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DBL%20Hendrix%20small.png College chemistry, 1983

Derek Lowe The 2002 Model

Dbl%20new%20portrait%20B%26W.png After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: Twitter: Dereklowe

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February 5, 2010

Sheer Economics: How We Got in This Fix

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Posted by Derek

I hate to do another post on this subject, after a good part of the week has been devoted to layoff news and the like, but this one is too much to ignore. A reader sent along this link, which quotes a Morgan Stanley appraisal of the pharma industry as an investment. Here's what they're telling their clients:

". . .Still significant value in Pharma - we see material upside to ROIC [return on invested capital], earnings and multiples as Pharma withdraws from most internal small-molecule research and reallocates capital to in-licensing and other non-pharma assets. Worsening generic pressure and R&D management changes lead us to expect material cuts to internal small research spend (~40% total R&D) in 2010/11, after a decade of dismal internal R&D returns. We expect AstraZeneca and Sanofi-Aventis to be among the leaders in externalizing research, and this is a key driver of our upgrade of AstraZeneca today to Overweight.

Reinvestment of internal research savings into in-licensing will yield three times the likely return, we calculate. Under in-licensing deals, downside risk for pharma companies is currently materially lower than for internally developed drugs. Although upside is also capped by pay-aways and milestone obligations, the net present value of these payments is more than offset by the lower risk-adjusted invested capital. Over one-third of pharma R&D spend is in pre-phase II, where the probability of reaching the market is <10%. our proprietary analysis indicates that, unless the probability of an in-house molecule reaching the market is 30% or more, the risk-adjusted economic value added, or eva, is three times higher under the external research model, with a greater predictability."

It could be said in fewer words, but it's all there. If you're looking for the reason the big companies are doing what they're doing, look no further. Agree with it or not, there's a case to be made - and there's Morgan Stanley, making it - that the cost of running new drug projects in big pharma is just too high relative to the risks of failure. Those returns, in fact, are calculated to be off by a factor of three.

You may not believe that factor, and I have to say, I found it hard to believe myself. But let's say the Morgan Stanley folks have their numbers off. Perhaps it's only twice as profitable to bring in outside drugs as it is to develop them internally. Don't believe that one, either? Maybe it's only 25% more profitable - can you imagine making a move that would increase your company's return on investment by 25%? Industries get remade by such changes at the margin, and this one is remaking ours. Why do we have any internal R&D left at all, if those figures are anywhere near right?

Well, no one's tried to run a large company entirely by in-licensing, and I think that there are a lot of reasons why that wouldn't work. (For one thing, I don't think that there are enough things to in-license, and if one or more large companies announced that they were doing that exclusively, the price of each deal would go right up). And there needs to be some internal expertise left, if only to evaluate those external drug candidates to make sure you're not being taken. But still. All this means is that internal R&D will stay around, but it has to get cheaper and will very likely get smaller.

We can argue about the assumptions behind all this, but there's no doubt that a compelling business case can be made for this world view. Anyone who wants to argue differently - and a lot of us do - will have to come up with solid numbers and reasoning for why it just ain't so. I'm not sure such numbers exist.

There are many corollaries to this line of thought. One of them - and I hate to bring this up, considering all the horrible layoff news recently - is that one of the most psychologically comforting theories that we in R&D have for our present fix is likely wrong. I refer to the "Evil Clueless MBA CEO" theory, which has its satisfactions, but is a hazardous way to think. It is always dangerous to assume that people who do things you disagree with are doing them because they're just idiots or because they're innately malicious. In general, I'd say that the first explanation to jettison is malice, followed by stupidity (Hanlon's Razor). What that leaves you with is that these actions, stupid and malicious though they may appear, are probably being done for reasons that appear valid to the people doing them. I know, I know - some of these reasons are things like "So I can keep my high-paying CEO job", and we can't ignore that one. But a good way to lose a high-paying CEO job is to try to tell your board of directors (and your shareholders) why you're going to pass up an opportunity to get three times your ROIC.

Another thing to think about is, if these cost estimates are right, how did we get here? The best reason I can think of for such a disparity is that small companies (the source of these in-licensed drugs and projects) are often betting their entire existence on these ideas. They are very strongly motivated to do whatever they can do to get them to work (sometimes a bit too motivated, but that risk is already factored in), and if things don't pan out, they usually disappear. Basically, the in-licensing world unloads the risk from the large pharma company (and its shareholders) onto the investors in the smaller ones. The cost disparity will exist for as long as people are willing to back smaller companies. Now, this isn't to say that the big companies are always going to do a great job picking what to bring in. We've been talking a lot, for example, about the GSK-Sirtris deal, and that one may or may not work out. But the idea of doing big in-licensing deals in general - that's a different story, no matter how any individual company manages to execute it.

What that also means is that more of us are going to end up working for those smaller companies (which is something that I, and several commenters around here, have been saying for a while). If the large pharma outfits are going to devote more money to in-licensing, there will then be more opportunities for people developing things for them to in-license. The rough part is that all these structural changes in the drug industry are taking place (largely by coincidence, I think) during economic conditions which make funding such companies difficult.

And then there's the internal cost-cutting, for the R&D that's actually staying at the big companies. That, of course, generally means sending a lot of it to China, or wherever else it can be done more cheaply. And that's going to continue as long as it can indeed be done more cheaply, which means "not forever". Costs are already rising in China and India, although they have a good ways to go before they catch up to the US and Europe. I know that we can argue about how well that whole idea is going to work - there are clearly inefficiencies to doing a lot of your work through outsourcing, but as long as those don't eat up all the cost savings, it's still going to keep happening.

This, as a side note, is why I think that one of the suggestions that gets floated here in the comments from time to time, the idea of forming a "medicinal chemist's union", is completely useless. Unions form when workers have the leverage to preserve a higher-cost business model. In the end, the big industrial concerns of the early 20th century had to have workers, and they had to have them in certain locations, so the unions always had the threat of going on strike. At attempt to lower the boom under these conditions would result in everything going to China, and damned quickly.

So. . .what's happening to us, and to our industry, is not really mysterious. Our cost structure does not look to be supportable, and since there are cheaper alternatives that appear to be feasible, those will get tried. The disruption and destruction that all this is causing is real, of course. But the best I can offer is to try to understand what's driving all this upheaval, because that might help people to figure out how to protect their own jobs or where to jump next. Everyone has to give this some serious thought, because I don't see any reason why all this won't keep going on for some time to come.

Comments (109) + TrackBacks (0) | Category: Business and Markets | Drug Industry History


1. David P on February 5, 2010 11:08 AM writes...

Excellent analysis, Derek.

A colleague of mine recently speculated that Big Pharma would coalesce into about 4 companies and that they would pick and choose over the individual projects that small companies develop. This Morgan Stanley piece makes it look like it is moving that way even quicker than he thought.

On the plus side, I tend to prefer working in a smaller company (better work environment, despite lower salary/benefits), which will be handy if I want to continue in drug discovery.

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2. J-bone on February 5, 2010 11:09 AM writes...

I don't imagine you will make too many friends with this entry.

As a new postdoc I'm left wondering what scraps will be available for me when I finish. I hadn't planned on even doing a postdoc when I entered grad school, it just ended up being a necessity when the economy bottomed out. Now it looks as if I may end up having to do ANOTHER postdoc while job opportunities slowly emerge from the ashes.

Although I have experience in pharma and fond memories of it, I am open to suggestions about alternative fields where I might apply my trade.

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3. John FitzGibbon on February 5, 2010 11:09 AM writes...

This is an issue I've been thinking about for a while. Is a career in this model more or less attractive for scientists? While big pharma has it's drawbacks it has (at least in the past and I mean no disrespect to the people who are feeling the cuts right now) been fairly stable as a career. Whereas if one were to work in small companies with finite lifespans you have what I would perceive to be less stability, searching for a new job every five years or so. It's not something that really appeals to me.

All I'm saying is that there are already a lot of obstacles to becoming a research scientist, grad school is long and while many of your friends are buying houses and starting families you're sitting in lab on labor day running the longest column of your life. Then there's post docs, and I've seen 5 year post docs easy. Then you step out of that into a situation where you're not really stable? Is this going to push people away from science? I mean I already feel academia is doing that with the way it is. If the best and brightest are to choose this as a career there in some ways have to be other possible motivations than just love of science. Economic and family stability are things that a lot of people are looking for in life and I just can't see the pharma industry providing it now or in the future.

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4. Dave on February 5, 2010 11:13 AM writes...


Been a follower of yours both online and in Chemistry World for several years and I have to thank you once again.

As a still wet behind the ears chemist, I had dreams of finishing my PhD and heading into big pharma to make a real difference. As I "ride out the recession" (or so I tell myself) in a postdoc position (med chem) I have appreciated yours, and regular posters to this blog, insights into what's REALLY going on in big pharma. I don't want to join a company that does clinical trials and paperwork, I want to take the incredibly small chance that someday I'll make the drug that cures cancer/HIV/TB (take your pick).

Is it wrong though to expect to achieve this with some modicum of job security? You expect me to believe that in China they have life-long contracts in their biotech companies? Do these economists put a price on such a simple commodity as loyalty? Or should I accept that mine will be the life of a wild rover until, footsore and weary, I finally tire of the travellers life and settle down to any old job. No matter what the number crunchers say, that model of life just can't be right and surely there are arguments that settled workers are more productive? I would hope so.

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5. darwin on February 5, 2010 11:13 AM writes...

I am going out to open a Chrysler dealership

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6. Nick on February 5, 2010 11:17 AM writes...

So if the risks of internal R&D are so high relative to in-licensing, then how did we get to the current (now deteriorating) model of big pharma companies with internal R&D pipelines? Must one assume that the success ratio of R&D used to be higher? Is this current collapse entirely mediated by the exhaustion of low-hanging fruit and the shabby state of ladders to get us up to the higher branches? If so, then who, in this brave new world, is the giraffe?

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7. anonymous on February 5, 2010 11:23 AM writes...

The Morgan Stanley appraisal is essentially the rationale GSK Sr. management have given for the lastest round of layoffs and divestiture from the NS therapeutic area- that the risk/ROIC does not justify the significant level of financial investment, particulary compared to a better ROIC/ risk profile with consumer healthcare products. Although the margins are lower, ROIC looks better for toothpaste, nutritional products, etc that depression compounds.

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8. paul on February 5, 2010 11:23 AM writes...

There already is a med chemist union... it's those with a PhD. rather hard for anyone without one to move up in pharma research; it creates a barrier to entry that artificially increases cost of labor.

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9. cookingwithsolvents on February 5, 2010 11:28 AM writes...

Would someone with experience in the big pharma / start up be able to comment on the possibility of "loosing" more potential drug candidates to poorly run small companies just not getting the science done (well)? Is this a real possibility/fear? Certainly size buffers on against a bad decision which could easily sink a small company and a big R&D department allows more chances that the "right" person thinks hard about a crucial part of developing the drug.

This certainly falls into the realm of "there is no data for that". Anecdotes? Thoughts? I'm curious. . .

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10. J-bone on February 5, 2010 11:28 AM writes...

Paul, you'll be happy to know that many big companies have dropped the axe on Ph.D's (usually first to go due to salary) and dissolved the barrier that once existed between BS and Ph.D.

Back when I worked in pharma if I was looking for a job I skipped over everything titled "Scientist" because I knew it was for someone with a Ph.D. Now most of those same entries are looking for someone with a BS and 5 years of experience. Makes me wonder what I could be doing if I had continued with my previous company rather than go to grad school.

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11. PharmaHeretic on February 5, 2010 11:29 AM writes...

But how sound is the business model of financial institutions for them to preach fiscal sanity to others?

They are just publicly funded ponzi schemes, and therefore have no right to preach fiscal responsibilty.

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12. Hap on February 5, 2010 11:32 AM writes...

Outsourcing, though, works (among other things) by lowering the labor costs - and while that can happen for a while, at some point (unless there is some sort of intervention) labor costs will balance - wages in China for drug dev people are supposed to be increasing, for example, and if the jobs in pharma end up mostly being lower-paying and riskier small company jobs, the assumption would be that people will migrate to fields where they can get paid more (or more certainly), which will eventually force either labor costs higher (because there are fewer people) or force further outsourcing (which would increase labor costs elsewhere). There's also the issue of relative productivity, which this doesn't address (but, I think, whose resolution is not clear).

If outsourcing is mitigating early risks to smaller external companies, then won't companies simply demand more for their candidates, knowing that their potential purchasers have none of their own to support their business? Outsourcing also can't mitigate the expensive late-stage risks which seem to be the source of the cost issues (and which are, presumably, squarely in the niche that larger pharmas hope to secure for themselves), and outsourcing earlier risks will likely mean that risks will be pushed later (because, small companies have a large incentive to sell candidates, whether or not they may succeed in the long run, and unless diligence is good, larger companies will buy them and advance them to failure).

None of the benefits of outsourcing seem to be long-term ones (except, perhaps, the development of expanding markets, but that doesn't depend on outsourcing drug research, but on their general economic development). The method of outsourcing only mitigates those risks in the short-term (which, granted, is a requirement to reach the long-term) but does not solve them. It also creates problems for the long-term - for example, pushing people away from fields which require lots of learning to enter such as the sciences, for fields which either pay more or offer more situational flexibility (if my ability to get another job is my only security, then mastering a narrow field doesn't help me). If the ability to produce useful things and ideas is important, then basing an economy on the ability to manipulate things and money while devaluing the ability to generate the ideas and things to be manipulated seems to be damaging to our country's or society's long-term survival.

The incentives to outsource seems to be short-term cost cutting and not long-term company viability. The structure of executive pay (which seems to be fueled by low-cost stock options and direct pay, neither of which depend much on a company's short- or long-term successes) lead to the "MBAs are killing us" theory of pharmaceutical failure - people behave according to their incentives, and if their incentives make short-term benefits trump all else, well, then management will behave accordingly. I think, though, that pretending that outsourcing solves pharma's money problems is a management person's (or financier's) fantasy.

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13. g on February 5, 2010 11:35 AM writes...

It seems fairly obvious that this is not some cyclical downturn, but rather a fundamental restructuring. Morgan Stanley is saying that big pharma will become conglomerates, where they buy up mid-sized and startup companies.

The business model for these small companies is quickly becoming one where they madly rush to develop a drug, layoff everyone so they can pay for clinical trials, and then hope they can hold on long enough to show good Phase I and early Phase II data to get bought up.

Big pharma will hold the purse strings and will be the feudal lords and everyone else will be the lowly serfs doing the work for their daily bread. With the consolidation of big pharma, prices for buying drugs/companies will go up in the short term. But long term, I am betting on implicit collusion between the 3-5 remaining companies to push prices down. End result for scientists doesn't seem good-no job stability, downward pressures on compensation, and little likelihood for being around for the big payouts. eeep!

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14. LargerVier on February 5, 2010 11:42 AM writes...

Well said Derek. Also, the portrayal of the industry as “villainous capitalist” by governments and their doting media lapdogs have helped catalyze this industry’s reorganization with increased pressure on pricing. Although in the short term, capital will be hard to find to support new drug company startups, over the long term, more VCs will be lured in by the potential of huge returns.

It seems this will have a negative impact on the pipeline over the short term, but level out over the long term. Unfortunately, small market diseases may not see the opportunity for therapy they once had, and scientists may have to get used to bouncing from one venture to another with more compensation in the form of equity (risk spread even further). It would me nice to have a few “Pharmacon Valleys” spring up to avoid too much relocation during a career.

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15. Karel Krakatit on February 5, 2010 11:43 AM writes...

So does this new landscape for drug discovery alter the mission for those of us running academic research labs? As a PhD student in Medicinal Chemistry, I was taught by my professors that our goal was absolutely NOT to discover new drugs. That was the job of the pharma industry, and it was foolish to think we could, or should, compete. Our mission in academia was to innovate new insights and new tools valuable for the drug discovery process.

Now that big pharma is abdicating its role in drug discovery, should we step in to this vacuum?

This would be consistent with some of the grant proposal reviews I have been getting lately, in which I have been dinged for not presenting ADME profiles of proposed new compound families.

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16. Ty on February 5, 2010 11:47 AM writes...

I understand where Morgan Stanley is coming from. What it is is what it is. I believe it shows how this money-driven (ROIC, my ash) short-term 'visions' can take the entire industry down the drain. They did it for American electronics industry. They did it for American auto industry. Now, it's pharma's turn. They can save all the cost they want for now by externalising and in-licensing. But there are thing that you simply cannot translate into money.

I don't think anyone can change the tide. Don't look now, but there will be Samsungs and Hyundais of pharma in 10, 20 years while the current big pharmas will still be struggling to survive, if not taken down by then (bail out anyone?). And it's Western pharma company's own doing.

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17. anchor on February 5, 2010 11:47 AM writes...


Fantastic analysis and your take also informed us as to where this monster is headed. This Morgan Stanley analysis will put a serious dent on all those aspiring professors and students, if they really want to pursue carrier in organic chemistry/chemistry. What type of future awaits them, when they graduate? Opinion on this issue from your blog followers are much appreciated. Certainly, this sober article left me with a belief that our best days are behind us.

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18. Vader on February 5, 2010 11:50 AM writes...

All this is moot. With the omnibus health care "reform" bill on life support, Obama, Reid, and Pelosi are going to look for easier targets, and de facto nationalization of pharma is likely to take place. Fair nor not (I don't think it is) Big Pharma is not popular with many voters, and demagogues will take note and take advantage.

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19. BioBrit on February 5, 2010 11:55 AM writes...

Interesting post, thanks Derek.

So, I'm intrigued. Is the ROIC in a small company significantly different. Is it that much better because everyone cares more as they have 'bet the farm'? If not, why would anyone put money into a small company rather than a big pharma? And, given the push over the last year or so, for small companies to cut their discovery, or to just inlicence themselves, who exactly is going to discover the new stuff in the future? We can't all in-licence, surely those opportunities are going to dry up soon.

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20. Dster35 on February 5, 2010 12:02 PM writes...

Great points.
I'm relatively new to this industry and as such hear pinings for the "golden days" but didn't experience them.
I like the current environment as I'm resourseful and knowledgable and, due to the small cap science company I work for, am able to make an impact as my value is based on my aptitude and work ethic, not based on the number of years I've served or letters behind my name.
For any new graduate looking for "stability" - the only real stability you will find is in a solid network, good attitude, willingness to be resourseful and productively add to the value of an organization. I think the average, even just graduated, PhD has the opportunity to make impacts on many more smaller organizations than they did in the big pharma's that are just now adapting to the financial atmosphere of 10 years ago.

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21. David P on February 5, 2010 12:03 PM writes...

Karen (17):

There is a movement towards academic drug development. I believe the center at Vanderbilt University was the first (run by Jeff Conn), UNC has set one up more recently (staffed by several ex-GSK folks, naturally). I can see a place for them, especially now, where the drive is for publication and research rather than short term profit.

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22. processchemist on February 5, 2010 12:08 PM writes...

From my european point of view things are quite simple. The interests of the top management of the big global players (pharma, banks etc) is totally conflicting with the interest of the workers in the scientific field. Workers of different nations have different rights/levels of protection, but no one, IMHO, in Europe or US can swallow the pill of his layoff thinking that is for "a greater good". The real problem is that our contractual strenght, as singles or as category, has fallen to very low levels.
About analyses coming from Morgan Stanley, or GS, O JPM, well, these dudes did an heck of a brilliant job in the last three years, or I'm I wrong?
Sure, if they say so, in this direction things will go for some time (outsourcing to asia was heavily advertised from top world banks in the last three years).
How we and consequently a reasearch oriented western pharma environment will survive, this is the problem. And I think it's a collective problem, in the wider sense.

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23. Jack on February 5, 2010 12:10 PM writes...

Thought provoking piece, as usual. A minor quibble. Your comment about no big pharmas being successful by simply in-licensing stuff. You're probably too young to remember Marion Merrell Dow-they were hugely successful doing this, at least until they merged with Hoechst (remember them?). And today, Forest is a great example of a successful in-licensing only model. Sure, they don't just rely on small biotechs as providers, but they have successfully gone to Europe for regional deals, too (eg, Lundbeck). Shire is another successful in-licensing only company. And there are a number of others in the specialty space. So it can be done.

I agree with you that big P needs some discovery infrastructure to properly evaluate opportunities. And since a number of licensing deals are collaborations, there obviously has to be a coterie of qualified scientists within big P to enable that. In fact, when I was a big P licensing exec, I would "sell" our internal capabilities to drive the deal.

One point you bring up is particularly depressing-given that big P needs small B, where's the money going to come from to support the latter? Many VCs, thankfully not quite all, have become very gun shy of early stage discovery companies (they have good reasons to be this way due to the lousy financial climate); and big P is equally risk averse in this space-the heck of it is, that's where all the innovations will occur. Or not.

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24. Lu on February 5, 2010 12:15 PM writes...

Morgan Stanley seem to be interested in existence of small start-ups (borrowing money from banks) rather than large diversified companies financing research with their own profits.

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25. YoAdrian on February 5, 2010 12:15 PM writes...

One thing not really mentioned is the NIH's recent strong emphasis on funding "translational research" and away from basic science. This is basically subsidizing academic drug discovery efforts, which is where the IP originates for most small biotech start-ups.

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26. ManageThis on February 5, 2010 12:42 PM writes...


You said it brother. With way more eloquence and perspective than I ever could. Keep on speaking the truth.

I've been in both models, and the risky venture is the much more stimulating environment. Data go from your notebook to a presentation to investors in a matter of hours. Every success is an epochal victory and every failure is the brink of disaster. It's a rush. I'm looking forward to getting back to it.

And it's not all about outsourcing to Chindia. Read Derek's post carefully, the outsourcing bit only nibbles at the margins. In my experience, smaller firms actually outsource a lower proportion of their work, because they have to be nimble and they need to trust their data without double checking everything. So if one were really a sunny optimist one would say that the new model may actually result in more jobs for US/UK chemists. But nothing will happen until the VC money flows again. The financial crisis and the Madoffs of the world killed the VC spigot for a few years. As Derek alluded to, this is most unfortunate timing.

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27. hibob on February 5, 2010 12:50 PM writes...

Derek: I'm guessing the reason for the difference in ROIC is so high is because the numbers Morgan Stanley calculated are dominated by changes in the stock prices of the large company after each milestone during R&D rather than the differences in actual expense of taking drug candidates to failure/market in a small or large company. At each milestone, the big company is free to say "OUR drug is succeeding" or "THEIR drug failed".
The "dumb management" theory has a refuge there too:
"They are very strongly motivated to do whatever they can do to get them to work (sometimes a bit too motivated, but that risk is already factored in)"
Compared to an in-house project, the management in charge of licensed projects have had less incentive to keep questionable projects going, and probably face more pressure to terminate them. Management in charge of questionable in-house projects have had more "valid" (to their own careers) reasons to keep them alive until they die on someone else's watch.

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28. FMC on February 5, 2010 12:58 PM writes...

So guys,

before we all get way too excited, including Dr. Lowe I must add, I recommend to check what the Great Bankers of Wall Street are writing: "....our proprietory analysis......., with a greater predictability."
Well I have a couple of comments. When there is talk of a proprietory analysis, which I cannot check and people come up with a factor of 3 somewhere, favouring a new model then I must say that I do get a little suspicious, to say the least. Now when we are turning to more humble numbers, say like the ones quoted by Derek, then again I find that hard to believe (at this point of time). The additional issue I have with the analysis provided by Morgan Stanley, is that devilish half sentence: with a greater predictability !!!! Greater predictability of what? R & D spend? Reaching market? Not entirely clear to me. In this context, as we are talking outsourcing, in licensing and all that we should not forget, that the shift change in the business of big P that we are witnessing might finally bear a much larger cost on society than we can fathom at this point in time. Derek has touched that subject already marginally. If the workforce (highly qualified and driven) that was formerly needed in the US and Europe is obsolete (due to outsourcing into countries with a wage structure that is below ours) than one must think about the ramifications of this change also to academia. Furthermore, how in say 20 years time will it be possible to assess a good outsourcing/licensing deal, when the caliber of scientists that is available (well was available) to companies is just not there anymore ????
Over and out. All the best to you folks that are in trouble at GSK ....

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29. Curious on February 5, 2010 12:58 PM writes...

I am not in the pharma industry, but quite interested in what is going on in it. I found this forecast quite informative:

Some obvious overlaps with Derek's thoughts, though it seems to me the way big farma are headint to this future is too quick, agressive and risky.

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30. barry on February 5, 2010 1:00 PM writes...

I am reminded that Merck was one of the most admired corporations in the US and one of the most profitable for decades, and it was based on small-molecule research, rather than on M&A. Nothing in the past decade of merger-mania has shown us that this has changed. I don't know what's wrong with MorganStanley's model of reality, but it gives dangerously wrong results.

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31. Cloud on February 5, 2010 1:03 PM writes...

Great post, Derek.

One reason the small companies can do things cheaper has to do with the fact that it seems to be cheaper for them to do layoffs. I've been laid off from a biotech- I got 3 months severance, which I think is about average. I have friends who have been laid off from big pharma that, due to their years of service, got close to a year's salary. I think the biotech world just expects companies to shrink as well as grow sometimes. No one thinks anything of it if you have a series of 2 year jobs on your resume, because that's pretty normal.

John FitzGibbons- you are right that if you choose to work in this environment, you have to live with job insecurity. I deal with that by having a big financial buffer built up to carry me through the inevitable job search period after a lay off. You also start to get some spidey-sense about when bad things are going to happen, and some people will choose to start looking for a new job before the lay offs hit.

I personally enjoy the small company atmosphere and energy, and chose to leave a job at a large company to come back to biotech.

And I would argue that job insecurity has come to big pharma, too. In fact, I think it is coming to everyone, in every industry and we need to figure out how to handle it, both as individuals and as a society.

cookingwithsolvents- I think there are three big ways biotech companies fail: (1) bad science, (2) bad business model, (3) bad management. In my experience, reason #1 is the least common reason for failure. I've worked with a lot of great scientists in biotech. Small companies usually have a low tolerance for "deadwood", since there is no place to hide them. However, I have watched many companies go down because they never figured out how to make money or because their management couldn't figure out how to get them through the next stage transition.

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32. lynn on February 5, 2010 1:27 PM writes...

I see the perceived advantage for big pharma in going increasingly for in-licensing from biotechs - but, will that fill pipelines? In the antibacterial field, most small pharma that have succeeded [thus far] have in-licensed cast-offs from Big Pharma [or Asia] and there has been almost no novel discovery success - in big or small pharma [or academia] for years. Lots of reasons for that failure, of course. Mainly, it's hard. At least in the good old days, Big Pharma gave us more time [and many shots on goal] to come up with real candidates - and through that process, enabled a build-up of in-house experience and expertise. Time is not something small pharma will be able to provide. And, while some experience is provided to biotechs by ex-Big Pharma consultants, most of the biotech denizens (at least biologists) are not highly experienced.

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33. alig on February 5, 2010 1:59 PM writes...

A Bear-Stearns analysis in 2008 showed that compounds that made it through phase 2 which came from inside a big pharma had a much higher chance of making it to market than ones that were in-licensed (something like 80% versus 50%). Since it doesn't look like Morgan Stanley differientiated success rates post-phase 2, their analysis is fundementally flawed. >50% of development cost occur post phase 2, thus the "fail-fast" mantra inside big pharma.

I also wonder back to Witty's comment about no new NCEs from 98-07. He must be forgetting about Cialis(2003), which was discovered at GSK and given away by the BD folks after the marketing folks said there was no market for ED drugs. I wonder how a >$billion drug would have affected the ROIC of internal research.

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34. p on February 5, 2010 2:11 PM writes...

"given away by the BD folks after the marketing folks said there was no market for ED drugs. "

Wow, really? Must have been an analysis conducted by a 19 year old jock. Sex sells. Rule 1.

Good luck to everyone affected by all this.

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35. pete on February 5, 2010 2:43 PM writes...

Well written, Derek.

We all see that this change has been coming. But for me, with my 2 decades in Biotech, it's still pretty stunning how quickly the landscape has altered of late. Comparisons to what happened to the US electronics/textiles/tool manufacturing industries don't seem so off-the-mark anymore. The 'Decade of the Brain' ushers in the 'Decade of the Headache'.

Anyway, despite the gloom, I'm optimistic that smaller outfits will continue to provide an intellectually nourishing place for the energized life scientist. No doubt, though, it'll be a gypsy-like existence for some.

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36. Cloud on February 5, 2010 2:49 PM writes...

LargeVier: "It would me nice to have a few “Pharmacon Valleys” spring up to avoid too much relocation during a career."

They already have. San Francisco, Boston, and San Diego. To a lesser extent, Research Triangle. There are smaller concentrations in other places, too, and plenty of states vying to be next on this list.

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37. skyywise on February 5, 2010 2:50 PM writes...

Although times may be changing, I would hope that any company thinking about moving their R&D to China would still have serious reservations about (and I write this being part-Chinese and having lived in China, albeit not having worked in China):

1) The quality control of labs.
2) The honesty of scientists & managers regarding "progress" and/or raw data.
3) The likelihood that confidentiality will be broken or trade secrets will be stolen.
4) The risk that Beijing will simply confiscate that which they want to.
5) The hidden costs (graft/bribes) to foreign companies.
6) The questionable enforcement of IP laws (despite the 50 Intermediate People's Courts set up to primarily handle patent law).

China may be a large looming specter, but it is still a third-world country with first-world cities. One can't assume that laws and culture will give the same security as they do in the US or Europe. There is something to be said for conducting research where you don't have to worry about risks outside of the science itself.

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38. dearieme on February 5, 2010 2:52 PM writes...

"there has been almost no novel discovery success - in big or small pharma [or academia] for years." And there you have it.

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39. Anonymous on February 5, 2010 2:56 PM writes... about privitization of the industry? I haven't read about any giant cuts at Boehringer Ingelheim. All you have to do is stay in business by turning a profit each year. You could even save (gasp!) some of your money for when your blockbuster goes off patent.

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40. biobug on February 5, 2010 3:02 PM writes...

I think the Morgan Stanley piece is completely wrong. The Big Pharma companies have gone through bouts of in-licensing and merging, then cutting back on in-licensing. The trend has little to do with ROIC which is virtually impossible to calculate for these companies due to poor visibility into costs, and extremely long development time-frames. Do you take the ROIC based on R&D spend from 10 years ago? How many of these companies existed with the same name and structure? Innovation is not a strict money in, widget out proposition as you've often mentioned.

Instead, patent expiration moving billions and billions of dollars out of drug spending, is forcing a wide across the board contraction in all drug development activity. That's it. Until the FDA loosens requirements on drug approval, or there is some new break-though in therapeutics (such as stem cell or gene therapy or RNA technology suddenly starting to work), expect the industry to not resume robust expansion until at least 2015-2017.

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41. Gomer Pyle on February 5, 2010 3:21 PM writes...

Derek said-

"This, as a side note, is why I think that one of the suggestions that gets floated here in the comments from time to time, the idea of forming a "medicinal chemist's union", is completely useless"

Actually you seem to have limited vision with regard to unionization. Drugs are allowed onto the US market by the FDA. The FDA can also set the terms by which a drug is granted exclusivity, regardless of patent status.

I think legislation which mandates preferences for drugs developed on US soil should be a national security priority. This can take the form of tax breaks or FDA regulation.

The notion of "OMG, we're offshoring the entire US drug industry and there's nothing we can do about it!!!!!" is absurd.

And yes, there is a problem with sociopathic managers destroying their businesses to secure there own bonuses (or didn't you notice the trillions going to the banks????). Do you think the managers in Pharma are any different???

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42. iridium on February 5, 2010 3:23 PM writes...

We always discuss assuming that new drugs will be made because we need them, but someone has to pay their price.

While we can certainly agree on the need, are we so sure we will have a buyer for our very expensive products? No matter which model you pick (outsorcing or not, small biotech or big pharma) it will cost a lot of money.

What about "our" system crashing due the too high risk/price? Maybe there will be a word without med.chem... or not?

Did I take it too far?

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43. Wavefunction on February 5, 2010 3:24 PM writes...

Excellent analysis and post Derek. I think your point about the MBAs having their own valid reasons for acting the way they do is well-taken. It's not pretty but it seems to make sense.

The question then is; will there actually be great science for us to do in these small companies from which the big behemoths will in-license? As a pharmaceutical scientist I think I can speak for others that our first goal is to do great drug discovery science. Also, do you think that careers in these small companies will be more stable than in big ones, at least until they progress to the in-licensing stage?

And lastly, while you have not mentioned it, do you then see more basic drug discovery research happening in academia (with all its limitations?)

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44. Realitycheck on February 5, 2010 3:27 PM writes...

#28 is spot on, this analysis is much too "proprietary" for me. Now I'll admit my own bias & that I’m in a big company. We’ve inlicensed molecules from academia/spinouts, and usually when we get our hands on the compound it’s been worse than what we already had. Big pharma is MUCH choosier about what it puts into the clinic because it doesn’t have to generate hype (or publications) to survive. If your project doesn’t deliver something you’re confident will progress, you shrug and move onto another target. By that time a small biotech will have run out of cash and will have to put out a press release to raise some more.

I wouldn't be surprised if the success rate from big pharma PhI compounds is at least 3 times higher than those from academia/spinout.

Fortunately for the academic drug discovery sector, if big pharma management understands that it chooses to ignore it. There’s plenty of kudos for having the vision to inlicense compounds to fill your pipeline, and when it all goes tits-up they know they’ll be long gone.

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45. Tok on February 5, 2010 3:59 PM writes...

Morgan Stanley says "Jump!" the entire industry says: "How high?"

Clearly they were right about the housing market so they must be right about pharma.

Talk about power.

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46. oldtimer on February 5, 2010 4:05 PM writes...

Gomer Pyle

Re US preferences

Before you do that recognise that we live in the real world as far as Pharma is concerned and there is no US domination. A quick look at the asthma market will show you that the really successful treatments for that disease all came out of Europe, specifically UK, Sweden and Germany. Montelukast may measure up in termms of sales but not in terms of efficacy. The last thing this industry needs is a tariff war, the patient will be the loser.
On the other hand beware the risk that Chindia will renege on IP or even nationalise your assets.

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47. Anonymous on February 5, 2010 5:09 PM writes...

In the chemical industry, when a company decides a particular business area isn't a good fit for their long-term strategy, they usually either sell it to another company or spin it off. I don't understand why the big pharma companies are just chucking everything in the dumpster instead of trying to sell or spin off pieces of R&D, especially when it seems like small biotechs are the way of the future.

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48. outsider on February 5, 2010 5:18 PM writes...

Drug research is very much driven by the frequency of attempts, where each attempt has a certain probability of success (just like the Arrhenius equation). To maximize the frequency it is probably ideal to have a lot of small low cost start ups, with people working lots of overtime for small salary.

Bigger companies have a lot more overhead, plus stability for employees' also has a non-zero cost. From the observed rates of successes, there don't seem to be many synergies from having several projects taking place in the same location (like in a big pharma). There is an advantage in having a big distribution network with marketing dollars pooled together for sales and advertising.

So, the following things can be seen in the crystal ball:
-many small companies funded by VC
-a lot less stability for employees
-worse benefits

In short, better for investors, worse for science employees. Certainly not a good career path, if you ask me!

Welcome to the service economy, where the coveted jobs are pizza delivery, and manning cash registers in Walmart.

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49. Mutatis Mutandis on February 5, 2010 6:38 PM writes...

I think the flaw in MorganStanley's analysis is the assumption that the internal R&D productivity of the big pharma companies is what it is, and cannot change relative to that of the smaller companies. If that can be called a flaw, it is more an assumption. But I think it is wrong assumption, because I think internal R&D productive not only CAN improve, but MUST improve in order for the large pharma companies to survive. It must improve because I don't think a pharma company can run completely on in-licensing. All my experience suggests that having internal research programs is an important precondition for successful in-licensing of external compounds. With that internal know-how, a company is shopping blindfolded.

The key to the productivity of small companies, as Derek writes, is that they will do whatever it takes to develop their drug successfully, because their entire survival hinges on it. They are product-driven. But in large companies process-driven thinking tends to prevail. The question their management asks is not "How can we bring this drug to market?" but "Would it not be more efficient to set up a standardized process to bring drugs to market?"

Process-oriented thinking is fine if you are building the Ford model T, but in the pharma industry every product is a prototype, and building a fully automated production line for prototypes doesn't make much sense. Yet high-level managers are addicted to tinkering with processes, in part because there isn't much else they can do, and in part because it gives them a reassuring feeling of control. (I don't want to blame it on the MBAs, because many scientists develop similar reflexes when they enter management positions.)

But it simply cannot last. In the long run --perhaps the very long run-- 'Big Pharma' will have to learn to think like a biotech.

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50. Cellbio on February 5, 2010 6:40 PM writes...

outsider, it is not that bad. Yes instability is probably higher, benefits not much different, but you gain the ability to participate in bigger financial upside. Plus, you can actually make a difference, make a drug, as opposed to trudging along company dictated project paths, with metrics and processes often drafted by the likes of McKinsey, with a very modest prospect of having a single days work amount to anything useful.

Oh, and mixing with new folks, in new ventures, is not to be dismissed either. I can tell you I feel much more invigorated and inspired after leaving a bigco. I am now on my third venture, and have several other opportunities coming my way. In fact, with this network, I feel more secure in my career while also knowing my time at any one shop may be short. I did not have this outlook when working for the bigco. I could only think of trying to replace that job with a similarly constructed one, but now would not go back.

If you are truly passionate about the science, does it matter if you turn right or left out of your driveway? Maybe the science would be more pure if scientists were more mobile? I certainly judge the science behind a venture when evaluating my career choices. Previously, inside bigco, I would push for as much good science as the organization would. Why accept the false limits?

OK, so having a salary vs. not is an issue, but if you find yourself forced out, don't give up on science when alternatives with real benefits exist.

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51. milkshake on February 5, 2010 6:44 PM writes...

#50 Cellbio please would you drop me an e-mail? My gmail address is tvojkovsky. Thanks a lot.

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52. Jumbo on February 5, 2010 7:01 PM writes...

@Mutatis - well put, product vs process. I have worked both at large, 'old school' pharma and at very big biotech and one thing they unfortunately had in common was elaborate flow scheme rubriks: "compound must be of MW x, with potency at target of 25%, and CYP450 profile of n." And don't forget the need full a fully actualized biomarker strategy before beginning clinical tr