Whether Pharma R&D Should Wither


Consider the fact that for most of its history, pharma's core mission has consisted of developing new drugs to advance medical care. Then consider that over the past several years, pharma's productivity at this central task has steadily declined. For example, the number of new molecular entities launched last year by Big Pharma was the lowest in a decade. Over the same period, the number of drugs entering the early, Phase 1 and Phase 2 stages of clinical trials fell by 47% and 53% respectively.

An analysis published this year by the consultancy Booz & Co. makes it clear that until recently, the industry has failed to even adequately acknowledge its declining productivity at new drug development. Strategy& determined that more than 70% of product launches in recent years missed their initial analyst sales forecasts.

Looking at the same picture another way, since pharmas are publicly traded companies, this mission of developing new drugs constitutes their chief means of generating a return on capital.

Another consulting company, KPMG, concluded that returns on R&D investment among the 30 leading drug companies fell by 50% since 1990. At a 10% rate of return last year, they claim that pharma R&D is barely adequate to cover the cost of capital.

Even if an increasing number of new drugs start rolling down the pipeline, and some of them actually achieve blockbuster status, a growing number of observers claim this still won't help pharma's financial position. Such hypothetical new drugs will essentially just replace the sales from products now losing patent protection. In Sunday's Financial Times Andrew Jack referred to a September report from Deutsche Bank that found the seven largest European drug makers "spent $161 [billion] in R&D during 2007-11 to produce drugs with a net present value of just $86 [billion]."

Jack summarized the position of those who now consider pharma R&D to be a fool's errand by claiming, "Most [pharmas] will struggle to stand still based on the fruits of their R&D."

Since the stock market evaluates pharma company shares according to projected revenues from current drugs and places little if any value on pipeline compounds, investors have pressured their managers to reduce R&D funding and enter partnerships that don't require the fixed costs of their own laboratories and employees. Among those investors, a particularly aggressive segment claims pharma should no longer even try to conduct their own research. Dr. Nissim Darvish, director of an Israeli financial consulting firm, claims that "only 24% of the drugs that succeed in Phase III clinical trials come from big pharma." Darvish believes Big Pharmas that insist on doing their own research wind up spending more on it, even though the success rates are no better than if they outsourced the work to smaller, more efficient outfits.

In addition to quitting the drug development business, Darvish contends, "pharmas should also abandon sales and marketing." One can hardly fault his second recommendation, considering that the industry has stubbornly clung to approaches such as territory reps, conventions and buying the influence of key opinion leaders, despite mounting evidence that the credibility and the results from those methods are steadily dropping.

So without R&D, marketing or sales, what tasks would remain for pharma? Darvish for one suggests, "Their core business will be money and management. Drug companies know where to invest money and which projects ought to be fostered." In short, pharmas in his model would operate as venture capital funds, leading "the orchestra of organizations" by outsourcing everything and offering the various players an optimal mix of equity positions and fees.

Darvish and others who are leaning more modestly in his direction assert that pharma should adopt what Oracle CEO Larry Ellison once called "the Hollywood model."

The analogy to the movie studios sounds appealing, and if pharma had its own Walt Disney and Lew Wasserman, the strategy might even work. The problem is that the reconfigured movie studios that prospered after 1948 did so by doing more than outsourcing, partnering, relying on independent producers, and providing capital.

Take the example of RKO Pictures, one of Hollywood's Big Five studios during the "golden age" between the two world wars. In 1948 RKO fell into a ten-year death spiral, while Disney, Time-Warner, Sony, Paramount, Universal and Fox survived and prospered because they figured out other ways to make money.

During the golden age, the studios' major revenue source was making movies for theatrical release. Today, that represents a relatively small source of profits for the conglomerates that acquired the studios. By the early part of this century, the moviemakers generated almost five times more revenue licensing their films for home entertainment than from theaters.

Then in the last few years the business changed again as pay-per-view and businesses such as Netflix cut into the sales of movies on videocassettes and CDs. Today the revenue share from home entertainment does not substantially exceed theater sales. Yet again the movie conglomerates prospered, this time by following the path that Walt Disney blazed in the early 1950s. According to Edward J. Epstein, Disney "discovered the source for a vast universe of profits that extended well beyond the American box office." Disney's idea consisted of licensing his cartoon characters to other industries such as watch companies, book publishers, clothing companies, toy manufacturers and scores of others.

So what remains for pharma? As a highly regulated industry, requiring a decade to develop each new product, it seems unlikely that pharma could respond to changing conditions as adroitly and swiftly as the Hollywood studios.

Are the pharmas quick enough to compete with VCs? That also seems unlikely. Pharmas move with the speed of a fly in a Jell-O mold while financial markets, predicated on the time value of money and driven by programmed trading, change rapidly.

Can pharma manage a diverse orchestra of players on dozens of different product ventures? Maybe they can, but not with a leadership that sat on vertical broomsticks and allowed the industry to descend to its present state. Pharma's current leaders hardly possess what it takes to direct a happy ride into the sunset. They might think they can do that but, more likely, their sunset ride would become Thelma and Louise's mad dash off a cliff.

To check out more Check Up items go to www.philly.com/checkup.