Pharma R&D Productivity Continues to Fall

Drug developers are facing a development drought that persists despite greater R&D spending, consultants at Oliver Wyman find in a new report.  Specifically, the report claims the value generated by a dollar invested in pharmaceutical R&D has fallen by more than 70% in recent years.

To shed light on the R&D productivity problem, 450 new drugs approved by the FDA between 1996 and 2010 were evaluated by Oliver Wyman according to the following criteria:

  1. The number of new drugs approved by the FDA each year.
  2. The value of the new drugs launched each year (based on the revenue generated by the original NME in the fifth year after launch, in constant dollars).
  3. The total amount invested in R&D each year, again in constant dollars.

Data from the report

  • Based on the return of productivity metric, the study divides the fifteen-year period into an ‘era of abundance’ from 1996 to 2004 and an ‘era of scarcity’ from 2005 to 2010, divided by the September 2004 withdrawal of Merck’s Vioxx.
  • Even with recent reductions, R&D expenditures almost doubled over the study period, from an average of $65 billion per year in the good times to $125 billion per year. However, “those dollars produced significantly less” and in the era of abundance with drug companies making an average of $275 million in fifth-year sales for every $1 billion they spent on R&D. In the era of scarcity, that figure fell dramatically to $75 million.
  • The development drought also led to a declining economic value of approved drugs, to an average $430 million from $515 million.
  • Drug approval itself plunged about 40% in the dry years, amounting to 22 FDA approvals per year on average, versus 36 in the better years.
  • Drugs produced an average of $9.4 billion in fifth-year sales in the dry period, half of the $18.3 billion during the more productive years. Fewer blockbusters and fewer new drugs overall contributed.
  • In all, 17 of the 20 companies faced productivity declines, though Novo Nordisk, Bristol-Myers Squibb and Johnson & Johnson did better than most, the report notes. Dips in high levels of productivity hit everyone, however.

Possible explanations for the drop in return

A Forbes article last week explored this drop in productivity in light of Lipitor’s patent expiration – and, specifically, the lack of new blockbuster drugs in the wake of Lipitor’s huge success.

There may never be another medicine like it [Lipitor]. That’s because of fundamental shifts in our understanding of biology, because of the demands made by patients, doctors, and society on new drugs, and because new drugs now have to compete with the super-cheap, generic versions of every medicine ever invented. Already, eight of ten prescriptions are for generics, and the drug industry is focusing on higher priced, specialty products for patients who are not helped by existing options. Good luck creating a new cholesterol drug as potent, safe for most people, and widely tested as Lipitor.

The Forbes article touches on some of the same reasons discussed in the Oliver Wyman report for the poor return on R&D investment, namely it’s become tougher to find new drugs, and pharmacoeconomic pressure is changing the way drugs are prescribed.  Not mentioned in the Forbes article, but perhaps equally compelling to this discussion, are the effects of an increasingly stringent and inconsistent regulatory environment, and the shift from antiquated, brute-force marketing methods within the pharmaceutical industry to an emphasis on focused marketing in select, specialized areas, each of which will be discussed in more detail below.

The standard of care in many disease categories is high and rising

After decades of abundant discovery, many disease categories are well supplied with safe and effective therapies—once-daily pills that control symptoms or modify disease progression. And many are cheap: in the U.S. overall penetration by generic drugs reached 78 percent of prescription volume last year, up from 63 percent in 2006.  Increasingly, physicians and payers alike see less value in drugs with incremental benefits.

Tougher to find new drugs

Many within the industry acknowledge that the easiest biological pathways are now well understood, and the mechanisms for manipulating these pathways are targeted by some of the drug blockbusters referenced above.  Lipitor, a statin, is an excellent example.  Statins lower cholesterol levels by inhibiting the enzyme HMG-CoA reductase, which plays a central role in the production of cholesterol in the liver. Cholesterol levels are highly correlated with cardiovascular diseases – and a mechanism (statins) to control said levels.  On the other hand, diseases such as schizophrenia and Alzheimer’s disease are difficult to clinically classify and even more difficult to understand from a pharmacological perspective.  Yet these diseases and many others represent huge markets, but will require equally huge R&D investments to yield useful drugs.

Tougher regulatory environment

Lipitor was introduced prior to the big drug safety scandals that changed the industry.  After Vioxx’s link to heart attacks and worries that antidepressants like Paxil and Zoloft might increase the risk of suicide in some patients, the medical community, especially regulators, changed the way they evaluated new drugs.  Not surprisingly, the regulatory environment has become more stringent.  While becoming more stringent, many within the pharma industry (and those that invest in the industry) also complain that the FDA lacks consistency – both in terms of policy and timing, thereby leaving the industry with an even more difficult path to the market.

As expected with the tougher regulatory environment, the average number of NME approvals per year during the era of abundance (36 NMEs) is higher than during the era of scarcity (22 NMEs). (See Exhibit 1 of the Oliver Wyman report).  It’s also interesting to look at the number of NME applications filed to better understand the FDA approval rate during this period, and it’s effect on pharma R&D output (application submissions).  As the graph below clearly shows, less applications are being submitted to the FDA during the study period.

Source: FDA

Also, the nature of clinical trials has changed.  It used to be new drugs were introduced, and later approved, for a general indication (e.g., cardiovascular disease risk) that was prescribed to a large patient population by general practitioners.  Now, drug makers are being forced to design clinical trials to better identify those segments of the population that are likely to respond to the drug.  As a result, fewer drugs are being more highly scrutinized for smaller segments of the population.  This may be good science, but it cuts against pharma’s bottom line.

Pharmacoeconomic considerations

Rapidly rising healthcare costs are now a political and economic challenge in every mature economy. Payers are scrutinizing every category of expenditure, including drug spend, and they have become increasingly aggressive about using their purchasing power to push back on prices.

Also, many doctors are now wary of treating everybody with the same pill for years in order to get a small benefit for the average patient.  There is a push to better understand which patients are helped most by a particular drug (for example, through pharmacogenomic studies), and to utilize electronic health records to track how well medicines are working in the real world. The one-size-for-all system is being rejected, and it’s being felt at pharmaceutical companies.

New emphasis on specialized marketing

Previously, when a new drug made it to market, pharma companies would invest heavily in marketing it, while also leveraging its existing primary care infrastructure. All of the major drug makers operated in the same major disease areas, and competitive differentiation focused on power in sales and marketing.  But the new pharma environment, namely cheaper generics, more aggressive payers, more stringent regulatory standards and denser, tougher, rarer science—have upped the competitive requirements. Now big pharma is realizing that they can’t compete effectively in every therapeutic category, so they must specialize – whether it’s during the R&D phase and/or during commercialization.

Going forward

Regardless of the cause or the metric used to measure it, almost everyone agrees there has been a drop in productivity among pharma companies.  Still, as the report points out, pharma companies’ net income is a healthy 20 to 30 percent and the industry has maintained six percent annual growth over the past five years in the face of global economic headwinds.  In order to maintain these levels or improve upon them, the report recommends pharma companies:

•    Raise the bar on product innovation

•    Do more to solve the payer’s problem

•    Treat drugs not as predictable or abundant, but as rare

•    Make concrete moves toward differentiation and focus

Many of these recommendations have been suggested before, but the report digs down and focuses on addressing the needs of patients and identifying those who truly benefit from a particular drugs.  While the biology has gotten tougher, technology continues to advance in such a way that responders can be better identified thereby appeasing both the medical community and the payers. However, a lot of these changes come at the expense of pharma companies that will face smaller, specialized markets as they wean themselves off the fat days of widely prescribed drugs with marginal effects that resulted in large margins and high growth.

Regards,

The Bourne Partners Team

About Bourne Partners

As a healthcare-focused merchant bank, Bourne Partners provides financial advisory, direct investment, alternative assets and management consulting services to our client-partners. We play an active role in helping businesses grow by creating long-term, profitable relationships that extend beyond single transactions. It is our focus on relationships and long-term results that has yielded us an impeccable track record of client satisfaction . Our direct and indirect investments in sector-leading companies – often through our relationships with top-tier Private Equity funds – allow us to learn about the best-of-the-best from the inside and apply that knowledge to the companies we serve. At Bourne Partners, we operate within a specific set of core boundaries: integrity, accountability, teamwork, loyalty and commitment are the driving forces behind everything we do.
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