When 'New and Improved' Fails: Insulin Maker -2-

Danish drug giant Novo Nordisk AS is living through a corporate nightmare that any CEO might recognize from business school.

After the company concentrated on making essentially one product better and better -- and charging more and more -- customers have suddenly stopped paying for all that improvement. The established versions are, well, good enough.

In Novo Nordisk's case, that product is insulin, a hormone that is deficient in people with diabetes. Since its founding in 1923, the company has made successive waves of better insulin. It is the world's biggest producer of the stuff, and insulin brings in more than half of the company's revenue.

Over the years, that innovation has translated into an ability to charge more and more for the latest version, boosting profit margins and swelling the company's stock price. As diabetes -- an incurable disease -- morphed into a global epidemic in recent years, Novo Nordisk's tight focus on insulin provided reliable and growing profits.

Lately, that flow ended. Doctors, health-plan managers and insurers all have balked at paying for Novo Nordisk's newest version of its insulin. Clinical trials show it works as promised in controlling diabetes and delivers significant side benefits compared with its predecessors. But for many customers, all that isn't enough to warrant paying more -- because the older drugs on the market already work pretty well, too. In Europe, the company had hoped to price Tresiba at 60%-70% higher than its previous product.

"The incremental improvements don't seem to justify the premium prices," said Steve Miller, chief medical officer of Express Scripts Holding Co., one of America's biggest pharmacy-benefit managers, a key middleman that buys drugs in bulk on behalf of insurers.

Novo Nordisk's hopes for the new drug -- which it once expected to generate blockbuster profits -- have dimmed. The company has warned repeatedly it won't meet its long-term growth targets, and its stock price has shrunk by more than a quarter since the beginning of last year. Executives are scrambling to diversify -- pouring money into research outside its core insulin-focused science. The company announced 1,000 job cuts last fall.

"A lot of staff -- anyone who joined within the last 18 years -- had not seen anything but success and constant growth," said Chief Executive Lars Fruergaard Jørgensen in an interview.

As the turmoil at Novo Nordisk shows, there are commercial limits to innovation. Nokia Corp. and BlackBerry Ltd. both lost their market dominance in smartphones because competitors beat them with major technological advances. Both firms are in the process of reinventing themselves.

In other cases, though, innovation has hit a wall. That is especially the case in some pockets of the pharmaceuticals business, where the scope for big improvements is narrowing.

Common, deadly ailments, such as asthma, high cholesterol and heart disease, were the focus of the pharmaceutical industry during a golden age of drug launches in the 1990s. Now, building on those advances has proven costlier and more complex, and usually results in smaller gains. Incrementally improved medicines are harder to sell at the prices needed to cover their development costs.

Sanofi SA and Amgen Inc. are struggling to make headway with their new cholesterol-lowering drugs. These medicines, known as PCSK9 inhibitors, bring about a greater reduction in cholesterol levels than older statins alone for certain people. But the companies have yet to convince insurers that it is worth putting these patients on them: Both cost more than $14,000 a year before rebates and discounts. Older statins are available for just pennies a day.

Novartis AG hoped its new heart-failure medicine Entresto's proven superiority to older, so-called ACE-inhibitors would guarantee rapid uptake among cardiologists. But insurers initially incentivized doctors to prescribe older, cheaper drugs, leading to a much slower launch. That is changing as insurers gradually adopt more permissive policies toward Entresto.

People with diabetes don't make enough insulin, a hormone needed to convert sugar into storable energy. In Type 1 diabetes, the body doesn't make insulin at all. In Type 2, the far-more-common form linked to obesity, the body develops resistance to insulin, and the pancreas cannot produce enough for the proper effect.

Around 12% of American adults have diabetes, according to an estimate published this year by the Centers for Disease Control and Prevention, though around a quarter of those aren't aware they have the disease. That figure could rise to as many as one in three American adults by 2050, according to a 2010 report by the CDC.

Of those diagnosed with diabetes, about a third depend on insulin injections, the CDC said. That was about six million people in 2011.

Novo Nordisk has been making insulin since the hormone was discovered in the early 20th century. That breakthrough, by two Canadian scientists, led to the first effective treatment for diabetes.

August Krogh, a Danish medical professor and Nobel laureate, heard about the discovery in 1922 while lecturing in the U.S. with his wife, Marie, a doctor who suffered from Type 2 diabetes. After a stopover in Toronto, the couple returned to Denmark with permission to manufacture the lifesaving treatment in Scandinavia.

Nordisk Insulinlaboratorium was founded the next year. Denmark, home to one of Europe's biggest pork industries, made sense for a business based, in its early days, on harvesting the hormone from the pancreases of pigs and cows.

In 1924, two brothers left Nordisk to set up their own firm, Novo. The rival companies competed fiercely, one-upping each other with insulin innovations, such as injections with longer effects.

Novo adopted new genetic engineering technology in the 1980s. The technology ushered in synthetic human insulin and ended the dependence on animals. The two companies joined forces in 1989, leapfrogging America's Eli Lilly & Co. as the world's biggest insulin producer.

Over its history, the company's narrow focus was a strength: Its deep expertise boosted its ability to produce ever-better products.

Through the 1990s, the company tweaked the basic insulin molecule to fine-tune its performance. It developed a fast-acting insulin, called Novolog, that enters the blood quickly, providing a ready boost at mealtimes. It also rolled out a long-acting version called Levemir that releases a steady stream of insulin into the blood throughout the day.

In the mid-2000s, Novo Nordisk launched a handful of these so-called analog insulins, as patients clamored for more convenient forms. Doctors, patients and health-care managers in the U.S. and Europe were appreciative, willing to pay more for the new benefits.

Novo Nordisk's stock surged. By 2013, Copenhagen's tiny stock exchange was forced to change its blue-chip benchmark index to keep it from being overwhelmed by the company's swelling market value.

After the success of Levemir, Novo Nordisk aimed higher. It developed Tresiba, even more convenient: The drug can be taken at any time of day, whereas Levemir and Sanofi's equivalent, Lantus, require a regular dosing schedule. In addition, Tresiba is associated with fewer episodes of dangerously low blood sugar, or hypoglycemia.

An early set of results for Tresiba impressed executives, Novo Nordisk's research chief, Mads Thomsen, recalled. "We just sat there and said, 'Wow,' " he said. "We had kind of realized we were very close to perfection."

As it awaited final blessing from the U.S. Federal Drug Administration, the company rolled the drug out across Europe, starting in 2013. It hit the market with a thud.

Drug pricing in Europe is very different from the U.S. The biggest buyers aren't insurance companies and health-plan managers, but government-controlled entities or their middlemen. They typically negotiate hard with companies for supplies for an entire country. The system keeps prices lower than in the more-fragmented U.S. system.

Once a price is set by one of these bodies, it is very difficult to raise. So, drug companies typically launch a new drug at the highest price they think they can get, knowing they won't likely be able to increase it.

Novo Nordisk, however, struggled from the start to convince European buyers that Tresiba was different enough from Levemir to command a big premium.

In Germany, for example, a pricing board set the price for Tresiba at the same level as the basic synthetic human insulin that had been available since the 1980s, which has none of the long-acting or other special benefits of newer forms. An agency that assesses the cost-benefit of new medicines concluded Tresiba had no real advantage in terms of controlling the disease itself. Novo Nordisk withdrew Tresiba from Germany, Europe's largest drug market.

Other countries, like the Netherlands, Denmark and Spain, allowed Novo Nordisk to launch Tresiba at around its desired price of 60%-70% higher than Levemir and Sanofi's Lantus.

But to minimize the impact on their budgets, the health systems wouldn't reimburse patients for Tresiba, and the new insulin gained very little market share. Last year, Novo Nordisk lowered its price to a level that the health systems would reimburse, and use of Tresiba has picked up.

"In Europe, we launched with a very high premium," said Mr. Jørgensen, the CEO. "That turned out to be too high." He said Tresiba's premium over Levemir and Lantus is now around 20% in most European markets.

Still, executives were sanguine. Prices in Europe were now locked in at much lower rates than they had expected. But they thought they could rely on the U.S. market to more than make up. In the U.S., drugmakers usually introduce new products at a modest premium over previous versions, with the assumption they will be able to raise prices for years to come.

Novo Nordisk launched Tresiba in the U.S. in early 2016, ahead of the presidential election. Politicians on both sides were slamming drug companies for raising prices. Beyond the campaign rhetoric, insurers and health-plan managers were targeting diabetes medicine, in particular, for cost-cutting scrutiny. The medicines are their second-largest drug outlay, after cancer medicines, according to analyst Ronny Gal of investment research firm Bernstein.

Payers were girding for expected cost increases related to a raft of new cancer-fighting drugs, many of which promised big gains for patients. In the diabetes field, a string of new, pricey drugs designed to control blood sugar levels in early-stage Type 2 patients were also stretching budgets. These pressures made insulin, where the older products worked pretty well, an obvious target for cost savings.

Diabetes "is on payers' radar with big, red, flashing lights," said Barry Farrimond, a European drug-pricing analyst at ZS Associates, a management consultancy.

Amid that environment, Novo Nordisk couldn't convince executives at pharmacy-benefit managers such as Express Scripts that Tresiba was enough of a game-changer to warrant a significantly higher price.

For that, large clinical groups like the American Diabetes Association "have to tell us that this medication is clearly superior and as a result everybody who has diabetes should have access to it," said Troyen Brennan, chief medical officer of CVS Health Corp., another large pharmacy-benefit manager.

Doctors and the ADA view Tresiba as "not much different," he said. This year's ADA guidelines group Tresiba alongside other long-acting insulins and note that patients with well-managed, Type 2 diabetes can use basic synthetic human insulin "safely and at much lower cost."

Novo Nordisk accepted a list price for Tresiba only around 10% higher than Levemir. The list price doesn't take into account rebates and other concessions, and some pharmacy-benefit managers are charging a higher copay for Tresiba to steer patients to cheaper drugs.

At the same time, Novo Nordisk was being hit by another new threat: competition. Eli Lilly, which for years had mostly played in the short-acting insulin market, launched a low-cost, longer-acting one, pressuring prices even more.

"We knew the dynamics were going to change, but it ended up being more dramatic than we anticipated," CEO Mr. Jørgensen said in the interview.

This month, he told reporters the price for Tresiba would take another hit in 2018, having already fallen in 2017. "The competitive environment we are in is now a permanent situation," he said.

Tresiba is gradually gaining traction. As of June, it had grabbed a 6.2% share of the U.S. long-acting insulin market, according to health data provider Quintiles IMS. That momentum helped Novo Nordisk post better-than-expected earnings in the second quarter this year, leading the company to brighten its full-year outlook.

But the tougher U.S. pricing environment took executives by surprise. Last year, the company slashed its long-term profit-growth forecasts twice: in February, to 10% from 15%, and in October, to 5%.

The company's breakneck growth of the past two decades is "an era that's over for now," said Claus Johansen, senior portfolio manager at Danske capital, a top-15 investor in the company.

The company is protected from some market forces. In a quirk of its Danish ownership structure, a foundation owns the majority of the company, shielding it from an opportunistic takeover.

The Tresiba experience has prompted a strategic overhaul. Mr. Jørgensen, who had been chief executive-designate since September 2016 and formally took up the role in January, has pivoted the company away from making incremental improvements to insulin.

"The market will probably not be screaming to get a slightly better Tresiba," he said in a February investor call.

It is widening its research to diseases that the company considers "adjacent" to diabetes. Novo Nordisk has long had a sideline in hemophilia treatments but has generally refrained from dabbling in other diseases. Now, it will start investigating drugs for conditions like NASH, a disease in which fatty deposits build up in the liver; diabetic kidney disease; and cardiovascular disease.

Within the diabetes field, the company still makes and sells the popular, less-expensive insulins. A Novo Nordisk drug called Victoza is part of a new class of treatments that boost insulin production in Type 2 diabetes patients. And it hasn't given up on insulin research altogether. In October, it scrapped a project working on a tablet version of the medicine. Instead, it is now focusing on more meaningful improvements, such as "smart insulin" that acts only in the presence of high blood sugar.

"I still believe we will bring new insulin to the market," said Mr. Jørgensen. "But the innovative height has to be better than what we have today."

Write to Denise Roland at Denise.Roland@wsj.com

(END) Dow Jones Newswires

August 15, 2017 11:12 ET (15:12 GMT)