-house research. It is expected
that the ratio of in-house to external research will shift from 90:10 as observed
in the 1990s to perhaps a ratio of in-house to external research of 70:30 by
20
2010.
20
Changes in development models As revenues and profits have been forecast

to fall, pharmaceutical companies have increased their scrutiny of the cost side
of their business. There has been a growing trend towards pharmaceutical
companies outsourcing to contract research organisations (CROs) resourcedraining clinical trial work. Where large numbers of sites are required or
patients are expected to be difficult to identify, pharmaceutical companies will
Industry consultations; Department of Industry, Tourism and Resources, 2003, Australias Preclinical and
Scale-Up Manufacturing Capabilities, A Comparative Analysis, December; and The Grant Committee, 2004,
Sustaining the Virtuous Cycle: For a Healthy Competitive Australia, Investment Review of Health and Medical
Research, Final Report, Canberra, December, p 99.
16
tend to contract this work out to an organisation that can more efficiently
complete the work. Companies will also locate the clinical trial in the most
cost-competitive site, provided there are sufficient medical research
capabilities available to conduct the work.
Investing according to incentives Another key feature affecting

pharmaceutical industry development in the past few years is the considerable
competition between governments to attract industry investment. Countries
such as Ireland and Singapore as well as several US states have offered
significant incentive packages to attract capital-intensive pharmaceutical
investment. These packages have been shown to critically impact on some
types of investment decisions, especially manufacturing investment or reinvestment decisions. It is predicted that they will remain part of the
pharmaceutical industry investment landscape.
The changes in the industry resulting from the decline of the blockbuster business
model have been reflected in changing investment patterns. It has lead to the reality
that capital, in particular manufacturing and clinical trial investments, could in
principle be put in many locations globally. It has also facilitated a continued
consolidation of major, in-house discovery R&D investments in the US, in parallel
to some increasing opportunities for third party organisations to partner with large
pharmaceutical firms on some research.
1.2
Profile of the Australian pharmaceutical industry
As set out in the National Medicines Policy, Australia is committed to the

development of an industry that participates in the global value chain:
It is essential that industry policy and health policy be coordinated, providing a consistent and
supportive environment for the industry, and appropriate returns for the research and
development, manufacture, and supply of medicines. International competitiveness will only be
21
achieved if Australian industry can operate in a global environment.
In the past several decades, and influenced by several investment incentive

packages for the pharmaceutical industry, Australia has built up a presence along all
points of the value chain.
Key players in Australia
There are approximately 120 locally and foreign owned companies participating in
the Australian pharmaceutical industry, which comprises both local and
multinational subsidiary organisations.
The majority of industry players in Australia are subsidiary organisations. The
multinational manufacturers with subsidiaries in Australia include Merck, Pfizer,
GSK, Bristol-Myers Squibb and Novartis. Local manufacturers include CSL
Limited, Institute for Drug Technology (IDT), Mayne, Sigma and Alphapharm.
Some of these firms have significant secondary manufacturing infrastructure in
Australia, while others specialise in clinical trials R&D. There is little large-scale
manufacturing of active ingredients apart from some alkaloid production by GSK
and Janssen-Cilag.
21
Department of Health, 2000, National Medicines Policy, Commonwealth of Australia, Publication Number
2654, p 4.
17
Australia also has a number of research orientated biomedical science companies

and biomedical institutes. IDT, Zenyth Therapeutics and Cerylid Biosciences are
examples of these organisations. These organisations often work in collaboration
with hospitals, universities and other government organisations, which all play a
critical role in biomedical discovery R&D and clinical trials R&D in Australia.
Significant players include The Walter and Eliza Hall Institute, The Peter
MacCallum Cancer Centre, CSIRO and the Australian Nuclear Science and
Technology Organisation (ANSTO).
More recently, Australia has seen the growth of a young biotech industry, based
around small firms. According to the Department of Industry Tourism and
Resources (DITR), in December 2005, there were 2794 employed in 420 core
biotechnology companies of which 74 were listed on the Australian Stock
22
Exchange (ASX), of which 39 per cent were listed in the last three years. Most of
these firms were spun out of research institutions and universities, and their
products focus on the development of new drugs, especially human therapeutics,
and human diagnostics. These firms are highly R&D intensive operations, and
operate using a business model based around proving the concept of their
technology and licensing the IP to larger companies to commercialise.
Australian involvement in the global value chain
The Australian pharmaceuticals industry is an important contributor to business

R&D in Australia, which is currently running at under 1 per cent of GDP. It is
estimated that investment by the pharmaceuticals industry in R&D represents about
5 per cent of total sales by the industry. Recent estimates suggest that the industry
23
spends around $520 million on R&D per annum. This is small by world standards,
and reflects the traditional business model of the worlds leading innovative
pharmaceuticals companies, which until very recently has dictated that most major
discovery research is conducted in-house in large corporate laboratories located in
the US or Western Europe. Thus, a high proportion of the expenditure on R&D by
the multinational pharmaceutical companies in Australia is on clinical trials R&D,
which tends to be less capital intensive than discovery R&D investments.
The Australian industry plays a minor role in the manufacture of active
pharmaceutical ingredients (APIs), however, there is significant local secondary
manufacturing in formulation and packaging. Small scale API manufacturing in
Australia is largely focused on the synthesising of alkaloids, such as morphine and
codeine, from Tasmanias licit poppy crop. Participants in Australian API
production from Tasmanian poppies include GSK and Tasmanian Alkaloids. Other
API production in Australia is generally small scale and specialised. Australian
participants include CSL and the Institute for Drug Technology Australia.
Secondary manufacturing is conducted in Australia on a much larger scale than API
manufacturing. There are at least ten large secondary manufacturing plants,
including GSKs facility at Boronia.
A pharmaceutical services industry has also grown up alongside of these activities,
but is not generally regarded as a hub for any one type of service. Because of the
wide and varied nature of the types of services provided at different points along the
22
23
Department of Industry, Tourism and Resources, 2006, Biotech Business indicators. June.
According to Melbourne Universitys 2005 R&D and Intellectual Property Scoreboard, three pharmaceutical
companies were among the 10 largest spenders on R&D in 2003-04.
18
value chain, this report discusses these services as related to discovery R&D,
clinical trials R&D and manufacturing within the context of these primary
activities.
Australian responses to global trends
The changes in the global environment have had the greatest impact on the existing
manufacturing sector in Australia. For instance, the global consolidation of
secondary manufacturing plants has led to the closure of several manufacturing
plants in Australia as new investments or re-investments have been generally
located in countries offering more competitive tax incentives.
An exception to this trend has been GSKs investment in manufacturing, which has
increased by roughly $60 million over the past five years. GSK has two significant
manufacturing operations at Port Fairy and Boronia, which have very different
purposes. The Port Fairy plant specialises in producing active pharmaceutical
alkaloid products, including morphine and codeine, based on processing poppies
grown in Tasmania. The plant accounts for about one-quarter of the worlds
medicinal opiate requirements. The Boronia plant is a secondary manufacturing
facility, which formulates and packages a range of prescribed pharmaceuticals.
GSK at Boronia has developed a specialised and flexible workforce able to produce
a wide range of products in a very flexible way the products are exported to
many countries. Part of the expansion of the Boronia plant, which is now the 8th
biggest plant in the GSK world, is due to picking up production that was dropped
due to the closure of smaller scale, less economic plants elsewhere in Asia-Pacific.
Similarly, other firms with specialised manufacturing capabilities, such as CSLs
adjuvant manufacturing facilities and IDTs niche, small scale production
24
facilities, have been insulated from the same rationalisation of manufacturing
capacity observed by other players in the Australian market, who generally compete
with other international plants to supply global manufacturing requirements.
The general picture for R&D has been brighter than the manufacturing story.
Global trends towards growing numbers of alliances by pharmaceutical companies
with external organisations have resulted in some increased investment in discovery
R&D in Australia. The growth of, and alliances with, the Australian biotechnology
sector is perhaps the most significant example of Australia leveraging investments
from new global pharmaceutical industry trends. However, in Australia there has
been less interest in biotechnology alliances from the big pharmaceutical industry
25
participants than in other countries, and it is generally expected that the big
battalion R&D investments will remain offshore, particularly within the US.
Nevertheless, with the growth of genomics and proteomics, the biotechnology
sector could potentially see increased growth in investment in the Australian
pharmaceutical industry, albeit from a small base.
In the past several decades, the Australian Government has launched several
incentive programs to attract pharmaceutical industry investment. The first
incentive program to directly target the pharmaceutical industry was the Factor (f),
24
25
IDT has small scale production facilities for APIs for human and veterinary use, including production of
anticancer (cytotoxic) APIs; finished dosage forms for clinical trial use; highly toxic or active materials such as
cytotoxics and cephalosporins; small scale non-toxic materials; and viral vaccines.
Rasmussen, B., 2004, Alliance Opportunities for Aus Biotech, Working Paper no. 23, Pharmaceutical
Industry Project Working Paper Series, Centre for Strategic Economic Studies, Victoria University of
Technology.
19
which ran from 1988 to 1994, and was followed by the Pharmaceutical Industry
Investment Program (PIIP). Many industry participants credit these programs as the
catalyst for the current levels of involvement by their company within Australia.
The current P3 program was developed with a view to build on the lessons from
previous programs, and commits $150 million from 2000 to 2005 to support
incremental investment in R&D by the industry in Australia. Several
pharmaceutical companies have utilised the program to fund some R&D
investments within Australia since its commencement, however, critics have
questioned whether this has attracted additional investment or merely subsidised
activities that would have otherwise occurred. There were concerns that the
incremental nature of funding results in too little money being spread over too
many parties. In August 2006, after consultation with the industry, the Government
implemented changes to the P3 program to allow larger companies to apply for the
support of their R&D initiatives. Currently there is no incentive program in
26
Australia aimed at increasing manufacturing investment.
1.3
The wider benefits of the pharmaceutical industry to Australia
Beyond the direct contribution that the industry makes due to the scale of its
activities, the characteristics of the pharmaceutical industry allow it to produce long
term and profound economic benefits that go beyond the direct benefits associated
with industry investment and activity. As noted by the DITR, industries which are
highly innovative should be cultivated because they stimulate further economic
27
growth, over and above the production they entail. For example, it has been
estimated that the rate of return to Australia was between two and five times the
28
actual expenditure. The sources of this return to the Australian economy and the
range of spillovers from industry investment include:
the development of export capabilities;
improvements in productivity in other areas of medical research through

knowledge of new techniques and treatment strategies, and the wider, flow-on
impacts of that labour in the economy;
increases in the supply of skilled R&D professionals, and the wider, flow-on
impacts of that labour in the economy;
quality improvements in research outcomes, and the wider, flow-on impacts of

that labour in the economy;
increased demand for Australian research outcome from higher quality preclinical candidates;
spillovers from new partnerships;
spillovers from new technologies; and
contributions towards National Research Priority Goals.
26
27
28
See Appendix B for an overview of past and present incentive programs.

Department of Industry, Tourism and Resources, 2001, Discussion Paper, Pharmaceutical Industry Action
Agenda, Commonwealth of Australia, p. 44.
Access Economics, 2003, Exceptional Returns: The Value of Investing in Health R & D in Australia, Canberra,
p. 65
20
Together, these serve to increase demand for Australian output. Taken together,
each of these impacts can contribute to Australia achieving the status of a first-tier
innovator nation.
Export opportunities
Australian firms with a higher degree of foreign ownership generally have a higher
29
than average export propensity. This can be attributed to the fact that companies
with a higher degree of foreign ownership are likely to have a more global or
outward focus, and are able to compete in the global market. This may be through
better understanding of international standards and best practice, access to markets,
or a knowledge of overseas supply networks. This is not to say that domestic firms
lack this knowledge. However, the costs of gathering this information for a firm
with a significant degree of foreign ownership is likely to be far less than for a fully
domestic firm.
Pharmaceuticals are Australias third largest elaborately transformed manufactured
export after automobiles and wine, totalling almost $2.6 billion annually. While
Australias exports of elaborately transformed manufactures represent a relatively
small part of Australias total exports of goods and services, they are significant as
they tend to embody significant inputs of R&D, design and engineering and other
knowledge-based elements where spillover benefits are likely to be important. The
production of such products is skill intensive and employees tend to be paid higher
than average wages. The competition worldwide to attract investments involving
the production of elaborately transformed manufactures reflects the value that is
placed on them by governments.
Moreover, there are significant reputation benefits to be gained from strong export
performance in elaborately transformed manufactures. Such exports tend to be seen
as a reflection of a nations innovative capacity and contribute to Australias
reputation as a modern, knowledge-based economy and society.
Improved living standards
The average wage paid to employees in the pharmaceutical industry in Australia is

well above the average working wage. In 2000-2001 the pharmaceutical industry
average wage was $53,000, well above the average wage for the manufacturing
30
industry of $32,000. Higher wages flow through to higher household income and
in turn, consumption, which is a proxy for consumer welfare as it is assumed that
individuals derive benefits (utility) from higher levels of consumption. This also
results in GDP growth, which in turn may result in later rounds of investment in
basic research by government, and so on.
Spillover activity and knowledge benefits other industries
The introduction of new companies, or a significant degree of foreign control into

an existing domestic company can bring with it new management techniques, new
product lines, new methods of delivery or benefits which are even more intangible
such as a new work culture or corporate ethic. These benefits can be passed on
horizontally, through the movement of employees between foreign and
29
30
Access Economics, 2004, The Benefits of Inward Foreign Direct Investment to the Australian Economy A
report for Invest Australia, Canberra, Canberra, p. 19.
Econtech, 2002, The Economic Contribution of the Australian Prescription Pharmaceutical Industry: Report
to APMA, quoted in Medicines and Health, 1(6), 1 June 2002.
21
domestically owned companies, or through competitor firms adopting international

best practice; or vertically through the implementation of change throughout a
supply or distribution chain.
Both the R&D and manufacturing of pharmaceuticals require highly skilled and/or
educated workforce whose pay is commensurate to their skills. Developing highly
skilled workforce can bring considerable long-term economic benefits as it provides
a skills base for future investment and innovation. Their expertise can be used to
attract additional investment, train future employees and be directed at other
biomedical research. These knowledge spillovers are also expected to benefit other
industries. Many economic studies have shown that highly skilled workforces have
driven the economic growth and prosperity enjoyed by developed countries.
Industries such as the pharmaceuticals are a key source of such a workforce.
In particular, a strong pharmaceutical industry presence can provide a major
platform for the development of Australias biotech sector. The number of
biotechnology companies grew from almost none in 1981 to 1982 to over 300 in
2001 to 2002. The rapid growth in biotech firms has been coupled with a high
31
attrition rate. The growing number of small biotech companies rely on larger firms
with significant capital pools and development expertise to bring their ideas into the
market and fund continued research. These small firms can also tap into the critical
mass of skills and support services that the presence of major pharmaceutical
companies provides.
Infrastructure development
Pharmaceutical R&D investment is also a driver of improved biomedical research

infrastructure. Investment from pharmaceutical companies in small biomedical
companies, research institutes and public universities can increase the research
capabilities of those organisations both in the field of pharmaceutical research as
well as in other research areas. Similarly in clinical trials, patients benefit from
gaining access to innovative drugs, and physicians benefit by gaining an
understanding of new treatments as well as providing input into the trial
methodology, especially in early phase trials.
Realising benefits from public sector investments in basic research
Australias level of government-financed expenditure on R&D is high by

international standards. In 2000 it was 0.71 per cent of GDP, compared to an OECD
32
average of 0.64 per cent. Following the 1999 Wills Review, Commonwealth
expenditure for health and medical research was doubled over five years through
the injection of $614 million, while Backing Australias Ability increased
Australian Government funding for science and innovation by $8.3 billion for the
33
period 2001-02 to 2010-11.
The Commonwealths support for science and innovation has been more focused
and strategic than in the past. Backing Australias Ability represented a strategic,
whole of government approach. Similarly, the establishment of the Ministerial
31
32
33
Consultations with government experts indicated that Australia might have four times as many biotechs being
launched as in the US but that the majority of these would fail in Australia whereas firms in the US were far
more likely to succeed.
Department of Education Science and Training, 2003, Mapping Australian Science and Innovation,
Commonwealth of Australia, p 18.
http://backingaus.innovation.gov.au/, accessed September 2006.
22
Science and Innovation Committee points to the high priority given to science and
innovation issues by the Australian Government. The setting of National Research
Priorities exemplifies a trend to identify priorities to guide investment.
The states and territories, too, are taking an increasingly active role through the rollout of strategies and initiatives such as Queenslands Smart State, Victorias
Science, Technology and Innovation Initiative, New South Wales BioFirst Strategy
and Western Australias Innovate WA policy.
In contrast to public expenditure on R&D, Australias BERD as a share of GDP is
34
0.95 per cent, whereas the OECD average is 1.53 per cent in 2004-05. Moreover,
in 2004 Australia ranked 12th in the OECD, up from 16th in 2000, in the share of
gross expenditure on R&D undertaken by business (48.8 per cent) compared to the
35
OECD average of just under 62 per cent. Thus, attracting pharmaceutical
investment remains a significant opportunity for injecting commercial funding into
realising returns on public sector investments.
Contributing to Australia becoming a first-tier innovator nation
There has been recent improvement in Australias position in the international

36
league table as an innovative economy. A recent study by Gans and Stern argues
that over the last two decades Australia has been transformed from a classical
imitator to a second-tier innovation economy. However, Australia has not yet
lifted itself to the level of performance achieved by first-tier innovator nations.
A vibrant and growing pharmaceutical sector can contribute to Australia further
increasing performance to first-tier innovator levels. Achieving first-tier
innovator levels would see economic changes and benefits such as:
Strengthened growth in small, emerging technology-based businesses.
An increasing proportion of small, technology-based businesses breaking

through to become emerging globals. Australia has over the last two decades
produced some companies that have achieved such a breakthrough, with
Cochlear and ResMed being the outstanding examples. These companies
illustrate the potential upside in terms of value creation that such businesses
can contribute to the economy.
As a result of the increase in technology-based businesses and the greater

proportion of those that are able to become emerging globals, the aggregate
impact of technology-based companies emerging from the commercialisation
process in terms of contribution to economic value, well paid jobs and exports
will be highly significant.
Success in achieving recognition for Australia as becoming a first-tier

innovator nation will assist the process of attracting innovation intensive
activities by leading research-based multinational companies to Australia. It
will also assist the position of Australia in attracting and retaining highly
qualified researchers and innovators in all areas of activity.
34
http://www.abs.gov.au/Ausstats/abs@.nsf/39433889d406eeb9ca2570610019e9a5/bae5fb25d2121f6dca256
8a9001393ef!OpenDocument, accessed September 2006.
35
36
OECD, 2006, Main Science and Technology Indicators, June.

Gans, J., Stern, S., 2003, Assessing Australias Innovative Capacity in the 21st Century.
23
A virtuous cycle established in which greater investment in the generation of

ideas, will directly lead to the creation of greater value and jobs for the
economy which in turn will increase Australias capacity to invest in the
generation of ideas. Achieving a self sustaining virtuous cycle like this will be
vital to increasing living standards in Australia in the 21st century.
24
Chapter 2
Drivers of investment across the value chain

This chapter considers each key component of the value chain to analyse specific
37
trends and drivers in the global context.
2.1
Investment decisions general considerations
Economic theory and studies of location decisions of foreign investment suggest

that the primary consideration for the investing company is to ensure that the
expected rate of return on an investment in the favoured location exceeds the
expected rate of return from competing locations. This means in general that the
investing company is making the investment in order to access:
low cost locations;
specialised resources and skills; and
market demand.
In practice, given the opening of markets around the world to international markets
trade, with the exception of gaining access to very large emerging countries and
markets such as China and India, investors tend to be driven either by the search for
low cost locations and/or accessing specialised resources and skills.
Typically investment decisions involve a mix of two kinds of resources:
general resources; and
specialised resources.
By general resources are meant resources whose nature is invariable across

different locations. An example of such resources is a capital-intensive production
facility using a relatively small amount of labour in order to produce a limited range
of standardised products in high volumes. The knowledge to operate the plant is
essentially codified and hence the plant could be potentially located in many places.
Specialised resources are by their nature likely to vary across locations as the tacit
knowledge of skilled people varies and underlying systems also vary. An example
of such resources is teams of researchers.
Between the polar cases, there are likely to be investments that require a mix of
general and specialised factors and hence involve more complex approaches to
determine investment location decisions that take account of both cost and non-cost
investment drivers.
The implications of these cases for the investing company and potential host
governments, based on the mix of general and specialised resources employed, are
quite different. In the case of investments dominated by general resources, the
37
It should be noted that the discussions of investment patterns and decisions in each section of the value chain
could be easily expanded into their own respective analyses. Indeed, many studies have been completed that
focus in on only one narrow elements of the value chain. It is not possible for this report to provide the same
level of detail for every type of investment. The aim is to identify the drivers to a sufficient extent such that
levers for increasing general areas of investment can be identified.
25
investing company will look for ways of minimising cost including tax paid, which
from the investing companys point of view is a cost of doing business.
Fundamentally in the case of investments dominated by general resources, which
could, in principle, be located in many countries, the investments are cost driven.
The implication for governments wishing to attract such investments is that their
taxation systems need to be world competitive.
In the case of investments dominated by specialised resources, the investing
company will necessarily focus on characteristics such as the availability, quality
and productivity of specialised resources. While costs are important, unlike
investments dominated by general factors, costs are not the prime investment
driver. From the viewpoint of actual or potential host countries, investing and
building capability in the key specialised resources required by industry is central to
effective investment attraction and retention.
There will be a class of investments that will involve a mix of general and
specialised resources where the investing company will have to carry out a decision
making process which gives appropriate weight to both sets of resources.
Investment decisions will be driven by a mix of cost and non-cost factors.
The importance of strategic factors in investment decisions
A further aspect is likely to be involved in investment decision making where

strategic factors come into play. Such factors are unlikely to be significant in
industries where there are many competitors, where R&D and patent rights are
unimportant and where governments are not heavily involved in determining the
operating environment. But where competition takes place among the few, R&D
and patent rights are important and governments strongly influence the business
environment for the industry concerned strategic factors are at least potentially of
significance.
Just how important these kinds of factors are in practice is generally very difficult
to establish with precision. On the other hand, it would be dangerous to assume they
can be ignored as they appear to influence perceptions held by the worlds leading
innovative pharmaceuticals companies about the attractiveness or otherwise of
investing in particular countries. For example, strategic factors clearly appear to
have influenced investment decisions in New Zealand, where its small market size
and reimbursement scheme have resulted in a significant reduction in
38
pharmaceutical industry activity:
In May 1998, Bristol-Myers Squibb announced it will no longer invest in

clinical research and development in New Zealand. At the time BMS was
investing on average NZD$4 million per annum in research in NZ.
In 1995, Pfizer Laboratories withdrew its manufacturing operation from New

Zealand.
In January 2000, Lundbeck withdrew its antidepressant product from the New
Zealand market, blaming PHARMAC's policies for its withdrawal.
38
Company activity supplied by Medicines Australia, 29 November 2005. See also Clarke, L., 2005, Lessons
from the Kiwi Model, Researched Medicines Industry Association of New Zealand, Conference paper from
The Future of the PBS, 24 August 2005, Sydney and the Boston Consulting Group, 2004, Pharmaceutical
Companies and Biotechnology Cluster Development: New Zealand Case Study.
26
In 1996, Glaxo Wellcome closed its manufacturing operation in Palmerston

North. Whilst a variety of factors were involved in this decision, the company
also cited as a reason "an increasingly hostile operating environment in New
Zealand." More recently, Glaxo Wellcome withdrew a NZD$500,000 fund for
continuing education for doctors.
Eli Lilly announced in 1999 that will no longer include New Zealand in global
research programs on new medicines.
Boehringer Ingelheim has approximately halved its operation in New Zealand

over 2001, down from 34 employees.
The influence of strategic factors can also be observed in Western Europe, where
many governments have introduced reference pricing systems that doubled the price
disparity between its prices and the US prices between 1992 and 2004. Rates of
growth in R&D investment have slowed in Europe, with many companies moving
R&D to the US. Part of this may be attributed to the US outperforming Europe in
terms of drug development productivity, but several studies have also identified
reimbursement regimes as a contributing factor. A study into the German
pharmaceutical industry estimates that price controls lead to a $3 billion decrease in
R&D spending and a $900 million loss in additional innovation spending that this
39
R&D activity would have stimulated. The importance of strategic factors was also
clearly articulated by the British Pharma Group in their 2005 submission to the UK
government:
Location decisions are increasingly taken from the perspective of their effect on the overall
40
competitiveness of the global firm.
Considering the potential upside for countries that are perceived to support
innovation, evidence can also arguably be observed to show a positive correlation
between increased price protection of patented products and industry investment. In
2003, the Quebec Government commissioned an economic study of the general
41
equilibrium impacts that would arise from the abolition of the 15-year rule that
42
governs patented pharmaceuticals in that region. The study showed that since the
introduction of the 15-year rule in 1994, investment in Quebec had grown to
43
outpace other provinces in Canada. The study also showed that a reduction in
investment by pharmaceutical companies of $150 million would have a negative
impact on the government budgets, as reductions in economic activity would more
than outweigh an assumed reduction in pharmaceutical prices of 1.4 per cent.
Together, this would suggest that for some investments there is a nexus between the
underlying economics of the prospective project and other factors, such as market
39
40
41
42
43
Gilbert, J. and P. Rosenberg, 2005, Addressing the Innovation Divide, Annual Meeting 2004 Governors of the
World Economic Forum for Healthcare, 22 January, Davos.
The British Pharma Group is comprised of GSK and AstraZeneca, which represent a significant proportion of
the UK market. In 2004, these two companies invested 1.8 billion in R&D in the UK, out of a total global
R&D spend of 4.7 billion. This level of investment made The British Pharma Group companies the first and
second largest private sector contributors to R&D in the UK. As well as R&D, these companies also conduct a
significant amount of their manufacturing in the UK, generating exports worth 6.5 billion in 2004. Source:
British Pharma Group, 2005, The British Pharma Group (BPG) on Competitiveness and Investment Criteria.
The 15-year rule delays the entry of generic drugs onto the Quebecs Formulary (analogous to PBS listing).
This effectively grants additional protection to foreign-owned multinational drug companies beyond the patent
prescribed by the Canadian Patent Act.
It should be noted however that other incentives, such as R&D tax credits and other schemes, may also have
impacted on growth rates of investment in Quebec and Canada more generally.
27
size and reimbursement schemes. In practice, strategic factors are likely to show
themselves in general judgements by the investing companies about whether the
business environment in a potential host company is or is not welcoming. A lot of
investment promotion effort by nations is in fact devoted to demonstrating that they
have a welcoming attitude to foreign investment. This is likely in turn to affect the
investment attention a country receives and it may also impact on final decisions
taken between competition investment locations.
2.2
Investment decisions pharmaceutical industry specifics
The purpose of this section is twofold:
to identify the major types of pharmaceutical industry investments in R&D and

manufacturing that will be examined in detail in the report; and
to broadly categorise these investments by the mix of resources they use and
hence the primary investment drivers that apply to them.
This is done in this section in a shorthand way to provide an overview.

Subsequently, the chapter considers more closely the factors in play in the
identified types of investment in R&D and manufacturing.
Figure 2.1
TYPES OF INVESTMENT AND INVESTMENT CRITERIA

Flagship Discovery R&D investments
Focus on non-cost factors
Primary drivers:
-specialised resources
- proven productivity, track record
- geographic considerations
Marketing
Discovery R&D
investments
Clinical trial R&D
Re-investments
in infrastructure
and services
centres
Flagship infrastructure
investments
(actives plants,
biological centres)
Focus on cost factors

Primary driver:
- tax incentives
- operating costs
Source: The Allen Consulting Group
As shown in Figure 2.1, depending on the type of investment, different economic

factors influence decision making for different types of investment:
Discovery R&D investments Discovery R&D is driven by the search for

good ideas. Thus discovery R&D investments are governed in the main by the
scientific capabilities and performance records of the group of scientists to be
funded. Cost is generally categorised a second order concern.
On a smaller scale there might be some discovery R&D investments that turn
on other considerations. For example, some regions become significant for
example in follow the sun investments, which seek to create virtual
laboratories. Other discovery R&D might be better classified as marketing, as
28
many firms also invest in strategic geographic locations to either build a brand
presence (such as within an emerging market) or to their citizenship profile.
Such factors, however, drive only a small share of total industry R&D
spending.
Clinical trial R&D investments Clinical trial R&D investments are also
driven by established track records and capabilities of scientists as the quality
of the data must be high in order for the trials to be of any use to the firm.
However given the number of locations that meet basic capability
requirements, cost-effectiveness is also a strong dimension to this decision.
Core manufacturing and other infrastructure investment Flagship

infrastructure investments are greenfield investments or reinvestments in
actives plants, biological centres, and some small manufacturing. These are
driven almost exclusively by cost concerns because they require significant
upfront costs. Thus taxation incentive considerations are the driving factors in
these decisions. Re-investment, such as upgrading a plant, is thought to be a
function of both cost concerns as well as capability track records.
2.3
Discovery R&D investment: trends and drivers
Discovery R&D is focused on the development of novel approaches to treating

disease, through the development of drugs that generally fall into one of two
categories: small molecules and biologicals. Drug development moves between
several distinct phases, from the development of a drug target to a lead compound
to a clinical candidate. Discovery R&D for the purposes of this report covers what
are generally referred to as drug discovery and pre-clinical development.
Trends in discovery R&D investment
The pharmaceutical industry is one of the largest contributors to privately funded

R&D in the world. Pharmaceutical company investment reached US$56 billion in
2005. This figure has grown by approximately six per cent annually since 1995 and
44
is predicted to continue to grow at a similar rate in coming years.
The decline of the blockbuster business model and rise of partnering
While the rate of spending is set to grow steadily the pattern of this spending is
expected to change. As more and more small-molecule treatments for diseases
affecting large cohorts have been brought to market in the past several decades, it
has been argued that all of the low hanging fruit opportunities were realised. Thus
while spending on R&D nearly doubled from 1996 to 2003, the number of new
medicines approved has nearly halved, falling from 62 per annum in 1996 to 35 per
45
annum in 2003.
This has left the industry grappling for breakthroughs, which has been realised, in
part, with the mapping of the human genome. However due to the complexity of the
genome, the pace of innovation has not been as rapid as expected. Moreover, the
population sizes for drug candidates were shrinking as technology improved, as
44
45
The Economist, 2005, 'Pharmaceutical Industry Survey', The Economist, 16 June 2005.
Rasmussen, B., 2004, Alliance Opportunities in Biotech, Working Paper No 23, Pharmaceutical Industry
Project Working Paper Series, Centre for Strategic Economic Studies, Victoria University of Technology, p 2.
29
were exclusivity periods, with more and more fast followers entering the market.
This fostered the gradual collapse of the blockbuster drug model.
46
The slow down in product development, attenuating product life cycles and
shrinking market sizes has brought all pharmaceutical companies under intense
pressure to optimise their R&D efficiency and productivity, to streamline the
development process and to minimise total R&D expenditure. The result of this has
47
been a narrowing of product lines under development as well as an increasing
degree of discovery R&D alliance and in-licensing arrangements. Pharmaceutical
companies have also been increasingly outsourcing R&D services that support the
48
R&D and pre-clinical processes.
Generally, collaboration will arise between a smaller firm and a large
pharmaceutical company where:
the smaller firm possesses a scientific technique that will better help the
pharmaceutical company in its own research;
the smaller firm can help the pharmaceutical company better target their
molecules; or
the smaller firm has already developed a compound or a range of compounds.
From 1990 to 1996 the rate of all alliances between big pharmaceutical companies,
biotech firms and universities grew by 22.7 per cent per annum. However, this trend
49
slowed from 1996 to 2001, to 3.1 per cent per annum. It is generally held that
while in-licensing will remain a dominant trend in pharmaceutical R&D research,
that the pharmaceutical companies will still put the greatest focus on their own inhouse research. The reasons are straight-forward: this allows for greater control
over the research; larger firms are generally able to recruit the best talent; and their
intimate knowledge of their own track record and areas of expertise makes it
difficult for external parties to compete against the internal pipeline. It is estimated
that if the ratio of in-house to in-licensed research was 90:10 in the late 1980s and
early 1990s, that in 2010 the ratio will migrate to 70:30.
Requirements for third party researchers to progress research to later stages of
development
Discovery medical researchers are increasingly recognising the need to move

beyond drug target identification and into drug discovery. There are several reasons
driving this need:
46
47
48
49
50
50
The first is a push factor: in the US, the University of Rochester patented a
method of treatment using non-steroidal anti-inflammatory drugs (NSAIDs)
Emerging competition in the US from so-called follower drugs is estimated to have cut exclusivity periods
from on average around four years in during the 1980s to less than one year during the 1990s. PhRMA, 2001,
Pharmaceutical Industry Profile 2001, PhRMA, Washington DC.
For example Eli Lilly in the 1990s narrowed its R&D focus from eight to five therapeutic areas. See
Working Paper No. 15, Final Draft, Pharmaceutical Industry Project Working Paper Series, Centre for
Strategic Economic Studies, Victoria University of Technology, p 2.
See Aoris Nova, Advance Consulting and Evaluation and BioAccent, 2003, Australias Preclinical and Scaleup Manufacturing Capabilities A Comparative Analysis, prepared for the Department of Industry, Tourism
and Resources, Canberra.
Working Paper No 15, Centre for Strategic Economic Studies, p 5.
US Patent No. 6,048,850 Claim 1.
30
that selectively inhibited Cox-2 but not Cox-1 activity. Pfizer went on to
51
develop the compound Celebrex, which it patented. Rochester sued for
royalty payments of 10 per cent of the $3 billion in annual sales. However on
March 5 2003 a US district court ruled that the compound was where the value
lay, and invalidated the patent:
Quoting from Fiers v. Revel, Judge Larimer reiterated that an inadequate patent
description that merely identifies a plan to accomplish an intended result is an attempt to
pre-empt the future before it has arrived. Such a patent fails to comply with the
requirements of the federal statutes concerning issuance of patents and therefore must be
52
held invalid.
Therefore the likelihood that researchers will reap commercial returns on their
innovations is unlikely unless they are able to participate in the later stages of
the compounds development.
The second factor is a pull factor, with pharmaceutical companies

considering Phase II and later trials as early phase research investments. This
has the second impact of rendering work coming out of grant programs as too
53
risky for some venture capital firms. Thus researchers must seek to further
develop their discoveries to gain commercial interest in the project, as well as
ensure IP rights.
This need is seen in several categories of research, including both small molecule
development and biopharmaceuticals development.
US-centric focus of core R&D investments
The geography of these trends in major discovery R&D investment is

overwhelmingly US-centric, as the US is generally perceived to have outperformed
Europe in terms of drug innovation since the 1990s. In 1992, Europe-based R&D
totalled $10 billion, while investment in the US was $9 billion. However over the
next decade, US R&D investment has increased 11 per cent annually to $26 billion
in 2002, compared to only an 8 per cent annual increase in Europe to $21 billion.
51
52
53
The University of Rochester v G.D. Searle & Co, Inc, No. 00-CV-6161L, 2003 US Dist. LEXIS 3030 (WDNY
Mar. 5, 2003).
Shuster, M. J., H. Su, and S. Blaug, 2003, Protecting Rights to Early Stage Technology, Nature
Biotechnology, 21(6): 702.
It should be noted that the influence of this factor varies considerably from country to country.
31
Figure 2.2
LOCATION OF DISCOVERY R&D LABORATORIES
Some studies have suggested that this trend is also in part a function of
reimbursement and pricing schemes in Europe. These studies have argued that
while the track records of European firms are excellent, pharmaceutical companies
have sought to invest in nations where there is a coherence between price
protection on innovative goods and support for R&D activities.
Drivers of discovery R&D investment
In 2001, following the creation of the Action Agenda, a Working Group on

Strategic Factors and Decision Making for Investment was convened with the
purpose of developing an understanding of drivers of investment and Australias
capabilities within these areas. This Working Group commissioned a survey of
headquarter offices to assess Australias performance in terms of R&D and
manufacturing investments in order to understand general perceptions of Australia
as an investment location. According to the study, the desired outcome of the
survey was to inform policymaking in order to create a local environment that is
54
conducive to growth in the pharmaceutical sector.
Using the 2001 survey as a foundation for a follow-up questionnaire, a survey was
taken of the headquarters of 10 major Australian pharmaceutical subsidiary
companies. This sample was comprised of locally based and internationally based
55
MNEs, with a range of specialisations within the industry. According to the survey
results, human resources and infrastructure were the most important factors, while
geography ranked low as a criteria (Figure 2.3). This is consistent with the 2001
survey results and supports the notion that R&D investments are the search for
ideas. When one considers that approximately 72 per cent of total drug
54
55
The Lewin Group, 2001, Analysis of Investment Decisions by the International Pharmaceutical Industry and
the Competitive Position of Australia, presented to the Pharmaceuticals Industry Action Agenda Working
Group 2 Strategic Factors and Decision Making for Investment, December.
Due to some changes in survey methodology, including the sample size, caution should be used when
comparing to the previous survey results. For example, the smaller sample size will result a larger variance
than in the previous survey (where variance in statistical terms means the range within which we would expect
the true mean to lie). Generics companies were not included in the above survey sample.
32
56
development costs are spent on failures, it becomes clear that the capabilities of
researchers to efficiently identify high value drug targets or candidates is the
primary criteria by which investment decisions are made. This means that regions
with strong performance records will likely continue to attract the majority of
investment capital in the short to medium term.
In this way the survey results explain current patterns of investment, which is that
the majority of R&D investment continues to flow into large in-house laboratories
in the US and Western Europe. The legacy of major R&D investments in the US
and Western Europe near company headquarters (dictated by the traditional
business model) is that these centres have developed strong track records in terms
57
of research productivity, due to the ability to continually refresh departments with
talented researchers and the build-up of efficient research infrastructure to support
the innovation process. In short, it would appear that pharmaceutical companies
continue to be confident in their ability to attract the best talent and to run the most
productive research labs in the world.
Figure 2.3
SURVEY OF HEADQUARTER PERCEPTIONS FACTORS INFLUENCING R&D INVESTMENTS (2005)

Very High Importance
High Importance
Average Importance
Low Importance
Very Low Importance
Ge
Pri
aph
and
ez
ues
tim
iss
ture
one
ive
ent
inc
truc
and
nt
me
nce
ista
e
urs
ic d
imb
es
ssu
nt
me
fras
s in
rce
iron
sou
ry i
g re
ato
n re
ogr
cin
gul
ma
Re
Hu
env
ost
al C
tion
tion
era
a
Tax
Op
However, there will be a rise in some networking with external sources, due to the
currently high number of drug candidates in the pipeline originating from small
56
57
Walter and Eliza Hall Institute, 2005, CRC IID submission, unreleased draft.
Productivity is measured in terms of the value per drug identified, drug development efficiency, and the cost of
failure.
33
58
biotech firms (67 per cent). Again, the central driver of discovery R&D is the
search for quality innovations. Therefore, in terms of external investment in
discovery R&D, this too is driven by research capabilities and skills availability,
and competition may arise between internal pipelines and extra-mural research. The
R&D capital will follow the value. Because of the long lead times involved with
drug development, external scientists will likely need to collaborate with
researchers at the large pharmaceutical companies, and thus the funding will be
spread across the parties involved.
Other factors also influence the R&D investment decision, especially external
partnering options. One of these factors is the IP regulatory environment. Uncertain
IP regulations and applications will serve as a large deterrent against investment.
While there is not currently a high correlation between quality research bases and
poor IP regulations, some developing countries have been building their IP profiles
in the hopes of attracting some R&D investment within their borders. This is
evidenced perhaps best by R&D investment patterns in China and India. India,
which introduced global benchmark IP legislation on 1 January 2005, is
characterised as a potential R&D investment location, whereas China is seen as a
no-go investment location due to its poor IP environment.
Taxation of R&D investments and government support for R&D will also influence
some capital flows, and become significant in the longer term investment horizon.
As noted by the British Pharma Group in their submission to the UK Government
on Competitiveness and Investment Criteria:
Availability of scientific research skills and infrastructure, together with a high quality research
base are the most important factors in influencing such investment decisions. However, other
issues such as financial incentives or a low tax climate and the attractiveness of the local
59
market will be decisive in a choice between two locations with the necessary science base.
A competitive, stable tax policy has the potential to be an effective tool for
promoting innovation and investment activity in a region, especially as regulatory
barriers fall and nations become more economically integrated. It is particularly true
for MNEs. Many nations with high quality research bases also offer significant
incentives to secure additional R&D investments (See Box 2.1) with the aim to
expand their capacity for innovation and potential for larger investments in the
future. Ireland and Singapore provide outstanding examples of some of the
incentives on offer. The strategy of providing R&D taxation incentives clearly
requires a long-run investment horizon on the part of the government given the lag
between investments in synergies and the productivity of institutions.
Box 2.1
TAXATION INCENTIVES IRELAND AND SINGAPORE

Ireland
In the 1970s, Ireland was suffering from double digit unemployment and a consistent loss
of young, well-educated people through emigration. However, over the next 20 years,
Irish Governments developed and implemented a comprehensive range of policies and
programs directed at lifting economic growth and living standards. The Irish industrial
development model had a number of key reinforcing elements:
58
59
The Boston Consulting Group, 2004, Rising to the Productivity Challenge: A Strategic Framework for
Biopharma, May, p 6.
The British Pharma Group, 2005, The British Pharma Group (BPG) on Competitiveness and Investment
Criteria, prepared by GSK and AstraZeneca.
34
a clearly enunciated set of policy objectives;
a very low and attractive company tax regime (the corporation tax rate is now 12.5 per
cent);
an aggressive, well-staffed and well-funded investment attraction agency the

Industrial Development Authority with the ability to offer very considerable investment
incentives;
the provision of generous tax credits of 20 per cent on business R&D moreover,
combined with the ability to deduct R&D expenditure from company trading profits, the
overall tax subsidy for R&D can be as high as 32.5 per cent of the expenditure on
R&D; and
a linking of the higher education system and regional technical colleges to provide the
skills needed to support emerging industries.
Singapore
Again, like Ireland, Singapore provided low company tax rates to companies it wished to
attract to locate in Singapore the basic corporate tax rate is now 22 per cent and is
due to fall to 20 per cent next year. Similarly, the Singapore Government provides
generous R&D tax incentives and other forms of assistance for business R&D. It is doing
this through a 200 per cent tax deduction on R&D expenditure access to the R&D tax
deduction involves registration and negotiation with the EDB. In addition to the tax
concession, other government agencies, principally A*STAR, provide other support, for
example the Jurong Town Corporation runs business parks, incubators and science
parks across Singapore. The Government has also established a fund equivalent to
$A857 million to assist such companies in setting up their facilities, with a similar amount
to assist smaller start-ups and to support joint ventures between local and foreign
bioscience companies. Singapore currently invests over 2.5 per cent of GDP in
biosciences.
Source: The Allen Consulting Group.
Additionally, as alliancing becomes an increasing method of drug discovery and

development, patterns of investment will also be driven by:
the relative abilities of external researchers and business development

personnel to network with key internal decision makers within firms; as well
as
the ability of the research team to communicate the commercial imperative of

the research.
Many large pharmaceutical companies currently gate submissions, and consider

Phase II research to be early stage investment for many projects. Thus the ability of
R&D capital to be efficiently allocated across investment opportunities outside the
pharmaceutical companies will be driven in part by the ability of the smaller firms
and organisations to appropriately commercialise their own research, and in part by
the ability of larger organisations to identify innovations by external firms
worldwide. This will rely in turn, on smaller, external organisations having
sufficient knowledge of the commercial process and IP environment, as well as
large pharmaceutical companies having instituted systems for efficiently trolling
markets for new, profitable ideas.
2.4
Clinical trial R&D investment: trends and drivers
Clinical trial R&D is defined as all testing from Phase I onwards, with Phase I
involving testing on healthy human volunteers, Phase II involving small scale
testing on patients, and Phase III large scale testing on patients. At this point the
research body has developed the drug such that it is able to supply to the
35
appropriate ethics committee key information including its approved therapeutic

indication, pharmacology, believed mode of action, dosage regimen, and known
adverse side effects.
Trends in clinical trial R&D investment
Increased complexity, scrutiny of trials
Perhaps the most obvious trend in clinical trial R&D is the need for more data as
pharmaceutical companies are under greater scrutiny today to ensure the safety and
efficacy of their products, and as technology drives changes and complexities in the
way that trials need to be conducted. As target patient populations become more
precise, the nature of the trial becomes more complicated. Additionally, today
regulatory authorities apply higher levels of rigor in their investigations of different
aspects of the effects of the drug. The objectives of the trials have become more
robust and more complex with the increasing sophistication of the regulatory
authorities and requirements. There is also pressure arising out the threat of
litigation by consumers that have suffered potentially fatal side-effects of the
60
therapy, in light of recent drug withdrawals from the market.
International harmonisation of good clinical practice (GCP)
Over the past decade there has been sustained progress towards the global
harmonisation of regulatory requirements for medicines through the International
Harmonisation on Technical Requirements for Registration of Pharmaceuticals for
Human Use (ICH). As such, many countries have been adding regulatory oversight
to clinical trials that are in line with the ICH. For example, in the UK in the past, all
Phase I trials were not subject to regulation by the regulatory authority, however,
these will be subject to regulation going forward. Similarly Australia is considering
requiring TGA verification where it did not before.
This has the effect of reducing differences between nations in terms of quality
outcomes, especially in developing regions that have historically been characterised
as significantly lagging behind North American, European and Australian clinical
trial quality.
Outsourcing
According to an Aoris Nova report, outsourcing to contract research organisations

(CROs) has increased. It currently constitutes about 20 per cent of the drug research
61
market, and grew by 18 per cent annually from 1990 to 2003. This was expected to
grow going forward, with CROs projected to account for 29 per cent of all clinical
trial R&D spend in 2005. This trend is derived in part from smaller biotech
60
61
Medications called Cox-2 inhibitors, part of a class of drugs called NSAIDs, were designed to relieve pain as
effectively as other common painkillers (e.g. ibuprofen) but without the risk of ulcers or gastrointestinal
bleeding, a side effect of many NSAIDs.
These drugs quickly became extremely popular, however, several research studies have raised concerns about
their safety, particularly for heart patients. On 30 September 2004, rofecoxib (Mercks Vioxx) was voluntarily
withdrawn from the market after studies found that the drug was linked to an increased risk of heart attack and
stroke. These side effects were noticed 18 months after drug therapy began.
Although the drug was voluntarily withdrawn, legal action was taken against Merck that resulted in ruling that
it must pay $US253 million ($A337 million) to the family of a man who died after taking its Vioxx painkiller
(however under Texas law punitive damages are capped). The ruling sent Merck shares 7.7 per cent lower,
cutting $US5.2 billion from its market value on 21 August 2005. For more information on the voluntary recall
of Vioxx see the US FDA website at vioxxQA.htm.
Aoris Nova, 2003, Advance Consulting and Evaluation and BioAccent, 2003, Australias Preclinical and
Scale-up Manufacturing Capabilities A Comparative Analysis, prepared for the Department of Industry,
Tourism and Resources, Canberra.
36
companies having to rely on contracting for all their pre-clinical trial needs. It is
also driven by an increasing focus on cost controls that has lead to greater
outsourcing of complex, resource-draining trials.
Global integration of trials
An increased focus on cost has also fostered a rising trend over the last several
decades towards international integration of trials, with different phases being
conducted in the locations that best meet the benchmark criteria. It has also led to
an increasing consideration of low-cost locations such as India, as it is increasingly
able to demonstrate cost-effective quality outcomes and derives benefits from
British colonial legacies such as a relatively high proportion of English speakers
and higher education graduates. Growth in CRO services in India is currently 100
per cent per annum, albeit from a very small base only one per cent of annual
62
global clinical development budget is currently conducted there.
Drivers of clinical trial R&D investment
The key base level benchmark criteria for investment in clinical trial R&D are the
following:
Quality of trials Quality of trials is paramount, though in some ways it is

challenging to define and measure. Clinical trials are judged to be of high
quality when the data is clean, and the study has been conducted in a way that
answers the efficacy and safety questions that must be met in order to bring the
drug to market. Markets will not accept product unless trials have been
completed according to good clinical practice (GCP) and have provided
sufficient certainty about the effects of the drug.
Speed of trials The speed with which trials can be adequately completed is a
key driver of investment, as the faster a drug is brought to market, the greater
the duration of patent protection enjoyed in the market. This directly impacts
on revenues to the firm, and has become increasingly important with the rise of
generic drugs, which fiercely compete on price once a product is off-patent.
Speed of trials is also correlated with cost, as labour represents the largest cost
component in the trials. Reducing the time to completion then reduces the total
costs of drug development. Speed is determined by the ability to recruit
patients, the time required to meet ethics submission requirements at specific
sites, and the regulatory approval process (such as TGA approval to conduct
trials).
Costs of trials The costs of trials are a function of the costs involved with
recruiting patients, the costs to set up sufficient trial sites, investigator fees, the
effort to acquire ethics and regulatory process approval, and the time to trial
completion. Nations with low investigator fees per patient, relatively speedy
patient recruitment records, and streamlined regulations present a competitive
location for clinical trial R&D.
These are the benchmark criteria required of clinical trial R&D locations.
Increasingly, many locations, including India and Eastern European countries, are
equally competitive according to these criteria. In this way, pharmaceutical
companies have more freedom to be strategic in their choice of locations. The
62
Varawalla, N., 2005, Poised for Growth: The Indian CRO Industry, Contract Services Europe, April.
37
upshot is that many companies will begin to make investment decisions according
to other criteria. For example the impetus to locate clinical trials within a country is
dramatically reduced if the firm does not expect to list within that country once the
trials are complete. The reasons for this include a desire not to dash the hopes of
patients that they might be able to take advantage of a new innovative drug, as well
as a desire to reinforce coherence between R&D investment and patent price
protection.
2.5
Manufacturing investment: trends and drivers
The pharmaceuticals manufacturing industry in 2004 was reported to generate

global sales of approximately $400 billion annually, of which more than $100
billion is US-based. North America is reported to be both the largest and the fastest
63
growing market for pharmaceutical products.
There are two distinct phases of manufacturing work:
Primary manufacturing the making of the active ingredient of the drug,

through either large scale manufacturing of a single blockbuster product or
through specialised manufacturing facilities where multiple products may be
produced, sometimes on a shared basis; and
Secondary manufacturing facilities designed for formulation as well as

packaging of the pharmaceutical product.
Generally speaking, world scale actives plants require investments in the hundreds
of millions of dollars and the decision to locate them are cost driven, where costs
include the taxation provisions to which they are subject. Historically, large scale
primary manufacturing plants were historically located near corporate headquarters.
However, today, actives plants can in principle be operated equally well in a large
number of countries and, driven by the search for lower costs, including taxation
costs, are being located in the most cost effective operating sites. The reason that
actives plants can be located in a number of possible places is that the operation is
capital intensive; the knowledge of how to operate the plant is codified; and the
inputs of skilled labour required are relatively small.
Secondary manufacturing plants, on the other hand, tend to require less investment
and relatively more labour input to operate than actives plants. Cost
competitiveness is important, but it is not the only factor that drives the investment
decision on location. Historically, smaller secondary plants were more dispersed
internationally, with companies attempting to capture cost efficiencies by locating
formulation plants close to markets. Australia has not attracted large scale actives
plants, but it does have a number of secondary manufacturing facilities reflecting
the somewhat different drivers of investment in primary and secondary
manufacturing facilities. However, as its pharmaceutical companies have been
under pressure to reduce costs there have been successive rounds of rationalisation
of secondary manufacturing facilities that have affected the viability of such plants
in Australia.
Biopharmaceutical and niche manufacturing plants similarly tend to be smaller in
scale compared with actives plants, and require a comparatively larger amount of
63
KPMG, 2004, The CEOs Guide to International Business Costs, Pharmaceuticals Industry International
Comparison, available at www.competitivealternatives.com.
38
specialised resources in order for the plant to economically operate.

Biopharmaceutical manufacturing, like secondary manufacturing investments,
therefore tend to consider other factors in addition to cost, including the availability
of skilled people and systems, and tend to be dispersed globally.
Trends in manufacturing investment
Plant rationalisation
The shifting economics of drug development has perhaps been observed most
dramatically within the manufacturing sector where firms have placed a redoubled
emphasis on efficiency. In an effort to tighten cost controls and realise greater
economies of scale, manufacturing operations have been rationalised worldwide.
This process has been hastened by a flurry of mergers and acquisitions within the
industry since the early 1990s, as firms have sought to release operational synergies
by joining up asset bases.
This trend has been observed for large and small scale actives plants as well as
secondary manufacturing facilities. However, because secondary plants and small
scale actives production (see contract manufacturing below) tend to require greater
specialisation of skills and systems to operate economically, some of these plants
have been able to continue to operate and in some cases even expand. This is also
true in cases where a plant is unique within the companys asset structure.
Oftentimes it is cheaper to expand the existing plant than relocate the facilities to a
new location. Therefore some manufacturing facilities with distinguishing features
such as a concentration of skilled resources or specialised outputs (i.e. that do not
face competition from other parts of the organisation) might be insulated to a large
extent from this rationalisation trend.
Given the advent of genomics and proteomics research commercialisation in the
past decade, biopharmaceutical plants are only beginning to be constructed and
therefore are in a period of expansion in total world capacity.
Strengthening regional powers
China and India with their large populations and commitment to rapid economic
growth and higher living standards both have potentially very large domestic
markets for pharmaceuticals. For example, China is expected to be the fifth largest
market for pharmaceuticals in the world by 2010 and the second largest market
behind the US by 2020 with sales revenues of $US 60 billion. At this stage access
to the Chinese and Indian markets is still subject to impediments not present in
developed country markets. Against that background, there is considerable
incentive for the leading pharmaceuticals companies to establish plants in these
64
countries to meet the growing domestic demand.
The low labour costs available in China and India, other things being equal, provide
an additional incentive to locate manufacturing operations in these countries. To
this stage China accounts for a small share of global production but this is expected
to rise. India already has significant generic drug production capability. China and
India also have many well educated people and in time can be expected to also be
active competitors to attract investment in R&D.
64
For example, Pfizer has recently invested US$50 million in plants in China. For more information see Einhorn,
B., 2004, Go East, Big Pharma, BusinessWeek, 13 December.
39
Incentive competition
Several countries have been vying for greater manufacturing bases within their
borders by offering significant tax credits and holidays to companies. As the total
number of primary and secondary manufacturing plants has been decreased, the
stakes have risen. Aggressive nations have included: Ireland, Taiwan, Puerto Rico,
Canada, Singapore (See Box 2.2), as well as several US states.
Box 2.2
SINGAPORES PHARMACEUTICAL INDUSTRY HUB

Singapore has been one of the most successful countries in attracting new
pharmaceutical industry investment over the past few years. During 2004, Singapore
attracted more than US$520 million in biomedical science investment. Recent major
investments include:
Pfizers US$350 million API manufacturing plant;
a GSK facility for pre-clinical research into neurodegenerative conditions; and
the public/private Novartis Institute for Tropical Diseases.

Singapore has invested heavily in its biomedical capabilities through the creation of the
Biopolis and Tuas Biomedical parks. There has been significant work done to enhance
the attractiveness of Singapore as an investment location for pharmaceuticals and
biomedical science. Singapore offers a variety of tax based and other incentives to
attract pharmaceutical investment and has had some success in attracting skilled
research scientists to further enhance its attractiveness as an investment location.
Source: Economic Development Board Singapore, Site Selection Online.
Contract manufacturing
For some product lines, demand is too lumpy or insufficient for pharmaceutical
companies to cost-effectively manufacture the product. Where economies of scale
are lacking, and costs are high to produce a certain line, pharmaceutical companies
have been outsourcing some lines to other firms. Currently, more than 50 per cent
of all pharmaceutical manufacturing is contracted. This is a low margin component
of the value chain, as competition for contract manufacturing is fierce worldwide.
Drivers of manufacturing investment
With regard to drivers of manufacturing investment, the survey conducted of MNE

head offices indicated that operational costs and taxation were key drivers of
investments (Figure 2.4). As in the previous 2001 survey, taxation issues ranked
highest in terms of overall importance for manufacturing investment decisions. In
the previous survey pricing issues were also ranked as highly important, however
here this issue receives a lower score. Geographic considerations were ranked in
this survey and in the 2001 survey as low on the list of criteria, reflecting the ability
of capital to be located in the most cost-effective locations.
40
Figure 2.4
SURVEY OF HEADQUARTER PERCEPTIONS FACTORS INFLUENCING MANUFACTURING INVESTMENTS (2005)

Very High Importance
High Importance
Average Importance
Low Importance
Very Low Importance
aph
nce
ista
one
ez
tim
ues
iss
and
ent
em
ture
ruc
ive
ent
inc
ast
nd
infr
nt a
nd
me
sa
es
urs
ic d
imb
ssu
rce
iron
sou
ry i
g re
ogr
cin
Ge
Pri
ato
gul
n re
env
ost
al c
tion
tion
ma
Re
Hu
a
Tax
era
Op
This matches with industry consultations and the available literature on

manufacturing investment. At a base level, a country must offer a cost structure for
the proposed plant that will result in low costs of production by world standards. In
the absence of taxation incentives, the basis for the decision would be:
Cost-competitive labour Although manufacture of pharmaceuticals is

capital-intensive, companies will also seek to purchase labour at least cost,
especially given that most countries will be able to offer a stable supply of
skilled employees.
Sufficient and stable supply of skilled workers Given the R&D intense
nature of pharmaceutical manufacturing and the need for quality in the
product, the skills of the plant employees are paramount. Poor quality products
risk litigation or goodwill and market share losses.
Minimum risk of supply interruption Supply interruption, depending on the

nature of the product and the number of other manufacturers in the market
supplying the good, could also represent material goodwill and market share
losses, as well as the potential for litigation.
However, because so many countries are cost-equals, the decision of where to

locate a plant often comes down to the level of incentives offered.
Taxation incentives are critical for attracting large scale primary manufacturing
investment to a country (eg, actives plants). Low taxation delivers a higher overall
profit to the firm as it tends to reduce the total tax payable. Table 2.1 shows some of
the most effective taxation incentive regimes globally, and identifies some of the
investment that has followed from these incentives. Globally, the driver of
41
investment in manufacturing infrastructure is (and has been) the bottom line figure
of the project. Firms tend to locate manufacturing on the basis of costcompetitiveness first and foremost.
The situation is more complex as concerns secondary, biophamaceutical and small
scale contract manufacturing which, although capital intensive, has a higher input
of skilled people reflecting the complexity of the manufacturing process in terms of
dealing flexibly with a large range of products produced in varying volumes. In the
case of these plants, which are more dispersed geographically than primary
manufacturing plants, in addition to cost drivers, investment decisions also take
account of factors such as:
broad based capability including the presence of sufficient specialised

engineering and production personnel; and
logistics considerations that is, how the plant will align with the rest of the
firms operations including supply of products to a number of markets with
varying labelling and other requirements.
42
Table 2.1
THE INVESTMENT CLIMATE FOR THE PHARMACEUTICAL INDUSTRY AMONGST AUSTRALIA'S COMPETITORS (2005)
Country
Average
corporate
tax rate
Ireland
12.5 per
cent
Tax concessions and incentives offered to the industry
Tax credits of 20 per cent on R&D expenditure, uncapped.

Exemption of stamp duty on the sale of IP.
Potential to negotiate a grant from the government through the Irish Development
Agency.
Singapore
22 per cent
Recent investment attraction success
Pfizer recently announce that it would expand its Irish R&D

facilities to include a high containment development facility. The
investment is worth $30 million.
A range of government assistance is available for R&D and intellectual property

creation. These include direct assistance and tax based incentives.
Pfizer opened a $440 million dollar API plant in the Tuas

biomedical park.
Investment fund of $700 million for public-private partnership investments in

biomedical sciences.
Novartis has announced plans to build a $240 million

manufacturing facility.
EDBs investment arm has a biomedical sciences offshoot that co-invests in

promising projects in Singapore.
Canada
36 per cent
20 per cent tax credit on R&D activities.

The government organisation Technology Partnerships Canada co-invests in R&D
investments.
20 year patent exclusivity on pharmaceuticals patented in Canada.
Novopharm, a subsidiary of the Israeli manufacturer Teva,

invested $38 million in expanding their manufacturing facility.
Generic manufacturer Ratiopharm is investing $100 million in
expanding their new manufacturing facilities.
Provincial governments offer additional and varied incentive packages.
In 2003 Merck Frosst Canada Ltd. a subsidiary of Merck & Co

invested $116 million in research and development in Canada.
United
States
40 per cent
A variety of state administered programs and incentive packages to attract

pharmaceutical industry investment. Pennsylvania, New Jersey and North Carolina
have considerable programs to attract industry investment.
North Carolina attracted a $380 million Merck & Co vaccine plant.

Incentives including tax credits, direct cash incentives and
funding for bioscience education were instrumental in the
investment decision.
Spain
35 per cent
Spain has several grants programs for pharmaceutical R&D including the PROFIT
and Profarma II program.
Merck and Cos subsidiary MSD has just opened a

manufacturing plant in Madrid. It has invested $214 million in this
plant. MSD has earmarked a further $100 million for investments
in Spain in 2006.
The biomedical research fund provides direct funding for over 11,000 researchers
from a combination of public and private sources.
43
Chapter 3
Australias competitive position

This discussion draws out areas of Australian advantage and weakness along the
supply chain, and identifies potential threats to either its existing capacities or its
growth prospects by other regions. This analysis also attempts to highlight
opportunities for Australia going forward.
3.1
Key features of the Australian investment climate
In the past, Australia has shown a substantial commitment to attracting investment

across the value chain. Today it appears to be targeting the R&D end of the
spectrum, and is more or less leaving manufacturing investment to be determined
by factors other than its involvement.
This chapter applies the Strength-Weakness-Opportunity-Threat (SWOT)
framework to key components of the value chain in Australia in an effort to
understand its potential to leverage the strengths in the current global operating
environment to capture more industry investment. Figure 3.1 summaries some of
the key findings along the Australian value chain.
Figure 3.1
STRENGTHS AND WEAKNESSES IN THE AUSTRALIAN VALUE CHAIN (2005)

PRE-CLINICAL
RESEARCH
(inc. scale-up
manufacturing)
CLINICAL TRIALS
LARGE SCALE
ACTIVES
MANUFACTURING
- Excellent biomedical
- Skilled labour force
- Skilled labour force
research base
research base
DRUG DISCOVERY
SECONDARY AND
SMALL SCALE
MANUFACTURING
(biopharmaceutical)
Strengths
research base
- Reputation for quality
- Reputation for quality
- Geography (virtual
- Heterogenous
regulation
regulation
lab opportunities)
population
- Recognised
capabilities
Weaknesses/Threats
- Lack of track record
- Funding gaps for
- Complex,
- Non-competitive tax
- Non-competitive tax
- Insufficient scale,
some research
duplicative ethics
incentives
incentives
synergies
- Gaps in infrastructure
committee processes
- Distance from
- Lack of track record
- Potential regulatory
headquarters
- Insufficient scale,
changes (Bansemer
- Pricing Environment
synergies
report)
- Distance from
- Pricing Environment
headquarters
- Potential threats
- Pricing environment
from other countries

in region
44
Overarching the economic realities of operating within Australia are several

strategic considerations that colour headquarter perceptions and investment
decisions:
The PBS represents a negative lens through which pharmaceutical companies

generally perceive the Australian operating environment. Within Australia
drug prices are low by world standards, with prices around 60 per cent less
65
than US prices. Previously, given Australias small size (approximately one
per cent of the market), the impact of reference pricing policy was
comparatively small. However, it has become an increasing concern as other
larger markets, such as the US and Europe, have become ever more aware of
disparity in prices globally and in some cases have begun to reference their
66
prices to Australia and New Zealand. Many countries have also legalised
parallel importing, allowing higher price countries to import drugs from lower67
priced nations. This has lead to a more unified response by pharmaceutical
companies to nations where reimbursement policies are perceived to
68
undermine innovation than in the past.
Federalism in Australia sometimes results in the States and Commonwealth

working at cross-purposes, which in some cases results in an undue amount of
uncertainty being injected into the investment decision, and more generally
presents a complicated, confusing system through which pharmaceutical
companies must navigate. There are numerous incentive programs to consider,
both at a Commonwealth and State level. In other jurisdictions, the process is
far more streamlined, which aids their ability to attract investment and
increases their overall ability to win attention from key decision makers.
It is critical to underline however that these characteristics of the Australian

investment climate represent weaknesses of the Australian investment proposition
not threats. They are unlikely to be the tipping factor in a large number of
decisions, but generally reduce the overall attention paid to Australia and therefore
limit its ability to achieve its optimal performance in pharmaceutical investment
attraction.
The real threat to Australia is that it fails to recognise the true drivers of global
investment. By doing so there is a risk that Australia will lose out in the worldwide
competition to attract particularly desirable investments by the leading
pharmaceutical companies.
3.2
Overall perception of Australian investment
The survey of MNE head offices highlights the negative overall perception of
Australia at pharmaceutical headquarters (Figure 3.2). In the 2001 survey Australia
was ranked as a worse investment environment than the US, UK and Singapore,
and as About the same or worse than the EU. This is consistent with the updated
results. Also similar to the 2001 study, Australia is seen as better to much better
65
66
67
68
The Productivity Commission, 2003, Evaluation of the Pharmaceutical Industry Investment Program, p. 3.10.
See for example, Verband Forschender, 2004, The Pharmaceutical Industry in Germany: 2004 Statistics.
See for example, the Illinois i-SaveRx program.
See for example, Clarke, L., 2005, Lessons from the Kiwi Model, Researched Medicines Industry Association
of New Zealand, Conference paper from The Future of the PBS, 24 August 2005, Sydney.
45
than New Zealand. Today Australia is seen as worse to about the same as
69
Canada.
Figure 3.2
SURVEY OF HEADQUARTER PERCEPTIONS AUSTRALIAS OVERALL

INVESTMENT POSITION (2005)
Much better
Better
About the same
Worse
Much worse
lia
lia
stra
stra
Au
Au
lia
lia
stra
stra
Au
Au
lia
lia
stra
stra
Au
Au
ed
ed
par
par
com
com
ed
ed
par
par
com
com
ed
ed
par
par
com
com
ew
to N
d
lan
Zea
ore
gap
da
EU
UK
Sin
US
ana
to C
he
to t
he
he
to t
to t
he
to t
These perceptions would appear to reflect the strategic climate for investment. Thus
New Zealand, which is a small market that has not had a strong industry presence in
the past and is generally characterised as a hostile operating environment as a result
of recent changes to its reimbursement schemes, received lower scores in terms of
average performance. By contrast the US is seen as a strongly positive location for
investment reflecting its long record of strong productivity along the value chain as
well as its importance in terms of overall market size and growth. Similar to the US,
Singapore is on average perceived to be an excellent investment climate. This likely
reflects the significant and ongoing industry incentives that Singapore has offered
the industry in both R&D and manufacturing.
Consultations with industry indicated that this overall negative perception of
Australia as an investment location by global company headquarters is in the main
due to the negative messages generated as a result of the reimbursement
69
The 2001 Pharmaceutical Industry Action Agenda survey conducted by the Lewin Group did not poll opinions
on comparisons with Canada.
46
environment. During interviews with both local offices and headquarter

management, the clear message from industry was that key head office decision
makers receive a stream of negative messages from their Australian affiliates,
arising from reimbursement issues such as reference pricing outcomes, time and
costs required to list, PBS restrictions on volume, ad hoc policy changes (such as
the 12.5 per cent price regulation), and so on. The negative perceptions so created
become the lens through which Australia is viewed and, all other things being
equal, exert a chilling effect on potential investments in Australia today.
Moreover, the negative perception of Australia as an investment climate is also
linked to clear concerns about the long run impacts of growing monopsony power
by governments worldwide on innovation and the viability of the pharmaceutical
industry. In the situation of low margins across all pharmaceutical products (the
worst case scenario), in the long run this would result in not only reduced output,
but also reduced investment in R&D, reduced innovation for consumers, and in turn
threaten the viability of the industry, as labour and capital would migrate into other
industries. This has been observed as a material risk by governments. For example,
a joint 2004 study by the US Department of Justice and US Federal Trade
Commission identified the potential downstream effects of market failures arising
from monopsony power:
The exercise of market power by buyers ('monopsony power') has adverse effects comparable
to those associated with the exercise of market power by sellers [monopoly power]. A likely
market effect of government-based monopsony power would be not only lower prices for
pharmaceutical products, but also reduced investment in R&D. Subsequently, less innovation
70
in the pharmaceutical industry might result over the longer term.
If this situation were to occur, this would significantly impact on the viability of the
71
industry more generally; like the US experience with the vaccine industry during
the latter half of the 21st century, the long run effect would be an increase in
72
industry consolidation.
To the extent that Australia is viewed to materially contribute to this long run risk
of untenable price reductions for the industry (due to global pricing considerations,
parallel import concerns and the export of its reimbursement schemes overseas),
Australia is in danger of being characterised by local and head office managers as a
location where investment should be limited wherever alternatives exist.
70
71
72
Federal Trade Commission and the Department of Justice, 2004, Improving Health Care: A Dose of
Competition, Washington D.C., Chapter 7.
This adopts a static view of the future, and does not take into consideration responses by governments and
other players to an increase in industry concentration.
From the consumers perspective, this situation would create significant risks. It may lead to some adverse
outcomes for consumers including the full withdrawal of production of a product. As noted by the Committee
on the Evaluation of Vaccine Purchase Financing in the United States Board on Health Care Services (Institute
of Medicine, National Academies of Science): The rate of exit from the vaccine industry raises two chief
concerns. The most immediate of these is the lack of backup capacity should a manufacturer experience
production problems or other disruptions. When Wyeth opted out of the production of DTaP in 2000, for
example, the suddenness of the firms withdrawal left competing firms unable to fill the gap, resulting in a 2year shortage of the vaccine. Production efforts by other companies to compensate for such a supply disruption
can take well over a year. Longer-term concerns include the potential for the exercise of market power by the
remaining firms and the potential for the total loss of supply of a vaccine product. See the Committee on the
Evaluation of Vaccine Purchase Financing in the United States Board on Health Care Services (Institute of
Medicine, National Academies of Science), 2003, Financing Vaccines in the 21st Century: Assuring Access
and Availability, National Academies of Science Press, Chapter 5.
47
With this as a backdrop, the following sections consider key dimensions of

Australian advantage and vulnerability at each point along the value chain
thereby disaggregating these broad perceptions of Australia vis--vis other
investment locations into its component strengths and weaknesses. Additionally,
Appendix A provides an historical overview and brief analysis of the incentive
programs that have sought to shape the Australian investment landscape.
3.3
Assessment of the competitiveness of the Australian environment

for discovery R&D investment
For the reasons outlined in Chapter 2, Australia is unlikely to become an investment

location for major in-house R&D research. However, Australia has, and could
continue to be, recognised for its vibrant research base, and as a region of alliance
opportunity.
Overall, in terms of discovery research, Australia is competitive in terms of the
quality of its researchers, the relative cost for its skilled scientists, and the quality of
its laboratory facilities. However, competitors in Asia Pacific are not standing still.
Several other regional players have been raising their profiles as countries for
quality R&D investments while remaining a fundamentally more cost effective
environment than Australia. This is perceived to be an increasingly important threat
to R&D activity in Australia.
Figure 3.3 shows headquarter perceptions of Australias strengths and weaknesses
within the sphere of R&D, including both discovery and clinical trial investments.
48
Figure 3.3
SURVEY OF HEADQUARTER PERCEPTIONS AUSTRALIAS R&D PROPOSITION (2005)

Operational
Costs
Taxation
environment
and incentives
Human
resources and
infrastructure
Regulatory
Issues
Pricing and
reimbursement
Excellent
Good
Average
Poor
Very Poor
ad
s to
ls
ent
sem
bur
tica
eim
ceu
ls
of r
rma
pha
tica
ility
ceu
tab
ma
dic
har
pre
ces
t ac
rke
ma
of p
and
ing
ncy
ctio
ces
tor
sec
nce
pro
up
plia
om
Pc
val
tart
nce
ent
em
ista
ture
re
ctu
stru
ass
rov
mp
ch
ruc
ear
ast
res
infr
nfra
ys
pro
rote
GC
Pp
pric
are
nsp
Bro
Tra
stic
of I
ity,
f ap
log
al i
leg
hno
yo
tec
enc
ual
lQ
our
me
Do
Rig
Tria
edi
bio
and
cal
try
el
dus
onn
, in
ers
rch
edi
sea
e re
dp
iom
kille
in b
of s
f th
nce
nce
yo
fina
ive
Exp
Act
IT,
alit
Qu
elle
Exc
nts
ty i
nne
rso
tivi
f pe
duc
ts o
pro
ns
gra
sio
es
ces
ntiv
ility
nce
ilab
er i
Ava
Oth
con
ts
and
cos
ble
atio
sts
cos
tax
tor
rate
ax
Dt
rpo
iga
f co
ted
ma
rela
nsu
and
f co
eo
est
R&
Co
Inv
ltur
Cu
st o
lary
Sa
Co
Given that the major driver of R&D investments in discovery research and clinical
trials is the quality of the researchers, the above survey indicates that Australia is
well positioned to offer innovative ideas and quality clinical research. The latter is
also supported by head office perceptions of a strong regulatory environment,
which is of key importance to clinical trial work. However the survey also indicates
that Australia is not perceived to offer significant cost advantages over competing
nations, scoring only average in terms of operational costs. This could offset some
of the strengths in the research base, as could pricing and reimbursement issues in
cases where investment decisions might be governed to a certain extent by strategic
considerations.
Following on from the survey results, Figure 3.4 summarises Australias strengths,
weaknesses, opportunities and threats (SWOT) with respect to discovery R&D
investments as assessed through academic and private industry research, industry
consultations and the survey results. The remainder of the section discusses these
dimensions in depth.
49
Figure 3.4
SWOT ANALYSIS DISCOVERY R&D (2005)

Strengths
Skilled
labour
force
Effective IP
protection
Geography
(virtual lab
opportunities)
Opportunities
Increased
alliances
between local
firms and intl
firms
Weaknesses
Lack of
Funding
recognised
gaps
track record,
syngeries
Pricing
environment
Market
factors
Threats
Competing
tax
incentives
FTA
amendments
Funding
gaps
Developing
nations in the
region
Strengths
Excellence in basic medical research and IP protections
Australia has a broad human capital base to underpin science and innovation, with
education and training systems providing a wide range of skills. Relative to its size,
Australias overall contribution to the development of scientific knowledge is
among the largest of all countries.
In 2002, Australia contributed 2.88 per cent of the worlds output of research
publications (including in the sciences, social sciences and humanities), up from 2.3
per cent in 1988, and further was reported to have 1.9 per cent of the worlds most
73
highly cited scientists. Importantly, the areas of Australian science with the
greatest research publication output are the medical and health sciences (which
accounted for about one-third of the papers published in 1996-2000), and the
biological sciences (about 20 per cent of publications). Figure 3.5 shows the
number of publication by field of research.
In 2003, Access Economics reported that the annual 74
rates of return to Australian
health R&D were up to $5 for every $1 spent on R&D.
The 2004 Grant Review recognized that the overall Australian investment in health
and medical research (HMR) increased to $1.7 billion in 2001, with the
Commonwealth Government investing around $800 million, and the NHMRC
distributing around $225 million of this amount. The HMR investment has grown at
around 10% per annum since 1993, and probably exceeded $2 billion in 2003.
In the 2006-06 Federal Budget, the Government announced that they will provide
$500 million over four years to increase investment in health and medical research.
73
74
Department of Education Science and Training, 2003, Mapping Australian Science and Innovation,
Commonwealth of Australia.
Access Economics, 2003, Exceptional Returns the Value of Investing in Health R&D in Australia, Prepared for
the Australian Society for Medical Research. Canberra, September, p1.
50
This funding will enable the provision of additional research grants through the
National Health and Medical Research Council.
The Government also committed to provide $170 million over nine years (including
$99.3 million from 2010-11 to 2014-15) to establish an Australian Health and
Medical Research Fellowship Scheme to attract and retain leading researchers,
through the National Health and Medical Research Council. This is a long-term
commitment from the Government to develop and enhance research capacity and
maintain Australia's world class reputation.
Figure 3.5
NUMBER OF AUSTRALIAS SCIENTIFIC RESEARCH PUBLICATIONS BY FIELD OF

RESEARCH (1996-2000)
Source: Department of Education, Science and Training, 2002, National Science Indicators Database,
2002 edition. Note: Includes all NSI publications in the sciences, social sciences, and arts and
humanities.
Australia also has an effective and enforceable IP protection framework, the major
features of which are comparable to those of other industrialised economies and
75
conform to worlds best practice.
Weaknesses
Size and Scale
The need for critical mass is recognised in every competing market. For example, in
the US, investments in critical mass include San Diegos CONNECT, Arizonas
Brain Imaging and Alzheimers Research Centre, and New Yorks Oncology and
Cancer Research Centre. Similarly, Singapores Biomedical Research Council
(BMRC) has a five year budget of $A1.14 billion to develop a number of institutes
in order to attract the best international talent to its Biopolis.
Despite some notable successes with incubator models, such as NeuroSciences
76
Victoria, the Australian biotech and biopharmaceutical industries are characterised
75
Over the past several years, changes have been introduced to effect closer alignment with the systems of our
international trading partners, helping Australia to secure 10th position in the World Competitiveness
Institutes global survey of patent and copyright infrastructure. The Australian system is the best in the AsiaPacific region and outperforms countries such as the United Kingdom, France and Norway. See DEST, 2003,
Mapping Australian Science and Innovation, Commonwealth of Australia, p 12.
51
as small scale, fragmented, lacking funding, and lacking the required business
knowledge and savvy to bring products to market. Facilitating consolidation of
research, where appropriate, might usefully unlock some of the strengths in the
Australian research base.
Innovation gap: funding and skills
Drugs can be generally characterised as emanating from one of two disciplines:

small molecule chemistry or biologicals. In terms of small molecule development,
there is currently a gap in skills and funding for medicinal chemistry research,
which is required to bring small molecule projects beyond a proof of concept phase.
From the biologicals perspective there is currently a gap in scale-up
biomanufacturing, which frustrates the commercial development of biological
drugs. The reasons for both small molecule and biologicals funding and skills gaps
are the following:
the investment falls outside the government grant programs and philanthropic
investment criteria, with the research generally being held to be too
commercial; and
the investment falls outside industry or venture capital interests, as the research
is held to be too risky. Moreover, due to the general lack of size and scale of
many Australian institutions, venture capitalists tend to require substantial
warranties that would not be required in other countries, namely the US.
Together this substantially limits the availability of seed funding to institutes and
growing biomedical and biotech companies, and has fostered the creation of the socalled innovation gap. Some researchers blame short-termism on behalf of
funding organisations, others claim these activities fail to capture research attention
and funding because they are perceived to be boring areas of research. However,
given that pharmaceutical companies tend to consider pre-compound research to be
early stage research, it is critical that this gap is bridged.
Opportunities
Growing biotech sectors
The number of biotechnology companies grew from almost none in 1981-82 to 420
77
in 2005. A diverse research base with strengths in particular fields has been an
important factor in this growth along with government support at Commonwealth,
78
state and territory levels. There has, and will continue to be, a payout for risk
relationship between these smaller companies. For early phase, risky research the
payout might be comparatively small as a percentage of the potential final revenue.
The more developed the drug, the greater the payout. For Phase I, II, III drugs the
payout to the institute increases. Thus to the extent that Australian firms are able to
better develop their ideas, they will secure a higher share of any eventual
76
77
78
Neurosciences Victoria, created as a scaled consortium of the University of Melbourne, Howard Florey
Institute, Monash University, and the National Stroke Research Institute, has secured funding of $60.85
million in government and industry contracts. These contracts, secured in association with the successful bid
for a Major National Research Facility now known as the National Neurosciences Facility, attracted industry
investment of $32.5 million. Investments by industry included: $25 million from Schering; $5 million from
Prana; and $0.75 million from GSK. Other examples of successful collaborations between Australian
institutions include The Peter MacCallum Cancer Centre and Pfizer, the CRC for Chronic and Inflammatory
Disease and AstraZeneca.
Department of Industry, Tourism and Resources, 2006, Biotech Business indicators, June.
Hopper, K., and L. Thorburn, 2002, 2002 Bio-Industry Review: Australia and New Zealand, Aoris Nova and
Advance Consulting and Evaluation Pty Ltd, Sydney.
52
commercial payoff. Realising this opportunity will rely on a greater consolidation

of Australias research base where appropriate, in order to improve their chances of
commercialisation.
Better support for securing IP rights and commercialisation
Australia is often described to punch above its weight in medical research, and yet
its track record in terms of revenue from commercialisation is relatively poor. This
has been characterised by several studies, including the Department of Education,
Science and Trainings (DEST) 2003 Mapping Australian Science and Innovation
report on Australias innovation capabilities, as due in large part to a lack of
awareness/desire by researchers to secure IP rights for their work prior to
publishing. Clearly the incentive structure inside universities and institutes drive
researchers to publish their work as opposed to seeking commercial development.
This leads to a publish and perish in the commercial sphere phenomenon. If
researchers were able to secure IP ownership of their ideas, they would begin to see
another flow of funds into the university. This could help fund the purchase of new
equipment and the early stages of additional research.
The answer is not generally perceived to be additional research offices. If these
organisations are under-funded or not sufficiently networked within key markets,
such as the US (where relationship facilitation is needed), which Australian
organisations of this type generally have been, these organisations are seen as
hindrance rather than a help. Other models, such as the research-developer model,
where an individual scours local markets for ideas to channel back to headquarter
decision making teams, was generally perceived to be a more efficient and favoured
model by industry and researchers alike.
Threats
Skills shortages
The long-term sustainability of Australias skills base in the enabling sciences is

under pressure in some areas. In terms of actual student numbers, physical science
enrolments have fallen from 81,842 in 1991 to 66,504 in 2000, while total Year 12
enrolments have increased from 183,257 to 185,810 over the same period. The
proportion of students taking two physical science subjects (chemistry and physics)
declined from 11.4 per cent in 1998 to 9.7 per cent in 2000. This combination of
subjects provides the basis for a common pathway to science, engineering or health
at undergraduate level.
International Competition
China and India have been increasingly representing a viable investment location
for not only manufacturing but also R&D. In the past the key features of these
locations were cheap, unskilled labour and a rather unsophisticated regulatory
environment. In recent times these jurisdictions have been building profiles for
greater skilled labour. India in particular boasts 500,000 physicians trained by a
medical education system inherited from the British and 800,000 post graduate
79
scientists. These countries also represent strategic opportunities for R&D
investment because of the massive market growth. As more persons within these
countries become wealthier and adopt increasingly Western lifestyles, they are
79
Varawalla, N., 2005, Poised for Growth: The Indian CRO Industry, Contract Services Europe, April, available
at http://cse.adv100.com/cse/article/articleDetail.jsp?id=159695&pageID=4.
53
likely to increasingly demonstrate Western disease patterns. The magnetism of

these future markets makes these developing nations a growing threat to investment
and re-investment in Australia.
Potential chilling effects on investment as a result of AUS-FTA amendments,
legislation
While Australia has been historically known for its robust IP protection framework,
recent legislation enacted following the execution of amendments to the USAustralia Free Trade Agreement (FTA) may present significant costs to originator
pharmaceutical manufacturers and could potentially have a further chilling effect
on R&D investments in Australia.
The amendments to the US-Australia FTA were intended to prevent the emergence
80
of evergreening patents in Australia, as is commonly observed in the US. It was
argued by some groups that without the amendments, new legislative provisions
created by the FTA would make it more difficult for generic drugs to be brought to
the Australian market (PBS). However this ignored that to date no evergreening
case had been identified in Australia and it also did not take into account
differences in the intellectual property laws in Australia and the US. As noted by IP
Australia, these additional amendments to sanction evergreening were unnecessary:
In relation to evergreening, [the FTA would not] make any changes to the type of inventions
for which patent protection can be obtained. Under the terms of the AUSFTA, Australia will
not be required to make any changes to our existing patent extension regime patent owners
will not be able to extend the term of their patents beyond what they can do under existing
arrangements. Therefore it is hard 81to see how the FTA will have the effect that is being
suggested [delayed generic drug entry].
Despite this, the amendments were adopted. Provisions in sections 26C and 26D of
the Therapeutic Goods Act 1989 were the legislative outcomes of the FTA
amendments. Under these provisions pharmaceutical patent holders risk heavy
82
penalties when seeking to enforce patent rights.
The impact of these provisions upon patent enforcement decisions by
pharmaceutical patent holders and upon MNE head office perceptions of Australias
pharmaceutical specific IP framework is yet to be determined. To the extent that
this risk is realised, this could have unintended consequences for R&D investment
in Australia.
3.4

for clinical trial R&D investment
Clinical trials account for nearly half (42 per cent) of all R&D spending in
83
Australia, or approximately 2.15 per cent of turnover each year ($229 million).
This is higher as a percentage of total R&D spend than in the US, where clinical
80
81
82
83
Evergreening refers to the practice whereby patent holders, in order to extend their monopoly, wait until near
the end of an original patent term to progressively file a series of patents in an attempt to extent the patent term
(keeping generics off the market).
Heath, I., 2004, Examining the Impact of the Australia-United States Free Trade Agreement (AUSFTA) on
Intellectual Property, Recent Developments in Protecting and Commercialising Intellectual Property 10 and 11
August 2004, IP Australia, Director General.
The maximum penalty is $10,000,000. See Section 26C, Therapeutic Goods Act 1989.
Department of Industry, Tourism and Resources, 2003, Australias Preclinical and Scale-Up Manufacturing
Capabilities, A Comparative Analysis, December.
54
84
trials R&D accounts for roughly 34 per cent of all R&D spend. In Australia
approximately 550 trials of therapeutic products are conducted each year at roughly
1,800 trial sites nationwide. This compares to roughly 1,600 trials per year in the
UK and 1,500 trials per annum in France. Figure 3.6 summarises the following
SWOT analysis of Australias position as an investment location for clinical trial
R&D.
Figure 3.6
SWOT ANALYSIS CLINICAL TRIALS R&D (2005)

Strengths
Skilled
labour
force
Weaknesses
Inefficient
system for
multi-site
trials
Heterogenous
population
Recognised
capability
internationally
Opportunities
Capture
increasing
number of
trials
Cost relative
to regional
neighbors
Average time
to completion
Threats
Lower cost
developing
nations in
the region
Regulations
delaying trial
completions
Pricing
environment
Strengths
Quality of trials, medical researchers
As shown in the survey results of headquarter perceptions (See Figure 3.3), the
quality of Australias medical researchers, clinical trials and good clinical practice
(GCP) compliance is currently perceived to be good to excellent. Thus the survey
would indicate that Australia is perceived to be a strong candidate for quality
clinical trial work.
Although it is difficult to establish Australias rank within the international context
of clinical trial research, it is generally held that Australia currently plays an
important role globally. A Centre for Medicines Research International survey in
1997 asked the top 20 MNE pharmaceutical companies where they routinely
conducted clinical trials. Australia ranked fourth behind Europe, the US and
85
Canada. Similarly, a 2003 benchmark study of global clinical trials by Proscribe,
with the support of Medicines Australia, showed that Australia was well regarded in
terms of quality outcomes: approximately half of the companies surveyed ranked
Australia in the top third of places in which to conduct trials in terms of
84
85
Department of Industry, Tourism and Resources, 2001, Discussion Paper, Pharmaceuticals Industry Action
Agenda, September, p 19. Note that this is based on 1993-94 relativities and should be treated to understand
orders of magnitude namely that clinical trials R&D is relatively large in Australia compared to other
countries.
The Bansemer Report, 2005, Report of the Review of Access to Unapproved Therapeutic Goods, Banscott
Health Consulting, p 41.
55
performance, and one third of all companies surveyed ranked Australia in the top
ten per cent of places to conduct trials in terms of performance.
Australia offers FDA accredited sites, cGMP and GLP facilities as well as centres
of clinical research excellence such as the University of Melbournes Centre for
Clinical Research Excellence in Infectious Diseases. The Proscribe FACTS report
demonstrated that Australia offers a wide availability of clinical trial coordinators at
trial sites, with the proportion of clinical trial coordinators at trial sites in Australia
86
nearly double that of Europe (nearly 100 per cent of sites). The availability of
coordinators at every site ensures consistency and quality in the trial results.
Australia is also well known for a rapid uptake of IT innovations and
communications infrastructure that foster efficiencies in trials globally.
Comparatively low labour costs
Historically, Australia has been positioned as not only a location with a quality
research base, but also as a relatively cost-effective location for trials. For example:
A 2004 KPMG benchmarking analysis of clinical trials costs ranked Australia

third overall in terms of cost behind Canada and the Netherlands. The UK was
ranked fourth and the US eighth in terms of input costs. Trial costs were
determined by comparing overhead requirements, labour costs, and other
annual operating characteristics, including the opportunity to access tax
87
concessions.
The 2003 FACTS study revealed that investigator fees per patient in Australia
were roughly half those in the US and Canada. Australias relative cost
advantage was also shown to exist in all therapeutic areas and across all trial
phases.
Nevertheless, industry has indicated that costs have been converging towards
European levels, and that Australia should not remain complacent in maintaining its
position as a cost effective location.
Speed of regulatory assessment and notification
The steps through which a company must proceed in order to gain approval for a
clinical trial are:
scientific assessment;
ethical assessment;
local research government assessment; and
regulatory assessment or notification (either via the Clinical Trials Notification

(CTN) or Clinical Trials Examination (CTX) schemes).
According to a recent benchmarking study of Australian clinical trials, Australia

currently has a competitive advantage in the regulatory assessment stage, as the
88
CTN scheme allows for one of the fastest regulatory approval times globally. The
86
87
88
Wooley, K. and M. Wooley, 2003, Clinical Trials in Australia: Finding out the FACTS, Good Clinical
Practice Journal, 10(5), p 2.
KPMG, 2004, The CEOs Guide to International Business Costs, Clinical Research Industry International
Comparison, available at www.competitivealternatives.com.
56
number of trials completed in Australia increased dramatically during the 1990s

with the introduction of the Clinical Trials Notification (CTN) scheme, which
accounts for roughly 99 per cent of the trials currently conducted in Australia. The
FACTS benchmarking study further reported that drug sponsors can receive
notification from the TGA in approximately one week; the mean delay was reported
89
to be 7.9 working days.
Market factors
The tyranny of distance has in some ways worked in Australias favour with respect
to clinical trials. Its close proximity to the Asian Pacific region combined with its
English speaking researchers and reverse seasonality to the Northern Hemisphere
makes it an excellent complementary base for trial studies. Some industry experts
pointed to time zone differences as an edge in some virtual trials. Moreover, unlike
New Zealand, it has a comparatively large, heterogenous population and ethnic subpopulations which makes it a viable location for investigating western lifestyle
diseases.
Weaknesses
Duplicative ethics committee processes
The number of multi-site clinical trials has been rising steadily since the early
1990s with the introduction of the CTN scheme. This has had several effects.
First, the Bansemer Report has stated that it has increased the volume of work
placed on the Human Research Ethics Committees (HRECs) that currently
provide scientific and ethical approval to sponsors seeking to conduct clinical
trials.
Relatedly, it has also made transparent the significant inefficiencies arising out
of the current needs to get approval from each ethics committee for each site.
The disunity among the various ethics committees wastes resources, results in
different conditions being imposed on the trial at different sites, and decreases the
competitiveness of Australia internationally by raising the transaction costs of trials
and delaying the time to market. Delays in the time to market cut into the
pharmaceutical companys exclusivity periods and therefore reduce the revenue
they can expect to realise. Concerns about inefficiencies in the current trials process
expressed by industry were summarised by Novo Nordisk in its submission to the
Bansemer Review committee:
For phase I and phase II trials where only one centre is involved these [ethics committee
issues] are not too burdensome. The main delaying factor is the time and effort taken to
submit packages to each and every Ethics Committee (usually with different requirements for
format and content)
and then for each Ethics Committee to fully review the clinical trial and
90
provide clearance.
Industry and several states have recommended that a centralised ethics committee
procedure be instituted for multi-centre trials whereby mutual recognition could be
introduced. This centralised, streamlined process would introduce a system where
the Ethics Committee for the Principal Investigator would provide clearance and
89
90
57
that would be adopted by all other centres without need for a review. This was
recommended by the Bansemer report as well:
Cooperation at both federal and State and Territory level is seen as necessary to achieve
a
91
streamlined ethical and scientific review, as well as monitoring function of clinical trials.
This reform of the ethics committee processes should also encompass other
weaknesses in the operation of HRECs, such as eliminating the use of different
forms and procedures to reduce duplication of effort and an unnecessary increase in
92
cost and variation across committees.
Patient recruitment: variations across therapeutic areas and trial phases
Benchmarking studies have shown that Australia in some therapeutic areas

struggles to effectively recruit patients. This is due to Australias small population
size and its extreme spread over a large geographic area. This results in a wide
variance in the incidence of disease in some therapeutic areas, which can adversely
affect the outcomes of the trial. In Australia the model for clinical trials has been a
patients come to the trials model. In order to meet enrolment targets for some
trials, it is recommended that more strategic selection of sites be developed. To
develop a trials come to the patients model, however, also relies on multi-siting
issues being resolved.
Opportunities
Capture increasing distribution of clinical trial R&D capital
The first opportunity is to capture increasing amounts of R&D spending being

distributed globally. Outsourcing as a proportion of R&D spend was reported to
93
have increased to 30 to 40 per cent in 2003, up from 20 per cent in 1998. This
trend is expected to slow, but a substantial proportion of expenditure will still be
available to external parties. To date, Australia has not captured this, however, it
remains an open opportunity. This trend will aid Australia in meeting the Action
Agendas goal of doubling Australias share of the global industry by 2012.
To do this, Australia needs to ensure that it streamlines its ethics committee
submission and approvals processes, and does not introduce any other regulatory
hurdles that might push out average clinical trial completion times. Australia has an
excellent, cost effective research base and track record on which to realise increased
investment going forward.
Improve recruitment rates
The second opportunity for Australia is to improve its recruitment rates, particularly
through improved site selection and increased public awareness about the need for
and value of clinical trial participation. As noted by the FACTS study:
91
92
93
Health Consulting, p 30-31.
The Grant Committee, 2004, Sustaining the Virtuous Cycle: For a Healthy Competitive Australia, Investment
Review of Health and Medical Research, Final Report, Canberra, December,
58
[Australia needs to develop initiatives to] focus on improving the way potential clinical trial
patients are identified (in compliance with privacy regulations) and will facilitate a more
strategic approach for site selection. There will always be a need to conduct certain trials in
major teaching hospitals in urban areas. However there are also clinical trials that may be better
suited to sites
that are currently under-used in Australia, namely regional, private and primary
94
care sites.
This will mitigate the impact of Australias small population, especially in terms of
competition with developing country locations.
Threats
Bansemer Report recommendations
Some of the Bansemer Report recommendations represent a material threat to the

competitiveness of Australian clinical trials. Recognising the large volume of work
required of ethics committees, the report recommended that scientific approval be
given outside of the ethics committee processes by the TGA. This will add another
step into the approvals process and will render the regulatory process for clinical
trial R&D more costly in terms of time, resources and patent life forgone down the
track. Clinical trials activity is predicted to see a dramatic drop-off in response to an
action such as this, and would reduce substantially the large gains seen in Australia
since the introduction of the CTN scheme, where trials, especially Phase II and III
95
trials, saw a near exponential growth from 1990 to 1998. Ultimately, this could
prevent the industry from realising its goal of doubling the share of the global
industry by 2012.
Lower cost competitors in trials and services
As identified in Chapter 2, outsourcing is a growing trend as the traditional business

model evolves in response to industry changes. The winners of this process may not
be Australian CRO affiliates but instead firms located within developing countries,
most notably India (See Box 3.1). This was underlined by industry representatives
as perhaps the largest threat to existing and potential Australian clinical trials
market share in three to five years time, and characterised to be exacerbated by
other potential regulatory impediments that might follow the Bansemer Review
recommendations.
Box 3.1
INDIAS GROWING COMPETITIVE ADVANTAGE IN CLINICAL TRIALS R&D

India's contribution to global clinical trials continues to be minimal, and less than one per
cent of annual global clinical development budget is currently conducted there. This
scenario has changed and the Indian contract research organization (CRO) industry is
presently experiencing a 100 per cent annual growth rate driven by a worldwide interest
to include India within global clinical development programmes.
Over the past decade, the Indian affiliates of Pfizer, Lilly and Aventis have developed
substantial global clinical development capabilities and continue to submit increasing
amounts of Indian Phase II and III clinical trial dates to their global clinical development
departments. As a result they have contributed to the training of Indian investigators and
clinical research personnel.
India offers a compelling opportunity for swift, meticulous and cost-effective global
clinical trial conduct because of easy patient access, a cost-effective environment and
94
95
59
the availability of an English speaking, educated and motivated workforce.

In addition to widely prevalent infectious and tropical diseases, rapid and extensive
urbanization has resulted in disease prevalence similar to that found in developed
countries including 0.7 to 0.9 million new cases of cancer each year; the largest number
of individuals with diagnosed metabolic syndromes in the world; 80 million persons
suffering from cardiovascular disease; 50 million asthmatics; and four to five million
persons shown to be HIV positive.
Compared with the US and Western Europe, clinical trial conduct in India offers the
opportunity for up to 40 per cent cost savings for comparable quality. Considering the
labour intensity of clinical trial execution, the lower labour costs for clinical operations
personnel (i.e., project managers, monitors, medical writers, data processors and
programmers) account for a substantial amount of these cost savings.
It is estimated that by 2010 the clinical development sector in India will be worth $1.5
billion. The CRO industry will account for $500 million of this and the rest represents the
activities conducted by multinational pharmaceutical companies themselves.
Source: Varawalla, N., 2005, Poised for Growth: The Indian CRO Industry, Contract Services Europe,
April, available at http://cse.adv100.com/cse/article/articleDetail.jsp?id=159695&pageID=4.
Reimbursement considerations
If firms are not planning to launch in Australia, the incentive to hold clinical trials is
dramatically diminished. If in the next 5-10 years firms plan not to launch some
new drugs in Australia, due to global pricing considerations, then there will be a
gradual, lagged decline in the number of clinical trials here. Industry identified the
need to avoid potential patient backlash that could arise were trials to be held within
Australia and then patients not granted access to the drug following the trial
periods. Overall, it could also mean delayed access for Australians to new therapies
as off-patent manufacturers will be required to wait for patent periods to lapse
96
before potentially bringing an alternative into the market. The impetus to list in
Australia could also be diminished by increasing restrictions on usage: in the past,
sponsors were in effect guaranteed large volumes for listing on the PBS but
increasing restrictions mean that the volumes expected from listing on the PBS may
not be sufficient to justify the costs. This could in the future adversely impact
Australias position as a clinical trial location.
3.5

for manufacturing investment
Recent mergers and acquisition in Australia can represent both an opportunity and a
threat for the Australian operations of these companies. On the one hand, with the
potential closure of small-scale plants in the Asia-Pacific region there is an
opportunity for expanded production in Australia. However, at some stage there
could be a risk that global rationalisation could go further and jeopardise the future
of Australian operations, especially with emerging low cost destinations, such as
China and India. Industry is generally predicting a decline of existing
manufacturing plant capacity, and point to the risk that Australia could have a
substantially diminished manufacturing presence in 10 years time.
96
Note that a drug may still not be brought to Australia if there is not a market for the product.
60
Figure 3.7
SURVEY OF HEADQUARTER PERCEPTIONS AUSTRALIAS MANUFACTURING PROPOSITION (2005)

Operational
Costs
Taxation
environment
and incentives
Human
resources and
infrastructure
Regulatory
Issues
Pricing and
reimbursement
Excellent
Good
Average
Poor
Very Poor
ad
nsp
Bro
Tra
ma
ls
on
niti
cog
g re
urin
ent
act
sem
nuf
bur
tica
ma
eim
ceu
of r
rma
pha
ility
ls
MP
tica
s, G
ceu
tab
ma
dic
s to
pre
ces
t ac
and
har
ent
ces
pro
eem
agr
of p
try
ing
ncy
rke
are
pric
oun
ces
ent
pm
elo
dev
nce
ista
ass
ent
em
try
ets
dus
rov
ark
nt m
el
orta
imp
onn
and
val
ing
pro
pro
f ap
rol
oc
stic
ry t
me
unt
Do
Co
yo
rain
nd
in
cha
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ea
ers
mp
, in
ty i
nts
tivi
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duc
ing
pro
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ise
rso
rem
uts
inp
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inc
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arg
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Exp
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ity
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es
and
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ility
ilab
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nce
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ts
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Supporting this, Figure 3.8 above shows headquarter perceptions in 2005 of

Australia as a place to locate manufacturing activity. The survey results show that
taxation and reimbursement issues act as general disincentives for investment,
while regulatory issues are seen to be a strength. This aligns with industry and
government consultations as well as existing research into Australias competitive
manufacturing position. Given the importance of taxation incentives (as discussed
in Section 2.5) as drivers of manufacturing investment, and Australias low score
with regard to the effectiveness of manufacturing taxation incentives, it is perhaps
not surprising then that Australias manufacturing capacity has been in decline in
the past decade. Moreover, negative perceptions of Australias pricing and
reimbursement scheme shown in the survey above would suggest that where
manufacturing investments might also include strategic considerations that the
current pricing environment does not aid Australias cause.
Figure 3.8 summaries its strengths, weaknesses, opportunities and threats, which are
discussed in turn below. This SWOT analysis draws on industry consultations,
private and academic research and our survey of head offices.
61
Figure 3.8
SWOT ANALYSIS MANUFACTURING

Strengths
Skilled
labour
force
Weaknesses
Pricing
environment
Reputation
for quality
goods
Opportunities
Potential small
scale biopharm;
niche; contract
manfuacturing
Disconnect
between
States and
Cmwth
Ops
costs
Threats
Competing tax
incentives for
biopharm, actives
and secondary
manufacture
Strengths
Quality labour
The development and production of manufactured pharmaceuticals involve two

broad labour market segments: the research, design and engineering workforce for
the plants construction, and the manufacturing workforce at the pharmaceutical
plant. In terms of the research, design and engineering workforce, the quality and
cost and quality of labour, Australia is very competitive compared to other OCED
countries and developed countries in Asia. For example, in the
biotechnology/pharmaceuticals manufacturing, the Australian salaries of
97
researchers are estimated to be 40 per cent less than those of the USA. It is also
recognised that the Australian research, design and engineering workforce displays
high levels of innovativeness and flexibility. An important characteristic is the
ability to integrate technologies from a wide range of sources to produce more
effective products and services.
However, Australia has significantly higher labour costs relative to less developed
countries in Asia. With abundant availability of skilled low cost labour in China,
Malaysia and India, and the increasing price sensitivity of customers, Australian
manufacturing cannot compete on price alone.
Australias workplaces are also very different to the largely unregulated workplaces
of manufacturing firms in China and India. This could be a positive (in terms of
quality) and a negative (in terms of higher production costs) for competitiveness.
Regulation as a source of competitive advantage
TGA regulatory approval is recognised as a significant barrier to entry for new

firms. However, TGA regulation is also viewed as an advantage for companies
already producing in Australia.
97
New South Wales Department of State and Regional Development. Key Industries: Booming biotechnology
and pharmaceuticals sector available at www.business.nsw.au.
62
The industry has a reputation for producing high quality and safe products as a
result of Australias high levels of regulatory oversight of the pharmaceuticals
industry. During discussions with industry stakeholders, it was noted that some
customers in less developed countries prefer higher-priced Australian-made
products to cheaper products produced in their home country, as these were
perceived as being unsafe. This trend is likely to grow as living standards rise in
these countries and customers become more sophisticated in purchasing decisions.
Regions where Australias regulatory system is a competitive advantage are Asia,
the Middle East and parts of Europe where Australian TGA-approved products
receive faster approvals. In terms of the USA market, access will be difficult for
domestic companies as regulatory arrangements in the USA are more onerous.
Weaknesses
Ageing technology without incentive for re-investment
Some of Australias current manufacturing plants are comparatively old, and are
likely to face a phase out over time unless new investments are made. For example,
one pharmaceutical company consulted for this study reported that it had recently
closed three manufacturing plants in Australia. The closure of the plants were a
result of:
ageing technology of plants in Australia;
consolidation of manufacturing operations globally, with older plants in

Australia not being re-invested/upgraded;
incentives on offer by competing nations, such as Singapore, India, Malaysia,

Canada.
The Smithfield infant formulation plant was replaced with facilities in Singapore.
Opportunities
Niche, secondary and contract manufacturing
In the absence of an industry wide incentive that will increase manufacturing

activity levels, there is the opportunity for the States and the Commonwealth to
support niche, smaller scale manufacturing investments. Examples of opportunities
include the Victorian governments support of the GSK alkaloids plant at Port
Fairy. Box 3.2 discusses the potential for niche manufacturing in Australia.
Box 3.2
NICHE MANUFACTURING
In discussions with industry stakeholders, there was a general view that sustainable
export manufacturing opportunities are likely to be found in those areas in which firms
have effective niche market strategies.
Niche market strategies require:
identification of the market opportunity;
R&D, product design and engineering capability needed to provide points of

difference;
achievement of high quality levels; and
high efficiency and flexibility in operating small production runs.

Many international studies have shown that the sustainability of a niche market strategy
63
is greater where the firms concerned are part of a supporting cluster of related firms and
institutions. This is demonstrated by the GSK Asthma Centre for Excellence, which is a
niche operation within the global firm and works in collaboration with the Asthma CRC as
well. Other examples include:
GlaxoSmithKline extracts opiates from poppies at a facility in Port Fairy for morphine
production;
Mayne Pharma specialises in injectable oncology products, with a unique

containment operation in Mulgrave;
CSL Limited specialises in vaccines; and
IDT Australia produces small-scale specialised active ingredients on a contract basis.
The unique skill sets present in the industry also provide opportunities for
companies to target niche patient markets. In particular, the Pharmaceuticals
Industry Action Agenda notes that small-scale firms with short manufacturing runs
who have the flexibility to change rapidly between products will be best placed to
98
service niche markets.
Threats
International incentives
The prime threat posed to Australian manufacturing is clearly more competitive

taxation incentives offshore, which not only prevent new investments from being
located here, but also threaten to gradually erode the existing manufacturing base as
firms opt to shut down old-technology plants in favour of cutting-edge plants
elsewhere.
Within the Asia-Pacific region, Singapore has positioned itself as a competitive
destination for investment, in particular by offering favourable tax benefits.
Multinational firms have established significant manufacturing and R&D operations
99
in Singapore over the past five years as a result of these financial incentives. China
and India also represent competitive investment locations for most types of
pharmaceutical manufacturing. In the past the key features of these locations were
cheap, unskilled labour and a rather unsophisticated regulatory environment. In
recent times these jurisdictions have been building profiles for greater skilled
labour. These countries also represent strategic opportunities for R&D investment
because of the massive market growth opportunities. As more persons within these
countries become wealthier and adopt increasingly Western lifestyles, they are
likely to increasingly demonstrate Western disease patterns. The magnetism of
these future markets makes these developing nations a growing threat to investment
and re-investment in Australia.
98
99
Department of Industry, Tourism and Resources, 2001, Local Priority Global Partner, Pharmaceuticals
Industry Action Agenda, Canberra, p 38.
Department of Industry, Tourism and Resources, 2001, Local Priority Global Partner, Pharmaceuticals
Industry Action Agenda, Canberra, p 17, 36 and 38.
64
Chapter 4
The outlook for the Australian pharmaceutical

industry
This chapter synthesises the drivers of pharmaceutical investment with Australias
current competitive position in discovery R&D, clinical trials R&D and
manufacturing investment as identified through industry consultations, the
headquarters survey and private sector research. It then provides recommendations
for the industry and Government to consider the actions required to see the industry
maximise its growth potential. The chapter concludes by mapping the benefits that
would flow from a rise in industry investment, including export, employment and
productivity increases.
4.1
Maintenance of the status quo: industry erosion
Analysing Australias competitive position has shown that despite its many
strengths, Australia currently faces major threats at all points of the value chain:
Australia possesses a strong biomedical research capability in its medical

research institutes, hospitals and the leading research-based universities. This
is reflected in Australia punching above its weight in terms of the contribution
it makes to world research in these areas. The Commonwealth Government has
provided increased funding to the NHMRC following the Wills Report.
However, while examples exist of strong and very productive links between
researchers and multinational innovative pharmaceuticals companies,
challenges remain, especially in building connections to key decision makers
in the global pharmaceuticals companies located in the US and Western
Europe. Significant challenges also face small biomedical companies in their
efforts to develop drug targets into commercially viable compounds.
Australias historical advantage in clinical trials and until quite recently, strong
growth in performing clinical trials, is under threat from more cost-competitive
locations in the Asia Pacific region. Domestically, clinical trial activity is also
under a potential regulatory threat that might introduce further costs and delays
to trials in Australia.
Elements of the current manufacturing base in Australia are ageing in terms of

the technology employed. The risk is that the manufacturing base will continue
to gradually erode as other nations offer more attractive taxation incentives.
This would continue to make reinvestment less likely and will result in an
accelerated migration of high value-add jobs overseas. Exceptions will be
where facilities are based on unique supply source within their firm, or where
the mix of specialised resources makes it difficult to relocate the plant
overseas.
Australia also battles against negative perceptions within MNE head offices
due to its reimbursement policies, which are reported by local and international
management to create a lack of interest in investment opportunities here. This
is a weakness to the environment that exacerbates all of the other threats facing
Australian activity levels and investment growth potential.
65
4.2
The likely impact of the Action Agenda on the status quo
Industry and Government, recognising the attenuating industry presence in

Australia, indicated a shared desire to reverse this trend through the creation of the
Action Agenda, which set a goal of doubling Australias share of global
pharmaceutical industry by 2012. The Agenda identified the following actions that
would need to be implemented to achieve this goal:
develop an agenda that promotes dialogue between the Government and

industry, coordinates support for investment through various Government
departments and agencies, and strengthens cooperation among industry
members;
position Australia to become an activity hub by developing a targeted industry

program aimed at increasing the amount of activity in facilities already in
Australia, and by increasing investment so that more local manufacturing and
R&D facilities and activities are established;
position Australia to become an activity hub by identifying infrastructure gaps

and removing export barriers;
create a globally competitive operating environment by streamlining clinical

trial approval processes and developing a globally competitive taxation
framework;
strengthen Australias ability to commercialise research by investing in skills

and promoting linkages between industry, researchers and academia; and
raise the profile of the industry globally to increase attention paid by MNEs.
These are excellent high level strategies for growing the industry. However,
considering the global context and current drivers of investment, at best the current
major actions implemented will result in only marginal improvements to industry
investment in Australia. The Action Agenda has not introduced major changes to
the environment that influences R&D and manufacturing decisions that would be
competitive by world standards. Moreover, its initiatives have arguably not
impacting on R&D investment patterns above what would have been invested in the
absence of the scheme. While it has proposed some changes to improve the R&D
environment, these changes will likely only result in minor differences over the
longer term, at which point the international drivers of investment will likely have
again shifted.
4.3
Interventions that are required to generate step change

improvements in activity, outcomes
Australia requires several major interventions above and beyond those proposed by
the Action Agenda if it is serious about lifting its performance in the
pharmaceutical industry investment game.
Reform the PBS to send a strong, positive signal to headquarter offices and
increase attention paid to Australian market
A concern expressed by the subsidiaries and headquarter offices of MNEs operating

in Australia is that the pricing and listing environment for pharmaceuticals in
66
Australia (through the PBS) creates a negative impression of the Australian market
and makes it harder to secure investment from the MNE.
Figure 4.1
MARKET CLASSIFICATIONS ACCORDING TO SOURCES OF GLOBAL ATTENTION

Attention paid to
market due to strong
internal cues
Squeaky Wheels
Major markets
Internal success
stories, or markets
with highly vocal
managers
Markets that represent big

opportunities
Examples
Ireland, Singapore
Potenial impact
of reimbursement
policy reform
Little to no attention
paid to market due
to poor internal cues
Examples
US, Europe
Low Attention
Markets
Honeypots
LIttle or no visibility
Markets that represent

big opportunities but
little current activity
Examples
Australia, New
Zealand
Little to no attention
given to market on basis
of poor external cues
(global market factors)
Examples
India, China
Attention given to
market on basis of
strong external cues
(global market factors)
Source: The Allen Consulting Group adaptation of London Business Schools Sources of Global
Attention framework, see, Birkinshaw, J., and C. Bouquet, 2005, Getting the Attention You Need:
Strategies for the Australian Subsidiary, London Business School in association with CEO Forum.
Building on the London Business Schools framework for understanding market

types on the basis of attention cues in the global market, the combination of poor
internal signals and small market size currently render Australia a Low Attention
Market (Figure 4.1).
Reforming the PBS would have the effect of improving the attention paid Australia
by MNE headquarters, by placing Australia in the category of a Squeaky Wheel,
as opposed to a Low Attention Market for investment. Australia would still
represent a small market compared with the North American and Asian giants of
the world, but it would benefit from the relay of potent domestic signals that would
mitigate perceptions of hostility. This is in line with the Action Agendas goal of
raising the profile of the industry globally to increase attention paid by MNEs.
This reform would also support the National Medicines Policy goal of fostering a
vibrant medicines industry, and further could result in a greater coherence between
Australias health policies and industrial policies. Additionally, this action would
have the benefit of ensuring that Australians have timely access to necessary
medicines at an affordable cost to both individuals and the community.
The corollary of sending a positive signal, such as through reform of the PBS to
improve the treatment of patent-protected products, is that the Government should
also seek to mitigate the number of negative signals to head offices. In general, the
Government needs to avoid policy actions that create unpredictability in the
operating environment. Policies such as the 12.5 per cent price regulation
introduced in 2005 by the Government are examples of policies that create
unpredictability in the operating environment. These should be avoided by
67
engaging with industry prior to any major shift in policy. Other actions, such as the
Pharmaceutical Industry Action Agenda, which has created a forum for long term
partnership and dialogue between Government and industry, are clearly useful
strategies for reducing the impact of negative messaging and for laying the
foundation for future collaboration.
Close the innovation gap and encourage scale among researchers
The Action Agenda focuses heavily on commercialisation of Australian discoveries,

with emphasis on forming partnerships between players throughout the value chain.
However, with a fragmented research base and clear infrastructure gaps in
biomanufacturing and medicinal chemistry, the basic research breakthroughs of
Australian scientists face a number of obstacles frustrating their path to be taken up
by pharmaceutical firms. This is especially true given that these firms now require
drugs to be developed generally to the compound phase, ready for Phase I trials.
The Action Agenda currently has a taskforce charged with bringing a mammalian
cell biopharmaceutical plant into Australia; this requires government intervention
due to the lumpiness of demand and the size of Australian players. The R&D
Taskforce has also been drawing up strategies for developing improved IP
outcomes beyond the skills of individual scientists. The Government should support
all efforts to bring this into the market if it is serious about developing Australia as
a key alliancing-opportunity region. This will ensure that the benefits the nation
may realise from its public sector investments in medical research are also
maximised.
In addition to these actions, to close the innovation gap Government needs to:
provide support for additional medicinal chemistry infrastructure and skills

development;
review current grant structures in light of adverse behaviours around patent

uptake and renewal; and
examine alternatives for funding proof-of-concept and other preclinical

research in light of low private venture capital involvement in Australia.
The need, for example, to provide for funding for proof-of-concept pre-clinical
research in medicinal chemistry is also particularly important when one considers
100
that small molecules are the leading type of drug under development currently.
Despite this, there is a perceived risk among researchers that this will be ignored
because it is boring research. This is in contrast to biopharmaceuticals, which
were characterised as enjoying relatively greater bandwidth because this science is
perceived to be cutting edge.
In addition to funding infrastructure gaps, there is also a need for States to be
vigilant in terms of identifying opportunities for feasible research consolidation, as
with NeuroSciences Victoria. Encouraging projects of this nature will release
operational synergies, through the use of commercialisation offices within these
scaled organisations. Continued fragmentation in the research base will destroy
value in the Australian research environment.
100
Aoris Nova, Advance Consulting and Evaluation and BioAccent, 2003, Australias Preclinical and Scale-up
Manufacturing Capabilities A Comparative Analysis, prepared for the Department of Industry, Tourism and
Resources, Canberra.
68
The payoff to Australia would be the realisation of greater royalties (Table 4.1) for
its research community, as well as second round effects of increased interest due to
an improving productivity record and relationship building. It would also reduce the
high failure rates observed for Australian start-up firms, spurring stronger growth
among its small, young biotech and biopharmaceutical sector.
Table 4.1
RISK AND RETURN PROFILE FOR DRUG DEVELOPMENT

Product status
Net royalty (%)
Discovery
nil
Preclinical
4%
Phase I
10%
Phase II
15%
Phase III
25%
Source: UBS Warburg, 2001, CMR Company Reports, quoted in Department of Industry, Tourism and
Resources, 2001, Action Agenda Local Priority Global Partner, Pharmaceutical Industry Action
Agenda, Canberra, p 33.
Address all current threats to clinical trial R&D growth
The potential threat to clinical trials growth represents a potential blind spot in the
original Action Agendas plan. This is reflective perhaps of the rapid changes
happening in industry. Many experts believed Australias position within the
clinical trials market was relatively secure only a few years ago, however, with
Indias recent introduction of IP legislation in 2005 and other recent regional
changes, Australias position is increasingly under threat. Threats identified in
Chapter 3 included:
added regulatory requirements recommended in the Bansemer Report that may

delay trial completion times, such as those that may arise due to separations of
scientific and ethical evaluations;
lower cost competitors in trials and services, including Phase II and III trials
(where the majority of growth has been since the introduction of CTN trials)
and bio-informatics services; and
reimbursement policies.
These are material threats to the Action Agendas goals that were perhaps not all
well understood at the time of the Agendas creation.
The Action Agenda has rightly recognised that inefficiencies in ethics committee
processes will increasingly reduce Australias current competitive advantage in
clinical trials. In addition to streamlining the approvals process, it will also need to
ensure that additional regulatory hurdles are not introduced, such as a requirement
for greater use of the CTX scheme or the requirement for pharmaceutical
companies to gain scientific approval for trials by the TGA instead of within the
ethics committees. According to industry, this will likely dramatically reduce the
number of trials conducted in Australia. There are current efforts underway to
address current inefficiencies as well as potential future hurdles. These actions need
to be supported:
69
there should not be any separation of scientific and ethics assessments; and
mutual recognition of an accredited, lead HREC should become the model for
regulation of unapproved therapeutic goods in Australia.
This should result in lower average times to approval, without reducing the safety
or ethicality of trials. Moreover, it should result in a more consistent trials process.
In addition to the above efficiency improvements, however, several other actions
must be taken in order to increase Australias share of the global clinical trials
market ten-fold by 2012. The Government will need to address delays created by
the current ethics committee processes. It will also need to address the disparity
between labour costs in Australia compared to other regional competitors such as
India and China. This may be accomplished through the successor program to the
P3 scheme, and should be a major consideration to the development of the design of
this industry program.
Without these changes, it is likely that clinical trials activity will come under severe
competition in the future. This will result in a dramatic reduction of the R&D
intensity of Australias pharmaceutical industry, as clinical trials activity accounts
for the majority (43 per cent) of all R&D investment in Australia. The removal of
these threats is required to keep the industry on its path to Australias share of the
global industry by 2012.
Develop competitive incentives for R&D and manufacturing investments
Existing support programs do not drive the type of investment in R&D,

manufacturing, services and partnerships that will be required to meet the Action
Agendas goal of doubling Australias share of the global industry by 2012.
Australias industry programs are too small to alter the calculus of the
manufacturing decision and arguably have not resulted in additional R&D
investment above what would have occurred in the schemes absence.
Considering that the cost of actives and secondary manufacturing plants

reaches into the hundreds of millions, the $10 million cap on the P3 takes
101
Australia out of the running immediately. Australias corporate taxation rate
(30 per cent) is uncompetitive relative to its main competitors for
manufacturing, which have corporate tax rates of 22 per cent and lower.
Several countries also offer zero per cent tax environments in the order of 10
years as well on top of low ongoing tax rates.
With regard to R&D, the incremental funding nature of the P3 program

sometimes appears at odds with the lumpiness and long development periods
of R&D investments, and moreover, because companies must submit to the
grant board their investment plans, it is argued that the investment is likely to
have happened anyhow. This is unfortunate given that industry provided
significant input into its development.
A set of incentive programs need to be created that is competitive in terms of

attracting R&D and manufacturing capital in light of global competition and the
lessons learned from existing programs.
101
Clearly the P3 was aimed at attracting R&D investments, nevertheless it remains the effectively the only major
incentive scheme available to the industry at the time of this report.
70
To consider what a coordinated R&D incentive program of sufficient scale might

achieve, it is useful to consider the Canadian experience. Canada provides a good
understanding of how an economy might improve its position in the global
marketplace:
The MNE subsidiaries in Canada offer similar range of asset portfolios that
is to say, it is not a purely marketing/sales region but also has some
manufacturing and a growing base of local firm-MNE R&D alliances.
Canada presents a comparable pre-tax cost structure. A recent KPMG cost

benchmarking study found that Australia and Canada were broad-based
leaders, enjoying second and first place, respectively, in terms of overall costs
of doing business. Australia trailed just behind Canada in the pharmaceutical
manufacturing, biotechnology R&D, and clinical trial R&D industries.
Canada also has a Federal system of government, with States and Territories
providing their own incentives on top of and often in conjunction with Federal
schemes.
Canada has a population of roughly 32 million spread over a large geographic

area, and sales out of Canada represent only 1.8 per cent of the world market.
It has a relatively high average corporate taxation rate of 36 per cent.
Canada has recognised, like Australia, the need for a coordinated, long term
strategy for attracting high value-add, R&D intensive industries to its
economic base. It has pursued a multi-tiered approach of tax incentives, grant
schemes and local institution aid.
Key differences between Australia and Canada are its proximity to the US market,
and the nature of incentives provided to the MNEs. However, the rise of Asia
Pacific powers such as Singapore and Taiwan broadly indicate that distance from
the US and European markets are not insurmountable obstacles. Thus it becomes
clear that the key difference is really its ability to offer incentives.
With regard to attracting R&D investments, the Canadian Government offers
102
uncapped SR&ED tax credits of 20 per cent to large companies on all R&D
103
expenditure and 35 per cent to Canadian Controlled Private Corporations
(CCPCs). CCPCs are also offered the credits irrespective of the firms profit or loss
position in the year, and this may be carried forward for 10 years; Canada has
104
sought to extend this access to other firms. This compares favourably to
Australias capped program, which only provides incentives on incremental R&D.
Furthermore, there are other attractive schemes provided. Provinces within Canada
also offer other tax credits, such as for example the Quebec R&D tax credit, which
is also refundable in full for all participants regardless of a loss position. There are
also price response mechanisms in some provinces where investment over a
102
103
104
Large companies are defined as firms having capital assets in excess of $15 million or $500,000 in taxable
income. Thus MNE pharmaceuticals are classified as large companies.
Canada is not alone in this approach. Several other countries provide R&D tax concessions to all investing
companies (that is, not restricted to firms where the IP is held within that country) on all R&D expenditure, not
on an incremental amount above some base level. For example, the UK provides a flat 7.5 per cent rebate on
R&D expenditure. However, it should also be noted this is a highly complicated program to administer.
See Warda. J, 2003, Extending Access to SR&ED Tax Credits An International Comparative Analysis,
Information Technology Association of Canada, December.
71
threshold unlocks price freezes on products. Moreover, there are other flexible co105
investment options also on offer to secure other large scale investments.
These R&D strategies have met with success. Canada accounted for 10 per cent of
all new global medicines discovered in 2001 despite its small population and sales
figures, and reported an R&D intensity equivalent to the global average of 17.7 per
cent.
There is clearly a need for Australia to consider whether the suite of its incentive
programs is optimising the amount of investment it might potentially attract. Some
options for future government incentive and support programs for the
pharmaceutical industry that should be considered at the conclusion of P3 could be:
the re-introduction of a scheme that targets manufacturing (capital) investment,

which would be in addition to any incentives aimed at encouraging R&D and
would need to be competitive with nations offering substantially lower levels
of corporate tax;
R&D royalty exemptions from corporate and income taxation;
an R&D tax concession without the beneficial ownership rule;
an R&D tax concession with the beneficial ownership rule not applicable to
106
pharmaceutical R&D (the ring fenced model from the PIIP review);
an incentive program with a longer duration (on the order of 10 years as

available in other jurisdictions) and a larger scale than P3 that combines the
most effective elements of Factor (f), the PIIP and P3; or
a new incentive program specifically created for the pharmaceutical industry

that rewards all pharmaceutical R&D on the basis of tailored criteria rather
than rewarding specific R&D over a base level.
The critical requirement for this to happen is for the Government to change its
perception of the revenue impact of incentives. Currently, any foregone taxation
revenue is seen as a cost to Government. However importantly, without the
incentive the additional investment will not occur at all. The Government must
consider whether the forgone revenue that would have been generated through the
immediate activity being subsidised, as well as from the other activity generated in
other industries, would be smaller than this perceived cost.
4.4
Mapping the socio-economic payoffs of decisive action
The payoffs from the above interventions will provide step change improvements in
investment outcomes for Australia, which will result in long run, multiplying
benefits throughout the economy. To understand the opportunity costs of not
pursuing decisive action, this section maps the payoffs for each intervention
identified above.
105
106
See Government of Canada, 2004, Achieving Excellence: Investing in People, Knowledge and Opportunity;
Government of Canada, 2002, The Canadian Pharmaceutical Industry: 2002 Innovation Profile; Warda. J,
2003, Extending Access to SR&ED Tax Credits An International Comparative Analysis, Information
Technology Association of Canada, December.
The Productivity Commission, 2003, Evaluation of the Pharmaceutical Industry Investment Program:
Research Report, Commonwealth of Australia, p. 7.6.
72
Payoffs from closing the innovation gap and improved commercialisation
The potential payoff from increased funding for local researchers to develop their
innovations to compound status would be largely captured by the researchers
themselves. Improvements in funding supplies and commercialisation abilities
would see researchers able to move from the prospect of either watching the project
fall over due to insufficient funding, or owning none of the IP rights if the
107
innovation is commercialised by a different group, to the prospect of being able to
realise a substantial profit from their research of, on average, 10 per cent royalties.
The prospects for success, and potential total payouts for the sector, increase with
the number of additional partnerships that can be formed (Table 4.2).
Table 4.2
FUNDING INNOVATION GAP AND COMMERCIALISATION INITIATIVES PAYOFFS

Number of
new Phase I
alliances
Probability
of 1
success
Probability
of 2
successes
Probability
of 3
successes
Royalties for
(Phase I)
success
No new
alliances
0%
0%
0%
nil
1 new alliance
formed
15%
0%
0%
10% of successful
project value
2 new alliances
formed
27.8%
2.3%
0%
10% of successful
project(s) value
3 new alliances
formed
40.2%
6.3%
0.3%
10% of successful
project(s) value
Source: The Allen Consulting Group. Based on risk return profile assumed for Phase I project status (15
per cent probability of success, royalties of 10 per cent) as reported in Department of Industry, Tourism
and Resources, 2001, Action Agenda Local Priority Global Partner, Pharmaceutical Industry Action
Agenda, Canberra, p 33.
This issue has been recognised by some research organisations. For example, The
Walter and Eliza Hall Institute, recognising the need for additional development in
order for its products to be attractive to external organisations like Big Pharma,
created the Biotechnology Centre at La Trobe Universitys R&D Park aimed at
developing drug targets into compounds. The Centre provides facilities for high
throughput chemical screening, medicinal chemistry, gene mapping and
genotyping, monoclonal antibody production and mouse genetics. The high
throughput chemical screening facility was established with the assistance of a
Bio21 STI grant from the Victorian Government and is the only facility of its type
in Australia. This initiative has proved successful in attracting investment, with The
Walter and Eliza Hall Institute forming alliances with AMRAD, Merck, GSK and
Pfizer as a result.
More broadly, the potential increase in the number of alliances would have wide
ranging flow-on benefits for the sector and Australia more widely. Figure 4.2 shows
some of these potential downstream effects.
107
See Box 3.2s discussion of Rochester University v. Pfizer, where it was ruled that the university was not
entitled to payments because the value was determined to lay in the compound, not the target.
73
Figure 4.2
SUCCESSIVE ROUND PAYOFFS (AND PAYOFF RELATIONSHIPS) OF CLOSING THE INNOVATION GAP
First round impacts would include improved productivity, increases in highly

skilled, highly-paid employment, rises in exports, and measurable improvements in
the return on public sector investments.
Second and third round effects would include an increase in consumer welfare
(consumption) due to higher wages being delivered to households, reputation
effects that might herald additional projects and support additional expansion of
biotech and medical research sectors. To the extent that a unique capability is
developed in Australia (similar say, to GSKs asthma research centre), niche
research and manufacturing may result as well. In turn, this could result in
additional investments independent of incentives.
Payoffs from addressing threats to clinical trial competitive advantages
The payoffs from removing all threats to clinical trial growth will likely be the
realisation of the Action Agendas goal to double Australias share of the global
industry by 2012 (Figure 4.3). Without the removal of these threats, it is likely that
the goal will not be realised.
74
Figure 4.3
POTENTIAL LEVELS OF ACTIVITY IN CLINICAL TRIALS
In addition to meeting the Action Agendas goal, the benefits of an increase in

clinical trials would also include those identified in the above section on payoffs
from PBS reform. Key amongst these are:
rising employment and higher household income;
skills transfer and improved productivity in biomedical research;
improved performance of public sector investments;
lower rates of firm failure;
earlier access by patients to innovative therapies and speedier product

launches;
increases in export levels; improvements in consumer welfare; and growth in

Australias GDP.
Payoffs from developing competitive incentives
Were Australia to introduce incentive schemes more on par with world standards in
terms of its overall scale and scheme structure, such as with those programs
available in Canada, the payoffs to Australia could be substantial. Depending on the
number and type of programs introduced, these could result in the realisation of a
major manufacturing plant in the next five to ten years, significant additional R&D
investment, and the retainment of the current manufacturing base. On top of these
industry benefits, this would also result in a number of flow on benefits to the
community in the form of increased exports, a growing pool of scientific and
commercial skills, rising employment levels, productivity increases, and an
improved return on public sector investments in medical research.
75
Using the Canadian example as a potential base case for what might be achievable
in Australia, and discounting its achievements by roughly 50 per cent to account for
second-mover disadvantages and distance impacts, it is possible to map a scenario
of the potential benefits going forward. With this assumed as a base case, Australia
could potentially see:
approximately one major plant being added every five years,
continued re-investment in the existing manufacturing base; and
a doubling of discovery and clinical trials R&D expenditure to roughly nine

per cent of turnover, comprised of an approximate increase in discovery
research to two per cent of turnover and an increase in clinical trials research to
seven per cent of turnover.
Figure 4.4 maps these downstream benefits of the increased investment, which are
discussed further below.
Figure 4.4
SUCCESSIVE ROUND IMPACTS, PAYOFFS OF COMPETITIVE INCENTIVES
76
In the above benefit scenario it was assumed that if a competitive R&D taxation
incentive program were introduced, Australia could see an improvement in the
overall re-investment of turnover in R&D activities of perhaps nine per cent. This
order of improvement was calculated based on evidence that in Canada
approximately 80 per cent of all R&D spend is in clinical trials, and 20 per cent in
discovery R&D, resulting approximately 14.5 per cent of all turnover being
reinvested in clinical trials R&D and 3.5 per cent being reinvested in discovery
R&D. Data from 1993-94 indicates that clinical trials R&D accounted for 43 per
cent of all R&D spending and discovery R&D accounted for roughly 34 per cent of
all spending Australia. Assuming that this relationship has held constant to 2005,
2.15 per cent of all turnover would be re-invested in clinical trial R&D, and 1.7 per
cent of all turnover would be re-invested in discovery R&D. Currently, this implies
that of the five per cent of turnover ($520 million) roughly re-invested in R&D,
approximately $229 million is allocated towards clinical trial R&D and $177
million towards discovery R&D.
If Australia were to introduce competitive incentives for R&D (which should be
different to the incentive offered to increase capital outlays, similar to the coordinated approach adopted by Canada), it may reasonably boost its spending on
clinical trials to 7 per cent of turnover, and its discovery R&D spend to 3 per cent of
turnover over a five year period. Assuming current Asia Pacific rates of growth in
108
turnover continue to 2012, and Australian firms are able to match growth in the
region, then turnover would be expected to rise to $23 billion in 2012. If Australia
were able to induce higher rates of clinical trial and discovery R&D investment
through more competitive incentives, this would result in an additional $299
million on discovery R&D ($690 million in expenditure on discovery R&D in
total), and an additional $1.1 billion on clinical trials ($1.6 billion in expenditure on
discovery R&D in total) in 2012 above what might be expected in the absence of a
competitive incentive.
There would also be additional flow on effects, in terms of skills transfer, improved
productivity and increased employment. Although skills and productivity
improvements are hard to measure, there could be an expected commensurate
increase in the number of jobs. Currently 36,000 persons are employed in the
industry; the additional increase in investment would represent a near doubling of
total R&D investment, which assuming current ratios of employees to R&D
spending, would imply an increase of employment of an additional 26,280
109
persons.
From the manufacturing perspective, if a competitive program targeting
manufacturing in addition to an R&D-focused program were introduced, the size of
the impact would depend on the number of projects won. However, as shown in the
above Figure 4.4, there would be many first and second round effects flowing from
additional manufacturing investments. For example, major first round impacts
would be step increases in exports and GDP levels. Because the number of
investments will depend on the nature of the capital outlay incentive program, it
108
109
From 2002 to 2003, turnover in the Asia Pacific region, including Australia, increased by 12 per cent. Forecast
data was unavailable. An alternative forecast based on regression analysis may indicate a different pattern of
growth. See IBISWorld, 2005, Medicinal and Pharmaceutical Product Manufacturing in Australia,
IBISWorld.
Note that to estimate the precise impacts a more complex model would need to be developed, or CGE analysis
could be performed. The aim of this discussion is to show that there is a positive relationship between
increases in investment (shock) and employment levels, and that the result could potentially be significant.
77
was necessary to consider a range of possibilities. Table 4.3 shows a range of step
change increases in exports as a result of manufacturing investments from between
110
$100 million to $400 million. This improvement in export performance would
flow to increases in GDP and government revenue, as well as to increased attention
by MNEs.
Table 4.3
DOWNSTREAM BENEFITS FROM INCREASES IN PHARMACEUTICAL

MANUFACTURING
Increase in manufacturing value-added
Increase in pharmaceutical exports
$100 million
$39 million
$200 million
$78 million
$300 million
$117 million
$400 million
$156 million
Source: The Allen Consulting Group, regression analysis calculated using data from IBISWorld, 2005,
Medicinal and Pharmaceutical Product Manufacturing in Australia, IBISWorld.
Thus competitive incentives represent a net-benefit improvement for Australia, in

the form of higher levels of highly skilled employment, exports, productivity, interindustry productivity spillovers, and consumer welfare.
Payoffs from PBS reforms and increased attention of the Australian market
While a stand-alone case exists for reform to PBS arrangements, a spillover benefit
of such reform would be the improvement of prospects for development of the
pharmaceutical industry in Australia. PBS reforms could improve international
perceptions of the attractiveness of the Australian market and could also improve
the prospects for investment being made into industry activity in Australia. While
not in and of itself a panacea, enhancing perceptions of the market would certainly
remove a current obstacle to industry growth in Australia.
This is supported by the Quebec experience, where the benefits to the economy
resulting from increased investment were shown to be substantial, and to outweigh
the potential savings that might be realised through a 1.4 per cent price cut in
111
pharmaceuticals prices.
110
111
The potential responses in exports were estimated by regressing past changes in manufacturing employment
and exports against changes in manufacturing investment levels for the years 1999 and 2004.
Clearly there are a number of other determinants likely to impact on export performance. The above analysis
has been used to show a rough, positive relationship between manufacturing investment and export
performance. To run a robust regression analysis would require a substantial amount of data to be marshalled,
much of which is not publicly available. The regression analysis would need to investigate for bias in the errors
and potential other determinants of export performance. Where multiple determinants of export performance
were identified, the analysis would need to test for causality, interdependence, multi-collinearity and
heteroskedasticity, among other issues, to ensure the rigor of the final data.
78
Figure 4.5
SUCCESSIVE ROUND IMPACTS, PAYOFFS OF SENDING A POSITIVE SIGNAL TO HEADQUARTER OFFICES
The recursive benefits of PBS reform would include (Figure 4.5):
increases in discovery R&D investments;
improvements in the attractiveness of Australia as an environment for

additional clinical trial R&D;
speedier product launches and greater access of drugs delivered to public as the
medical field will be across breakthrough treatments due to their interaction
with MNEs on clinical trials;
improved productivity in biomedical research;
improved performance of public sector investments in medical research;
increases in export levels, which would beneficially reduce current account

deficits;
an increasing number of high wage, highly skilled jobs in Australia;
improvements in consumer welfare, measured by increases in household

consumption levels due to the flow through of higher wages;
79
skills transfer and productivity spillovers into other industries; and
lower rates of firm failures.
These outcomes would represent long term, reinforcing benefits to Australia.

Although it is not possible to know the precise magnitude of the benefits that might
flow from such a reform, given current trends in global pricing regimes, a firstmover reform that attempted to reconcile the growth in generics with innovative
therapies would attract significant attention and should lead to increased focus by
industry on the potential for investment in Australia.
4.5
Conclusions and recommendations
Current policy settings and implemented actions under the Action Agenda will not
be sufficient to deliver step-change improvements in pharmaceutical industry
investment levels in Australia. The Action Agenda has set out a commendable
vision for the industry, however, without some additional changes to the current
operating environment, levels of investment will improve only marginally.
The four proposed interventions are not the only improvements that could be made
to improve industry activity levels in Australia. However, on balance, these
represent the highest return interventions available, and would result in significant
net benefit outcomes for Australia. It is difficult to quantify some of these benefits,
however, rough calculations using historical relationships show that the effects of
increased investment on employment, wages, household income, consumption,
exports, GDP and other socio-economic variables are positive and in some cases
significant. It is clear that industry and Government have the opportunity to
increase investment and the benefits flowing from that investment; they must now,
under the auspices of the Action Agenda, seize this opportunity.
80
Appendix A
Incentive programs in Australia

A.1
Past incentive programs
PIDP and the Factor (f) program
In 1987 the Commonwealth Government adopted the Pharmaceutical Industry

Development Program (PIDP) to encourage continued growth in Australias
pharmaceutical industry. Essentially, the program was designed to counter
perceptions of Australia as hostile to industry activity and to insulate Australia
from a global rationalisation of pharmaceutical industry investments. According to
the joint press release of Minister Button and Minister Blewett in 1987, the
objective of PIDP was to create an environment which would encourage a
significant increase in R&D performance by industry, together with increased
investment, production and export performance, and strengthened employment
112
opportunities.
According to the Industry Commission one of the main factors contributing to the
perception of Australia as a hostile environment for pharmaceutical industry
113
investment were the low pharmaceutical prices under Australias PBS.
Recognising this, the government of the day developed the Factor (f) program as
part of the PIDP. This program aimed to stimulate industry activity and counter
negative perceptions of the Australian investment environment by granting price
concessions to pharmaceutical companies investing in Australia.
Under the PIDP and Factor (f), the pricing structure for the pharmaceuticals
industry was to be rearranged. The Pharmaceutical Benefits Pricing Bureau was
replaced with the independent Pharmaceutical Benefits Pricing Authority (PBPA)
that would set the prices of drugs. Pricing decisions would take into account
considerations concerning product efficacy, safety and price and then an industry
development section of the PBPA would review issues relating to Factor (f).
Several fundamental principles were developed that companies would have to meet
to secure Factor (f) price concessions. Higher prices could be recommended if:
the PBS prices represented an impediment to industry activity;
they contributed to internationally competitive industry activity in Australia;

and
that industry activity resulted in a net benefit to the Australian economy.
114
Phase I of the Factor (f) program commenced in 1988 and ran until 1995. The
115
government set aside $198 million to this phase of the program. A second phase
commenced in 1992 and ran until 1999 that committed a further $820 million to the
112
113
114
115
Button, J. and Blewett, N., 1987, Joint Media Statement: Policies For The Development OF The
Pharmaceutical Industry, Ministerial Press Release Number 115/87, 13 September.
The Industry Commission, 1996, The Pharmaceutical Industry: Industry Commission Inquiry Report, The
Commonwealth of Australia, p. 96.
Commonwealth of Australia.
81
Factor (f) scheme. A total of $948 million was spent on both phases of the Factor
116
(f) program. There were a total of ten participants in Phase I and eleven in Phase
II. In return for the Governments investmentthe industry underwrote a total of
117
$5,900.4 million in production value-added and R&D expenditure. Factor (f) was
the largest item of specific sector outlays to the manufacturing industry of its time,
118
representing 87 per cent of all such expenditures.
In reviewing the program, the Industry Commission among others, suggested that
the program had produced significant benefits through increasing pharmaceutical
industry activity over and above what otherwise would have occurred. Several
companies reported that the program was a direct contributor to their decision to
invest in Australia and that it improved the perception of Australia as an
environment for industry activity. Notably, some companies who unsuccessfully
applied for Factor (f) funding, such as Eli Lilly, reported that the scheme improved
perceptions of Australia as a favourable environment for investment to the extent
119
that their investment in manufacturing and R&D increased as a result. It was
suggested that the Factor (f) program may have induced more activity than would
120
have occurred in the absence of price suppression.
The major criticism of Factor (f) was the strict eligibility criteria applied to
participants. To be eligible for the scheme, companies had to increase their local
activity in both R&D and manufacturing. This excluded some key companies from
participation who could have made some key investments in the local industry.
Another criticism of the Factor (f) was its relatively short duration that is not
reflective of the considerable time necessary to bring a product through discovery,
development and manufacture. The high-risk nature of the industry requires greater
certainty of funding for a longer period than other research-intensive industries with
shorter development and production times, such as the computer software industry.
A final criticism related to the fact that Factor (f) only benefited a small number of
companies when it was intended to compensate the entire industry for the reduced
121
activity caused by price suppression.
The Pharmaceutical Industry Investment Program
Following the success of the Factor (f) program and in recognition of continued
pharmaceutical price suppression in Australia, the Commonwealth Government
introduced the Pharmaceutical Industry Investment Program (PIIP). Again the
primary objective of the program was to contain the adverse effects of price
suppression on pharmaceutical industry activity.
116
117
118
119
120
121
Department of Industry, Tourism and Resources, 2002, Pharmaceutical Industry Action Agenda Local Priority
Global Partner, p. 24.
Department of Industry Tourism and Resources, 2001, Pharmaceuticals Industry Action Agenda: Local
Priority Global Partner, Commonwealth of Australia, Commonwealth of Australia.
Global Partner, p. 26
82
This scheme committed $300 million over five years to increase pharmaceutical
122
industry investment. The scheme was of a considerably smaller scale than the
Factor (f) and this can be partially attributed to the continuing benefits of
investment associated with Factor (f) program. The PIIP had nine participants who
collectively committed to $1.5 billion in production value-added and R&D and
123
created 1,000 jobs over the life of the program.
Participants that committed to increasing investment or activity in value-added
manufacturing and/or R&D would be awarded with price increases on nominated
124
pharmaceuticals that they supplied through the PBS. The guiding principle of the
PIIP was to increase both R&D and value-added manufacturing in areas of
international competitiveness and strategic importance. Applicants had to establish
the way in which their commitments were in line with these guiding principles.
The Productivity Commission, in their review of the PIIP, concluded that the
benefits of the PIIP did indeed outweigh the costs and that there was a strong case
for government intervention to stimulate pharmaceutical industry investment.
Investments in both manufacturing and R&D occurred over and above a base case
where no incentives were provided. Similar criticisms were levelled at the PIIP as
were levelled at Factor (f). The short duration of the program and the small number
125
of participants were again a cause for concern. The Productivity Commission in
its review of the PIIP questioned whether the Factor (f) and PIIP programs were the
best vehicles for industry subsidy and suggested that increasing the availability of
other programs, in particular the R&D tax concession, should be an option for
future industry subsidisation.
A.2
Current incentives
Pharmaceuticals Partnerships Program (P3)
The PIIP concluded on 30 June 2004 and was immediately replaced with the
Pharmaceutical Partnerships Program or P3. The government acknowledged that
large pharmaceutical companies could not access other government support
programs, such as the R&D tax concession, and P3 is intended to remedy this
problem.
P3 is a five-year program that is designed to increase pharmaceutical industry
R&D. The government has committed $150 million over five years to the scheme.
A new round of funding commences each year under P3 and companies are able to
decide the length of time that they participate in the program. Eleven companies
participated in the first round of funding and seven in the second. The Government
made an announcement in August 2006 in relation to the third funding round which
covers the period 20062009. The announcement allows larger companies to apply
for support for their R&D activities. Participants in the P3 program have to be
involved in the pharmaceutical industry but do not have to be suppliers of
122
123
124
125
Department of Industry Tourism and Resources, 2001, Pharmaceuticals Industry Action Agenda: Local
Priority Global Partner, Commonwealth of Australia, Commonwealth of Australia.
The Productivity Commission, 2003, Evaluation of the Pharmaceutical Industry Investment Program: Research
Report, Commonwealth of Australia.
83
pharmaceuticals. The P3 program is open to any company involved in

pharmaceutical R&D.
Unlike the previous Factor (f) and PIIP programs, the P3 program does not
compensate through price rises but as a direct taxable grant. Participants receive 30
cents for each dollar they spend on the agreed portfolio of R&D activities in
126
Australia over a base level. Grants are capped at $10 million for each applicant. It
is notable that P3 specifically targets R&D rather than manufacturing. This is unlike
the previous incentive programs that targeted all aspects of industry activity. A
further key aspect of P3 that should be noted is its emphasis on partnerships and
linkages with domestic activity. One of the selection criteria for P3 funding is the
level of partnerships and linkages that will occur as a result of the R&D
expenditure.
The P3 program has come under some criticism from pharmaceutical companies,
some of whom are participants in the P3 program. The scale of the program is
perhaps chief among these. Individual firms can access a maximum of $10 million
and the total value of the P3 fund is $150 million. It is argued that $10 million is an
insufficient incentive for a multinational pharmaceutical company to significantly
increase their R&D activities. Some pharmaceutical companies have suggested that
the small scale of the program resulted in participation being more of a strategic
exercise than a genuine commitment to increase R&D. Furthermore, the program is,
like its predecessors, of insufficient duration to be reflective of pharmaceutical
R&D timelines. It has also been suggested that the P3 program merely subsidises
activity that would have occurred anyway rather than stimulating additional
activity.
A further aspect of the P3 program that should be considered is its availability to
small to medium biotechnology firms. Several of the participants in the program are
biotechnology firms without an established record of successful R&D activities.
Representatives from the pharmaceutical industry have suggested that even with
government support these companies will find it difficult to commercialise or
further develop their activities due to insufficient reputation and scale.
Other incentive programs
The Commonwealth government has a number of other incentive programs to

encourage R&D in Australia and many of these are designed to promote activity in
biomedical sciences and biotechnology. Many of the programs stem from the 2001
policy of the Commonwealth government known as Backing Australias Ability.
This policy intended to develop Australias science and innovation base with the
help of significant Commonwealth funds. Other funds include the long standing
R&D tax concession and grants from the National Health and Medical Research
Council.
One of the most significant Commonwealth programs to stimulate R&D activity is
the R&D tax concession that provides a tax credit to firms with expenditure on
R&D. Companies can deduct 125 per cent of expenditure on eligible R&D activity
127
when lodging their income tax returns. It is not an industry specific program and
126
127
AusIndustry, Fact Sheet: Pharmaceutical Partnership Program, Commonwealth of Australia, accessed at

www.ausindustry.gov.au.
AusIndustry and the Australian Taxation Office, 2005, Guide to the R&D Tax Concession: An Overview,
84
is available on all eligible R&D expenditure conducted by companies incorporated

in Australia. Under the rules of the R&D tax concession, any intellectual property
that is created as a result of the subsidised R&D essentially must be owned in
Australia. This is known as the beneficial ownership rule. Australian owned
pharmaceutical companies such as CSL are able to access this concession, and it
provides significant support for their R&D. However, foreign owned multinational
pharmaceutical companies would prefer to register the IP outside of Australia and
do not participate in the program. One of the objectives of the P3 program was to
offset this problem.
These alternative incentive programs to P3 are generally geared towards small to
medium biotechnology companies, public sector research organisations and
Australian-owned pharmaceutical companies. There is no doubt that they have
contributed to Australias biopharmaceutical research infrastructure and
capabilities. However, they do not support the participation of foreign owned
multinational pharmaceutical companies. This is criticised, as it does not allow the
major research-intensive pharmaceutical companies to access government support
over and above the P3 program or participate in programs designed to further the
commercialisation of Australian research.
A.3
Future incentives?
Two key issues that impact on the effectiveness of incentive programs are scale and
duration.
Scale The current Australian P3 program, which narrowly targets

incremental R&D, is of insufficient scale to compete with alternative incentive
programs available to the pharmaceutical industry overseas. The program
arguably spreads to little capital over too many parties, and therefore does not
generate the kind of critical mass that could be expected to drive recursive
industry investment beyond the level encouraged by the scheme. It also does
not target the full value chain, and therefore investment levels in
manufacturing are reducing as plant and equipment age.
Duration The five-year duration of the program is not reflective of the long
pharmaceutical development timeline. If an incentive program were to attract
substantial pharmaceutical investment over and above what would occur in a
business as usual scenario then these two crucial issues with current programs
would need to be addressed.
Another primary concern is the current design of P3 program and the way that R&D
is rewarded. The current P3 program provides a reimbursement for pharmaceutical
R&D over a base level. An alternative that has been suggested by some in the
pharmaceutical industry and the Productivity Commission in its review of PIIP is an
incentive program that is not incremental in its design, but rather based on specific
criteria. Tax breaks or Government co-contribution on every dollar of eligible
pharmaceutical R&D expenditure may be one alternative, such as that on offer in
Canada or Ireland. This could result in a program similar to the current 125 per cent
R&D tax concession but perhaps more closely tailored to the pharmaceutical
industrys specific needs.
85
Maximising investment in Australia
Considering the question of how to maximise industry investment in Australia (that

is, what is optimal), options for future government incentive and support
programs for the pharmaceutical industry that should be considered at the
conclusion of P3 would need to include:
the re-introduction of a scheme that targets manufacturing (capital) investment,

which would be in addition to any incentives aimed at encouraging R&D;
and some improved incentive program for R&D, which might take the form of:
an R&D tax concession without the beneficial ownership rule;
an R&D tax concession with the beneficial ownership rule not applicable to
128
pharmaceutical R&D (the ring fenced model from the PIIP review) ;
an incentive program with a longer duration (on the order of 10 years as

available in other jurisdictions);
an incentive program of a larger scale than P3 that combines the most effective
elements of Factor (f), the PIIP and P3; and/or
a new incentive program specifically for the pharmaceutical industry that

rewards all pharmaceutical R&D on the basis of tailored criteria rather than
rewarding specific R&D over a base level.
128
The Productivity Commission, 2003, Evaluation of the Pharmaceutical Industry Investment Program:
Research Report, Commonwealth of Australia, p. 7.6.
86
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Drivers of Pharmaceutical Industry

The Allen Consulting Group Pty Ltd

The Allen Consulting Group

Important changes in the global industry

Things that need to be done to improve the chance of attracting

The Australian situation

Key challenges for Australia

Possible actions for Australia

The payoff to Australia

The pharmaceutical industry: key features and trends

1.1 Profile of the global pharmaceutical industry

1.2 Profile of the Australian pharmaceutical industry

1.3 The wider benefits of the pharmaceutical industry to Australia

Drivers of investment across the value chain

2.1 Investment decisions general considerations

2.2 Investment decisions pharmaceutical industry specifics

2.3 Discovery R&D investment: trends and drivers

2.4 Clinical trial R&D investment: trends and drivers

2.5 Manufacturing investment: trends and drivers

Australias competitive position

3.1 Key features of the Australian investment climate

3.2 Overall perception of Australian investment

3.3 Assessment of the competitiveness of the Australian environment

The Allen Consulting Group

The outlook for the Australian pharmaceutical industry

4.1 Maintenance of the status quo: industry erosion

4.3 Interventions that are required to generate step change

4.4 Mapping the socio-economic payoffs of decisive action

4.5 Conclusions and recommendations

Incentive programs in Australia

A.1 Past incentive programs

A.2 Current incentives

A.3 Future incentives?

The Allen Consulting Group