Can a Big Pharma Ever Be Worth $1 Trillion?

There are five tech companies valued at over $1 trillion. In healthcare, the closest contender is Eli Lilly.

This year it became the first big pharmaceutical to surpass a market capitalization of $500 billion thanks to the popularity of its obesity and diabetes medications and, to a lesser extent, its experimental Alzheimer’s drug. But hanging over Lilly and rival Novo Nordisk is a reality that puts the brakes on big pharma’s ascent: the patent cliff.

There are several reasons why there isn’t a big pharma company in the trillion dollar club, but the boom-and-bust nature of drug development is high on the list. Unlike Apple, which hypothetically can make huge margins off the iPhone for perpetuity, U.S. drug companies have a limited period from which to profit from their innovation. As their patents expire and generic competitors enter the market, sales plunge. Pharma executives, overly focused on short-term growth, don’t often prepare their companies for that.

As Lilly soars into the pharma stratosphere, a big question is whether it can avoid the fate that has befallen its competitors (and itself in the past). The company’s chief scientific and medical officer, Daniel Skovronsky, says he wants to avoid a key error much of the industry tends to make.

“When a company has a mega blockbuster drug that is doing really well, every investment on the margin goes towards that instead of towards something that’s untested and unproven,” he says in an interview. “And that drug overshadows the rest of the portfolio and everything else is starved for people, money and attention.” Once the big blockbuster runs out, he added, “they find out their cupboard is bare, and there’s nothing else coming.”

The predicament Skovronsky describes ails nearly every drug company at the moment to varying degrees. The industry is staring down a $200 billion cliff in annual sales by the end of the decade. And because companies need to keep their top and bottom lines growing, they wind up having to sacrifice long-term innovation for short-term growth. Rather than making bets on edgier science, they shell out billions of dollars on proven therapies, where investment returns are lower. Another way to put it, says Skovronsky, is that they are moving money from the balance sheet to the income statement.

“We think about that as going to the grocery store when you’re hungry. You end up buying things you don’t really need,” he says.

Lilly itself lagged behind peers in the early 2010s and its R&D was highly inefficient. Skovronsky, who joined Lilly after it acquired his brain-imaging firm in 2010, pushed the company to move more quickly and focus more on science. Those steps paid off handsomely.

For now, it isn’t clear there is something significantly different about Lilly’s DNA that might make it immune to the industry’s headwinds. While the company deserves abundant credit for making prescient bets, its stock surge—up 300% in three years—is largely because it landed on one of the biggest commercial opportunities of all time: the global obesity epidemic.

“This is a huge market that has never really been addressed,” says Evan Seigerman, an analyst at BMO Capital Markets. The question, he says, is whether Lilly can replicate that success.

Skovronsky says that the company wants to grow in areas where it isn’t a leader, such as cancer and immunology. Some notable recent deals include the purchase of immunology company Dice Therapeutics for $2.4 billion and a company in the radiopharmaceutical cancer space for $1.4 billion.

“We’re going at business development from a longer-term perspective of what could pay off in the decades to come or more,” Skovronsky says. “So some of our recent deals reflect that we’re acquiring not just molecules but also a team, a technology, and a platform that we think can expand our capabilities.”

Immunology and cancer are crowded areas, though. Lilly’s edge was that it saw an opportunity in obesity and Alzheimer’s when most of its competitors overlooked them. Skovronsky says the company will continue to go off the beaten path.

“You’ll see us working on areas that are unpopular because we have a hunch that the science is going to break and we just want to stay open,” he says. “We’re working on hearing loss, we’re working on pain.… These aren’t huge markets today.”

One challenge all innovative companies face is that as they grow, a bloated bureaucracy kills risk-taking. That could afflict Lilly as it grows its R&D budget, which is among the industry’s highest relative to sales. Skovronsky argues that the answer isn’t to just add head count. Instead, he says the company should stay nimble and preserve the culture of its acquisitions by, for example, leaving the acquired companies intact as separate entities within the corporation. Another strategy is to join with emerging biotechs through innovation accelerators it has been opening around the country.

Patent expirations, drug pricing pressures and competition are inescapable. What can separate Lilly from the pack, and perhaps help it hit more valuation records, is how well it keeps innovating.

Write to David Wainer at david.wainer@wsj.com