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Not Fun Reading

These numbers from Deloitte are not very reassuring. They do an annual survey of spending and returns on investment in the drug industry, and this year’s estimated return on R&D is down to 3.7%, which looks like the lowest yet. Back in 2009, another vast consulting house (McKinsey) estimated that returns were around 7.5% during the early 2000s. Deloitte has the figure at around 10% in 2010, but dropping pretty steadily ever since (and this is with the same cohort of companies).

Their take is that there hasn’t been enough M&A in recent years, which may come as a surprise to some folks:

Since 2013 there has been a steady decrease in the proportion of projected late-stage pipeline revenue derived from externally-sourced assets, a trend which accelerated in 2016 as more of the assets acquired as part of large-scale M&A in the late 2000s leave the late-stage pipelines. This trend, together with the decrease in returns, indicates that companies are struggling to replace pipeline value through self-originated assets.

One response to this is that productive mergers and acquisitions assume that there are things out there that can productively be bought. What if some of the big companies have been completely open to the idea of supplementing their in-house research but haven’t found as much that looks worth buying? Or have been buying stuff but having less of it pay off than formerly? Those are even less appealing answers, but they can’t be ruled out. At any rate, Deloitte sees a return to more acquisitions:

We anticipate that the coming years will see increasing M&A activity in a quest for higher R&D returns through R&D cost synergies or the acquisition of valuable assets. However the costs, both financial and otherwise, of these transactions are likely to be high and could place further pressure on R&D organisations that seem ‘too big to succeed’.

Gosh, that sounds fun, too (note this discussion from 2014 about spending money on acquisitions versus internal research). This would be a good time to mention that last year’s hefty number of FDA approvals appears to have been an outlier; a smaller number will go through for 2016 regardless of what the FDA pulls out of the regulatory hat the rest of this month. And some of the approvals have been impressive, but that (according to this report) doesn’t  mean that the underlying trends are good:

In response to the continual decline in returns, there is a tendency within the industry to use examples of successful launches to cite healthy R&D productivity. The original cohort of companies has been highly successful at commercialising their collective late-stage pipelines and launching new assets, with 233 assets launched since 2010 with total forecast lifetime sales of $1,538 billion. The past year has been no exception, with 45 approvals totalling $280 billion of forecast lifetime sales. However this commercial success releases value from late-stage pipelines into the commercial portfolio, and companies are struggling to bring forward new assets to replace those that are released into the market. Terminations and the rising costs of R&D have further exacerbated the fall in returns.

Gosh, where are all those drugs that we were assured a few years ago could be (in fact, were) developed for only $43 million or so? That would provide you with returns you could write home about, but it’s almost as if that figure is completely wrong or something.

That 2009 link back in the first paragraph mentioned that the R&D returns seen then were not comparing well with the capitalization needed to achieve them, and this report highlights the same problem. Deloitte estimates that the average cost of capital across the industry is about 8.4%, which means that for the last few years we’ve been increasingly running on fumes. They do mention, though, that smaller companies are in a much more favorable situation on average. I’d interpret this as the mean of a data set with a lot of variance, ranging from “spectacular returns” to “out of business entirely”, but overall looking sustainable (although sustainable on average – any individual company in this group can be a wild ride). Meanwhile, the cohort of 20 large companies they’ve been following also varies, but not by as much, and with averages that look, well, unsustainable they way they’re going.

I find the latter half of the report less compelling – that’s where there are recommendations being made about improving success rates and lowering costs. From what I can see, most of these sound quite sensible, sensible enough that you’d think that most people are doing them already, or attempting to. Focusing more thoroughly on specific therapeutic areas, looking carefully at the competition and the payment environment, designing clinical trials more efficiently – who’s against this stuff? If these were enough of an answer, you’d think that we wouldn’t be in the shape we’re in. And if they’re not?

Well, I realize that this is not exactly a feel-good post for the holidays. But the numbers are out there, and I don’t think that they’re likely to be so wildly off the mark that we can ignore them. They shouldn’t come as a total surprise, though – people have been saying for many years now that these various trends (success rates, R&D costs, pricing) are heading in the wrong direction, and this is just another indicator that yes, they still are. . .

46 comments on “Not Fun Reading”

  1. biotechtoreador says:

    Dear Lord, this is such stereotypical consultant pablum:

    “Align end-to-end decision making across the organisation” has got to be the winner, picture perfect consultant-speak.

    “Think small, win big decision making” is also good, though would have preferred to see something along the lines of “failure to plan is planning to fail”.

    “Lift the burden of data complexity”, well that just makes sense: Keep Is Simple Stupid…..brilliant!

    Seriously, who pays for this crap?

    1. Derek Lowe says:

      Yeah, that’s why I don’t find the recommendations part of the report too useful. The outlining-the-problems part is unfortunately more clear.

      1. simpl says:

        There is a topic foisted on Pharma by economists, which has got worse in the last years, but has still not been well enough analysed. Old products are increasingly being dropped before end-of-sales. The argument is correct, in that old products bring less percentage profit. But they still do bring good profits above cost of production, which do not drop below the average Pharma return. The extra costs of change eat into company costs too. The buyers vary from rip-off artists to honest generic companies.
        I suggest that old products are systematically undervalued, and consultant firms, who are catalysts for change, have oversold this particular change benefit.

        1. DP says:

          You’re correct in principle, but mature products carry surprising overheads and force a business to commit resources in Medical and Regulatory to ensure compliance in multiple international markets (e.g. updating labels, digitising all documents to meet transparency requirements) and manage risk and supply cost (complex supply chains are costly/risky) – there’re real trade-offs. Mature products aren’t like cows you can put to pasture, they need management and that requires resource.

          1. simpl says:

            Thanks DP, I’m grateful for the acceptance in principle. Since the first claim was that decent analysis is missing, I can’t ask for much more.
            I definitely agree with your comment on Regulatory, it is one of the largest causes of product loss, after new side-effects and, sometimes, lack of efficacy. Medical transparency I would also put in the regulatory basket, as the marketeers rarely request medical studies after patent expiration. The main root cause of regulatory problems is uncoordinated change over time, which each company is behoven to minimise, and mostly doesn’t do a great job with.
            Finally, I do like your example comparing pharmaceuticals to cows. Both are tricky businesses, as the main expenses are front-loaded, but they both continue to require management and have running expenses throughout their lives. If you tried to outsource either or improve (i.e. change) their product supply, you would in all likelihood reduce the profitability, as well as increase the regulatory effort.

  2. Andy II says:

    I think we should realized again and again that those consulting, opinion/recommendation generating firms position that pharmaceutical companies have to regard innovative drugs as purely a means of making money thru a sales. Not evaluating the value of R&D by counting number of patients that those drugs save the lives and/or improve their quality of lives.

  3. Next up, Fox Consulting Inc reports that margins in egg production are down, blames excessive henhouse design. Calls for a return to outdoor chickens.

  4. Hap says:

    Are assets from smaller companies paying off better in the end? My assumption is that smaller companies are optimized to get something to purchase by a bigger company (because they are unlikely to be able to put something all of the way through trials unless you can get it approved with a trial of, say, 12 patients, and so they are going to need someone to pay for the trials) . This might mean that the assets bigger companies need to get might not be as good (because not as much is known for them, either because the trials to know those things cost more than the smaller company wants to spend, or for less honest reasons). If assets from smaller companies are actually working, then maybe they have something useful, beyond being cheaper and less secure.

    Merging further puts everyone under the management of a few companies. Doesn’t that mean you will likely get fewer new ideas (and will thus be reliant on small companies to find the products to sustain your business)? That seems like it could either be a recipe for productive alliances or for the conversion of bigger pharma companies into vampires. Unfortunately, which of those looks like recent history?

    How do you keep data simple if the data is complex? You can organize it as best you can, but if you don’t know what’s important, then it seems hard to organize the data without losing something important.

    1. Cellbio says:

      Hap, from I’ve lived through and seen closely, totaling about 5 billion in acquisitions, the small companies assets did not survive in the clinic. In one case, a 2B deal saw all assets vanish after only 6 months. The deals did serve to relabel the sellers as ‘successful’ so they could go on and do it again, becoming serial entrepreneurs. Value created within the system but not an ROI for the whole system.

      I also lived through a very successful, technically speaking, run of showing how drug discovery was being poorly served by making complex issues more simple, by say, focusing on a single target, measuring potency, referring to cartoons that neatly depict the target in the center of a chain reaction that is known, known I say to be the key to superior outcomes and market domination. The very fact that we showed the neat system deployed as a rationale means of focusing resources (choose this TA, lay off that TA, buy that company) was false was reason enough to stop the effort. I did not matter that biology did not organize by target type or therapeutic area. When we relied on complex data sets that fully revealed drug impacts across cell types, revealed pharmacology not supported by the cartoons, questioned the premise of biological selectivity and even illustrated why clinical compounds were probably having issue, we were the heretics. Careers were to be made in selective truths, capital was in hand to buy assets portrayed in the right way, later failure simply a likely outcome. Excuse the long winded answer to say that for those that play this game, keeping complexity appearing simple does not lose what is important, it is what is important.

  5. Barry says:

    for twenty years, drug companies have tried to make up for lagging innovation by Mergers and Acquisitions (not the other way ’round as DeLoitte would have it). It has been disastrous. Advocating more of the same is predictable from DeLoitte. Drug companies would be stupid to comply (i.e. some will)

  6. Pete says:

    Consultant-speak. This beauty’s like a 10 year old wine.
    “We anticipate that the coming years will see increasing M&A activity in a quest for higher R&D returns through R&D cost synergies..”

    Translation: “how about if you hire 100%-groovy scientists, and we’ll hire 100%-groovy scientists, then we’ll buy your scientists, then we’ll fire 50% of the total and make the remainder do 232.45 % more ! ”
    Synergy, dude.

    1. Isidore says:

      In principle, a merger can lead to R&D cost synergies. Let us say you have two companies, with a mass spec lab with two mass specs and one senior scientist and one research associate apiece, who are kept busy, say 75% of the time. After the merger the company has one mass spec lab with four mass specs, two senior scientists and two research associates. It is possible to get almost all the work done by laying off one of the senior scientists or even replace the senior scientist with another associate, who costs 60% of the senior scientist, and decommissioning one of the mass specs, saving on service contracts. This sort of cost-cutting can work across the board. If you merge two medicinal chemistry groups or two IT departments you don’t need the senior directors and VPs from each company, you can keep one set of each or mix and match.

      1. Angus Cologne says:

        …and that’s a fine strategy to reduce costs to achieve profits today. I don’t think it’s a viable long-term strategy to put out better drugs or at least implement better strategies for drug discovery.

        1. Isidore says:

          I am not sure why it’s not a viable long-term strategy. The idea here is to utilize resources, including human hands and brains, as efficiently as possible. If the work can be done sufficiently well by three people why have four or five? Not to mention that companies that merge often have a good deal of overlap on projects. If a merger is done properly then the merged company keeps the most promising aspects of a project (e.g. bets targets or most promising molecules) along with the best researchers.

          1. Hap says:

            To merge correctly, you ought to have an idea of what assets to keep and what assets to get rid of, and in lots of mergers and layoffs that information seems to be irrelevant (either because the company just wants costs off the books or because the best projects and people and the management-favored projects and people aren’t the same, and since management is picking who or what stays and who goes, guess who (or what) stays?). Even when management doesn’t impose their desires on the merger, they may not realistically have this information. In that case, you take your best guess, but you can’t really assume that optimal benefits of a merger are likely then.

            You also are losing some of your ability to hedge your bets – if you had crappy projects, they shouldn’t have been around anyway (although if your company was healthy, it probably wouldn’t be merging, and so all of your projects being good is unlikely). If the projects aren’t crappy, then you’re cutting good stuff as well as bad. Of course, once the layoffs begin, the people most likely to leave are probably the ones you want to keep.

            There are an awful lots of ways mergers can fail, and the failure modes seem to happen a lot. If you can’t (almost) ever do mergers well, then counting their likely benefits from their optimal benefits is not reasonable.

          2. Dr CNS says:

            Hap,
            Watson will take care of that…

          3. Beaker says:

            The problem is that in many companies post merger what can efficiently done be three is being done by 2 or even 1. The result is that everyone is just trying to keep up and when a project stalls it is often abandoned. In research it is always hard to know when to quit but it is usually not with the first negative result.

          4. John Wayne says:

            Would you like to play a nice game of chess? – WOPR

            No, I would like to play global thermonuclear merger war. -MBAs

            The only way to win is not to play (for the MBAs: losers merge, winners buy)

          5. Angus Cologne says:

            Here’s a (poor) analogy to demonstrate why this isn’t a viable long-term strategy.

            Say there are two stores selling two different products. One has its resources managed as efficiently as possible and sells sludge, the other is managed sub-optimally and sells lemonade. You wouldn’t be surprised to hear that the lemonade guys have higher profits than the sludge boys despite the gulf in managerial prowess.

            At some point, optimizing the use of resources won’t compensate for having weak products. Obviously the market is a lot more robust than just sludge/lemonade and companies can dramatically improve themselves with a well-designed merger/acquisition. But at the end of the day, a solid foundation in product development is also necessary and no amount of M&A’s can replace that.

      2. Noobie says:

        Are you advocating for a monopoly?
        That’s where your argument goes as you push it to the limit.

        1. Isidore says:

          I am not. I think competition is essential for innovation. But competition is not necessarily antithetical to mergers, when certain conditions make them efficient. I suppose the limit on the other extreme from a monopoly might be a vast number of tiny companies all working on the same thing. There has to be a happy medium. And I am fully aware of the fact that what often sounds reasonable on the face of it (synergies, avoidance of overall, etc.) is botched up horrendously in practice.

  7. Chrispy says:

    The industry is broken on so many fronts that it is difficult imagine a change without a lot more pain. FIrst, reimbursement is becoming an increasingly big problem — “what the market will bear” is less and less “whatever you want to charge.” That jackpot reimbursement is what allowed R&D to continue to exist, and having been abused by jackasses like Shkreli it will not continue, particularly given that it was mostly a US phenomenon and an outlier in global markets. Second, drug approval is altogether too expensive — the authors allude to both of these when they state that the industry faces blockbuster expenses without blockbuster returns. Third, the quality and reproducibility of published science is rubbish, making it very difficult to move research from a headline grabber to a real therapy. Finally, attracting talent to this career wasteland is becoming a harder and harder sell, with the brain drain happening at both ends: old timers purged because they are too expensive and youngsters realizing that they have a better chance of a stable career if they take up computer science (or card counting). Ironically, the tools are better than ever — we have the human genome for crying out loud — but the fundamentals have eroded, and the birth of a new model will come at the expense of the old one, if it comes at all.

    1. Peter S. Shenkin says:

      “What the market will bear” is not a U.S. phenomenon. In fact, it’s the opposite. “What the market will bear” is only possible if there’s a market. If a huge customer, Medicare, is legally prohibited from negotiating prices, there cannot seriously be said to be a market.

      On the other hand, outside the U.S., including Europe and, say, Canada, national health plans can and do negotiate. Which is why prices even for drugs developed in the U.S. and sold globally are less expensive outside the U.S.

      So outside the U.S., there is a market, and “what the market will bear” leads to significantly lower prices for drugs than we find inside the U.S., where normal marketplace mechanisms are forbidden to operate.

      (For clarity, though I guess it’s obvious, this comment is restricted to this single point, and I don’t think this single point explains the panoply of woes to which Pharma is heir.)

  8. anon says:

    Consulting = getting paid for hype and wishful thinking

    1. dearieme says:

      Research = getting paid for wasting the shareholders’ capital.

      Alas, that’s the problem isn’t it? The Golden Age of Medicine is long gone.

      1. Hap says:

        Except you don’t get the earnings without having products, which takes research and development, people with experience and knowledge, a body of corporate, knowledge, and failure, all of which waste investors’ capital.

        Everyone is hoping to make money without having to spend on anything that doesn’t make money. Which works great if you’re a god (in which case, you wouldn’t be doing this), but doesn’t really work out so well otherwise (because of the first point, above). Since that is working about as well as one can expect it to, pharma (and other businesses, I think) seems to be in the “let’s eat the seed corn and hope for a miracle” mode so that current investors (including lots of randoms) will have something to retire on, and the issue of products will be solved by the soon-to-arrive (real soon now!) miracle. If you take off the optimists’ glasses (http://dilbert.com/strip/2004-08-04), where do you think we’ll end up afterwards? Does anyone care?

  9. steve says:

    Once again the answer is very simple. Pharma has grown so large by accretion that it can no longer develop drugs with big enough revenue to feed its voracious gut. One can always blame the consultants but they at least identified the problem. The current pharma model is simply unsustainable as it’s driven by blockbuster drug mentality, with MBAs deciding which direction to go based on flawed marketing models and the need for profits commensurate with the enormous size of these companies.

  10. Biotechie says:

    I am not sure it is possible for mega companies to do effective R&D anymore…just look at the difficulties of any bright individual who has come in and tried to turn things around. John Reed came to Roche from Sanford Burnham hoping to reinvigorate R&D. Now rumors suggest he is scrambling to push anything late-stage he can as fast as possible through to approval. Will Jay Bradner re-invigorate Novartis? These are the best qualified individuals but they face an uphill struggle because 1) they do not have the power in the companies like the Black’s, Vagelos’ or George Merck’s of old; 2) the companies themselves are like tankers…it takes for ever to turn them around; and 3) the lawyers leading the companies are beholden to quarter-to-quarter earnings, share buybacks and stock holder sentiment and are too isolated from the people doing the R&D (all they read are reports from internal leadership and reports by consultant types like people at Deloitte). In the end, the model will change and these big companies will be superseded but it will likely take a long time to unseat them.

    1. hex says:

      “look at the difficulties of any bright individual who has come in and tried to turn things around”

      But that’s the biggest part of the problem! “Bright” people are parachuted in to places to try to “turn things around”. Think about that for a moment. Are they so much brighter than the 1000 people already there, who basically know what’s wrong with their organization but don’t have the power to change it because at the top is someone with “I know best” mentality? One new person coming in with that same mentality, which I admit is what happens, is pretty much doomed to fail.

  11. Shanedorf says:

    In one of the graphs they talk about total pipeline value vs external-sourced pipeline value and show that it has dropped significantly since 2013
    One of the reasons for this is the current model of small biopharma that sets up an LLC for each program. So when Big Pharma comes calling, they only buy the 1 asset they want instead of the entire company/portfolio as in years past. Less total company M&A and more licensing or single-compound deals

  12. Mark Plummer says:

    I guess in all this discussion, I am waiting for someone to mention the failure of the outsourcing model. It has been my experience that whether outsourcing synthesis, at early discovery stages or outsourcing the running of clinical trials at late stages that outsourcing is never as efficient as what was formerly accomplished in house. Yes it saves dollars and maybe provides a degree of flexibility— both short term benefits, but in the end the product is only delivered, if delivered at all, late, very late. Isn’t this the problem we are discussing that organizations have lost control and effectiveness of their discovery, development and clinical research?

    1. Dr CNS says:

      Mark,
      I believe the challenge with outsourcing is to do it in the right proportion for your organization.
      Do you think there is any drug discovery organization in the World with internal access to all technologies and the corresponding expertise it needs to deliver a drug? Sooner or later you need to work with external folks.

      As for these reports and the BD-driven view of the industry…. it sure sucks!

  13. Kelvin Stott says:

    The law of diminishing returns (diminishing output and incremental benefits at increasing cost) is a natural and unavoidable consequence of prioritization. As long as we pursue opportunities with the greatest expected returns first, we will always be left with lower returns later on. Even our efforts to improve productivity obey the law of diminishing returns, with diminishing incremental improvements being made at increasing cost.

    There is no way to avoid the law of diminishing returns, except with a paradigm shift to a completely new and fundamentally different model to create value.

    1. no science, no drugs says:

      Kevin,
      Presumably a science breakthrough can do the trick?
      I don’t think that a “a paradigm shift to a completely new and fundamentally different model to create value” is needed… actually that sounds like a BD talk to me…

      1. Kelvin says:

        No, I actually meant a paradigm shift.

        We have already had hundreds of “scientific breakthroughs” over the past 60 years, but pharma R&D productivity has continued to decline despite all of them!

        1. no science, no drugs says:

          well… maybe there has been some productivity due to the hundreds of breakthroughs…
          Glass half empty, or half full?

  14. PUI Prof says:

    As someone who is interested in, but not in, the field, I have a naïve question. If the entire industry burns down, as appears will happen, are there enough Americans here, who could raise the industry from the ashes and form a functioning unit, in America?

    1. simpl says:

      After nuclear war, you can live on existing drugs for a few years. Until ten years ago, I would have trusted Mylan to do that job.

    2. Brasstacks says:

      The real question is, raise it to what?

      It has been extremely successful in providing medications that serve the needs of the vast majority of the population, most of which are now very low cost generics.

      Human beings live longer healthier lives today that ever before in history.

      Now, are we talking about that or the pump and dump, let’s blind them with science efforts of a bunch of modern day snake oil salesmen that daytraders and greedy VC’s love?

  15. ddds says:

    Clinical trials are too expensive.. rethink the system.. align the salaries with the whole R&D…

  16. Anonymous says:

    I didn’t read the report. But are they saying that (1) as the amount of outside consulting increases (Deloitte, McKinsey, et al) AND (2) as Big Pharma clients follow the advice of those consultants to do more and more M&As THAT (3) ROI is steadily declining? Gee. Who’da thunk it?

    But I need to see the Excel chart and Powerpoint slide before I believe it.

    1. DP says:

      I’m a poacher turned gamekeeper, so I’ve seen R&D managed in multiple large pharma companies, and I can tell you that business acumen is in short supply among R&D leadership teams and their lieutenants. Believe me, you want more (high-end management) consultants in there, not fewer, because they carry business discipline and accountability into highly political, indecisive and profligate organisations.

      1. steve says:

        It depends on how you define acumen. If the goal is short-term benefits (e.g., mergers) so the upper management can pocket lots of bonuses then they are excellent. If it is to build long-term value and drug discovery programs then hell yeah, they don’t have a clue.

  17. Doc says:

    What seems to be happening is that pharma R&D is asymptotically approaching the spend level of consumer product R&D. (Around 1.9% for those of you who make real drugs as opposed to say hairspray)

    As a long-retired R&D exec, I find that an interesting phenomenon. Speculation: R&D will -in mature industries- be around 2% of the budget, as an asymptote. Discuss.

  18. J. Walker says:

    Rather than focusing on wishful thinking of consulting firms, that ahve a vested interst in the process, a better analysis, using real data, can be found in :
    Haucap, Justus; Stiebale, Joel (2016) : How mergers affect innovation:
    Theory and evidence from the pharmaceutical industry, DICE Discussion Paper, No. 218, ISBN 978-3-86304-217-2
    We have crossed the Rubicon, where innovation, and intellectual output, will not bring better ROI because we may no longer have the critical masses absolutely necessary across the industry. We are not lean, but rather starving to death. Either projects, and the scientists, receive proper funding, time to rebuild, and space to think, or we can all go home and let cancer, metabolomic diseases, neuro diseases, and superbugs win.

  19. bewilderedchemist says:

    So they mean to tell us that filling the labs with people from C&I or altogether moving research to those countries hasn’t produced any results!!??

    Imagine that.

    It seems to work for the box store industry.

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