Big pharma incentive model flawed, according to new research from Hay Group

Long and short-term incentives pay out based on financial success instead of product innovation - small and mid-caps set the new standard

PHILADELPHIA – March 18, 2011 – Big Pharma’s dependence on traditional executive compensation plans threatens to work in opposition to the very “medicine” of innovation that could restore the sector’s once vaunted health.

The analysis of 2010 proxy data from 50 big and small publicly traded U.S. pharmaceutical companies suggests that the compensation committees of Big Pharma organizations remain fairly change averse. Instead of seeing this moment in time as an inflection point that requires both risk taking and role modeling, the executive compensation programs at the likes of Eli Lilly, J&J and Merck seem to remain oriented towards rewarding compliance and near-term financial outcomes.

Revenue remains the most common measure of both short and long-term incentive programs at large pharma companies. Eighty percent of metrics used to determine incentives are financial while only 12 percent relate to drug development and commercialization.

“For at least a decade the pharmaceutical industry – both sales and R&D – has operated with the premise that activity yields results. That formula doesn’t work anymore,” says Ian Wilcox, Vice President and Global Sector Leader for Life Sciences at Hay Group. “The industry now has to turn itself inside-out and focus on investments that produce results for customers.”

In the case of the pharmaceutical sector, sustained transformation and performance will require a level of risk taking and change that Big Pharma has yet to embrace—fundamentally changing how it defines, measures and rewards performance, according to Hay Group. Without immediate redress, the price of today’s wave of well-intended actions will almost certainly be paid for with the missed expectations that accompany incomplete – or wrong – solutions.

A flawed incentive model

Hay Group consultants say that if this were a scorecard for the state of affairs in the industry, Big Pharma would probably be at the bottom of the class. Biotech and biopharma are innovators not only in the technology and products coming out of their labs, but also in how they measure and reward their executives.

Short-term incentives are a common way of rewarding executives, but are often the wrong approach in an industry with very long product development pipelines.

According to Irv Becker, National Practice Leader of the U.S. Executive Compensation Practice at Hay Group, “We believe the pharmaceutical industry plight should prompt companies to step back and ask some fundamental questions. For example, should short-term incentives continue to play such an important role for senior executives in an industry with incredibly long, multi-year product development cycles?”

The story is much the same when it comes to long-term incentives, which ideally should link executives’ interests with the health of the company. Here too, 80% of the long-term incentive measurements are based on financial data points, while only 20% are related to the pipeline development and commercialization of innovative, new therapies. Another way to think of this is that financials are a lagging indicator, says Hay Group.While the past decade has been a tough one, the next decade contains even more pitfalls. As valuable blockbusters fall off the patent cliff over the next few years, Big Pharma collectively stands to lose $100-150 billion in annual revenue. “The situation could get much worse before it gets better,” says Matt Gurin, U.S. Reward Practice Leader for Life Sciences at Hay Group.

A better way from biopharma

According to Gurin, Compensation Committees cannot themselves re-fill the pipeline with novel therapies and products, but they can implement novel programs and practices to encourage executives to place innovation much higher on their list of priorities. According to Hay Group’s research, that’s the game in early biotech and emerging biopharmas – not just pay for financial “performance” but pay for new and innovative technologies and products which are the lifeblood of these new companies.

Specifically, while Big Pharma has continued to lean heavily on financial performance measures to drive compensation plans, the mid-size pharma companies and small biotech firms that live and die based on whether their drugs are approved have been much more creative in weaving pipeline and R&D measurements into their incentive strategies. Big Pharma has an advantage here – rather than re-invent the wheel, they can look to biotech or even other industries that have demonstrated track records in product development and innovation.

For more information, or to interview one of Hay Group’s Life Sciences experts, contact Mitch Kent at 215 861 2315, mitch.kent@haygroup.com.

About Hay Group

Hay Group is a global management consulting firm that works with leaders to transform strategy into reality. We develop talent, organize people to be more effective and motivate them to perform at their best. Our focus is on making change happen and helping people and organizations realize their potential. Visit www.haygroup.com

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