Just as life sciences companies have begun to stabilize following the peak of the COVID-19 pandemic, a new storm of macroeconomic challenges is hitting the industry. A looming recession, high inflation, and ballooning energy costs are compounding already significant financial pressures. Staffing shortages in hospitals are limiting procedure volumes, and foreign exchange rates are reshaping cash flows.
Additionally, supply chains are proving fragile. The talent shortages spurred by pandemic-related resignation and burnout are likely to become endemic, as the employment share for middle- and low-wage workers is decreasing.1 The war in Ukraine and China–US tensions are also adding to the strain.
In the near term, the sector’s financial performance is likely to fluctuate. For example, in the second quarter of 2022, medtech companies raised or lowered revenue guidance at twice the rate that they did in the same quarter of 2019 and one and a half times that in the same quarter in 2021. The change in median share price in the weeks following earnings calls was three times that seen in 2021.2
As a result, a sector often considered “recession proof” is undergoing its third year of uncertainty, causing concern among industry leaders. According to the 2022 McKinsey Life Sciences Resilience Survey, 70 to 80 percent of life sciences company executives report having experienced negative impacts on their business because of the described overall macroeconomic challenges.3 Less than 25 percent are confident their organization is well prepared to meet the challenges (Exhibit 1).
Despite these concerns, most life sciences executives maintain a positive outlook, with only 20 percent of surveyed executives expecting further margin decline; 80 percent expect demand to increase. Accordingly, the time has come for executives to focus on how their companies can emerge from the current downturn thriving.
Learning from previous economic downturns
Historically, the life sciences sector has had mixed results when weathering recessions compared with the overall S&P 500, as measured by changes in TSR headed into and rebounding from each crisis (Exhibit 2). However, investors have made clear that macroeconomic forces, such as an aging and growing global population creating a high demand for life sciences innovations, overshadow any near-term uncertainty. As life sciences leaders consider how to manage this recent turbulence, they can draw lessons from businesses in other sectors that performed well during previous market downturns.
A 2019 McKinsey analysis of more than 1,100 companies found that those in the top quintile for TSR from 2007 to 2011 dramatically extended their lead over peers after the 2008 financial crisis.4 By 2017, the cumulative TSR of these “resilients” exceeded that of “nonresilients” by more than 150 percentage points. And nearly 70 percent of resilients continued to be top-quintile performers, while only a fraction of nonresilients joined them. McKinsey has identified four ways that companies can maintain resilience through a crisis: taking bold action on direct and indirect costs, continuing to fund innovation, adopting a through-cycle approach to M&A, and creating operational and financial optionality early in the crisis.
Navigating the new period of macroeconomic uncertainty
Drawing on the lessons from the past, life sciences companies can consider five actions to help build resilience to thrive after the current crisis:
- maintain growth and address margin pressure
- build supply chain resilience
- attract, retain, and unlock the potential of talent
- reevaluate innovation, inorganic-growth, and financing strategies
- invest in foresight and adaptability
1. Maintain growth and address margin pressure
Growth and profit margins for life sciences companies are being challenged on multiple levels. On the demand side, public-health systems are tightening spending as inflation and high interest rates put pressure on government budgets. A potential rise in unemployment could threaten insurance coverage levels in the United States, while hospital staffing shortages are depressing procedure volumes across the globe. Amid these challenges, three key attributes can help build resilience:
- A healthy cost base and financial grounding. Reshape the company for leaner operations and support functions and address debt early in a downturn.
- Flexible resource allocation. Create the ability to move resources rapidly from one area to another when an opportunity arises.
- Focused investment profile. Ensure that resources are aligned to opportunities, given current market positioning, competitors’ moves, and near-term developments, to maximize growth-driving opportunities and maintain position elsewhere.
For example, a European life sciences company is shifting away from bottom-up budgeting, in which leaders responsible for profit and loss must spend their budgets by year-end. It is moving to a top-down approach, in which leaders pitch their projects and needs and then resources are allocated to those that add the most value. This approach enables better adaption to new challenges and pursuit of new opportunities.
2. Build supply chain resilience
Over the years, life sciences companies have consolidated and externalized their manufacturing and supplier networks, leaving them more vulnerable to supply chain disruption. In the McKinsey Life Sciences Resilience Survey, 50 percent of respondents highlighted the operational dimension as the one most affected by such disruptions in the previous 24 months. However, experience in other industries suggests that three things can help companies address the challenges:
- Transparency. Develop end-to-end supply chain visibility several tiers deep to locate weaknesses before they disrupt customer-facing activities.
- Stress testing. Routinely check for vulnerabilities, such as supplier concentration and inventory levels; remediate shortcomings; and better manage shocks by leveraging digital and real-time data.
- Elevation and focus. Inform the C-suite about supply chain issues to ensure enterprise-wide understanding and strategic preparedness.
For example, Novartis developed a business continuity and supply risk framework ahead of the COVID-19 pandemic. The framework has helped it maintain its operations throughout the pandemic. Now the company is taking additional steps to digitize its supply chain processes through forging external partnerships, creating end-to-end visibility, and using AI and predictive analytics to generate forecasts.
3. Attract, retain, and unlock the potential of talent
Like other industries, life sciences has seen a rise in resignations amid low unemployment and greater demand for flexible working arrangements. In a large, global survey conducted by McKinsey between February 2022 and April 2022, 45 percent of respondents said it would be easy to get a job elsewhere with similar pay and benefits, and 33 percent said they were at least somewhat likely to quit in the next three to six months.5
Like other industries, life sciences has seen a rise in resignations amid low unemployment and greater demand for flexible working arrangements.
Against this backdrop, life sciences companies compete for digital and analytics talent with businesses in other industries. To counteract these forces, companies can strengthen their talent propositions by acting in three areas:
- Culture. Embed resilience at the employee level through mechanisms such as company-wide purpose statements and frequent town halls to address issues that workers care about.
- Talent attraction and development. Hire at two speeds by prioritizing full-time positions for roles central to the company’s long-term strategy while outsourcing to manage near-term pressure points. Tailor recruiting messages to highlight the long-term benefits of working in life sciences over other sectors and to emphasize the company’s resilience.
- Organization, governance, and decision making. Empower individuals across the organization to make quick decisions.
For example, Takeda Pharmaceutical launched a training program to strengthen leadership resilience and reenergize teams. It brought in experts in mindfulness, learning retention, and psychological safety to teach more than 3,000 employees how to apply ideas related to resiliency to their professional and personal lives.
4. Reevaluate innovation, inorganic-growth, and financing strategies
Following a decade of rising innovation investment and inorganic-growth activity, inflation and supply shortages are challenging the internal R&D timelines of life sciences companies. Competition is pushing deals to higher-risk preclinical assets, and more diverse pipelines require a broader range of capabilities and talent to develop, manufacture, and launch products. On the other hand, this evolution is creating new opportunities that more resilient companies can harness, including the following:
- Portfolio optimization. Shed less-strategic and dilutive assets to focus on a company’s most strategic areas. As McKinsey’s research on resilients and nonresilients demonstrates, the gap between top performers and the rest of an industry can be extreme coming out of downturns. The most successful companies will have the cleanest portfolios and be ready to accelerate after the uncertainty has ended.
- Alternative financing solutions. Royalty deals previously reserved for marketed assets have become an option for late-stage development, spiking in number and value because they carry low risk and a moderate cost of capital. Another nontraditional form of financing could come from private equity. In recent years, many American and European investors have increased their capabilities to enable clinical-trial financing and blurred the lines between private equity and venture capital by acquiring or investing in venture capital companies.
- Rethinking M&A strategies. Despite the slowdown in M&A activity, history has shown that successful companies tend to divest going into a recession and invest on the rebound. Companies can benefit from taking a through-cycle approach to these transactions by scrutinizing cash management and financing options and by rethinking the path to long-term value creation. The impact of such actions will be even more profound for biotech companies as they rethink their M&A strategies after the downturn.
- Broadening innovation sources. Life sciences companies are increasingly using outsourcing to access innovation rather than relying on M&A. Their outsourcing partners include venture arms within pharmaceuticals and medtech companies and contract development and manufacturing organizations. For example, Merck, a global life sciences and electronics company headquartered in Germany, developed M Ventures, a strategic venture capital arm, to invest in innovative technologies and products to strengthen its core business. M Ventures screens and funds new opportunities, creating companies and developing business.
5. Invest in foresight and adaptability
Companies are working under pressure to live up to the demands of the ever-increasing volatile, uncertain, complex, and ambiguous world that they have to operate in. Examples of the challenges of such an environment include price fluctuations after a natural disaster shuts down a supplier, increased regulations and national specifications, moves into immature or emerging markets, and competitors’ pending new-product launches. The life sciences industry is especially affected by this trend because of the long lead times and high uncertainty before a new product can be launched.
How well companies can predict the results of their actions and how much they know about the situation differ fundamentally in these challenges. Instead of awaiting what might come, meeting this situation with a structured approach, including the following elements, can be very important:
- Corporate-foresight operationalization. Establish a recurring process to identify potential adverse scenarios and conduct stress tests to develop action plans.
- Early-warning system. Create leading key risk indicators based on adverse scenarios to provide an early warning of impending disturbances.
- Nerve center. Develop a nerve center that brings all organizational knowledge together and can coordinate responses, mobilize resources, and give the leadership team the information and insights it needs to make decisions quickly.
Launching a holistic resilience program
Becoming resilient isn’t easy. Company leaders won’t know all the answers on day one of a major disruption or financial crisis, but they can create systems that will help. Resilience is about not just maneuvering through times of uncertainty but also positioning a company to outperform after the uncertainties have passed. By 2025, life sciences leaders might be able to look back at these turbulent times and identify which companies were managing for survival and which were priming for acceleration.
The first step for a company becoming primed for acceleration is to assess its vulnerabilities, or resilience gaps, and the strengths that it can use as a foundation. The second step is to prioritize initiatives that address the gaps, reinforce strengths, and identify the key external developments to monitor. The last step is to implement, monitor, and adapt the initiatives to emerge from the economic downturn stronger than before.