I wanted to extract and annotate a comment of Bernard Munos' from the most recent post discussing his thoughts on the industry. Like many of the ones in that thread, there's a lot inside it to think about:
(Arthur) De Vany has shown that the movie industry has developed clever tools (e.g., adaptive contracts) to deal with (portfolio uncertainty). That may come to pharma too, and in fact he is working on creating such tools. In the meantime, one can build on the work of Frank Scherer at Harvard, and Dietmar Harhoff. (Andrew Lo at MIT is also working on this). Using simulations, they have shown that traditional portfolio management (as practiced in pharma) does achieve a degree of risk mitigation, but far too little to be effective. In other words, because of the extremely skewed probability distributions in our industry, the residual variance, after you've done portfolio management, is large enough to put you out of business if you hit a dry spell. That's why big pharma is looking down patent cliffs that portfolio management was meant to avoid. Scherer's work also shows that the broader the pipeline, the better the risk mitigation. So we know directionally where to go, but we need more work to estimate the breadth of the pipeline that is needed to get risk under control. Pfizer's example, however, gives us a clue. With nearly $9 billion in R&D spend, and a massive pipeline, they were unable to avoid patent cliffs. If they could not do it, chances are that no single pharma company can create internally a pipeline that is broad enough to tame risk. . .
That's a disturbing thought, but it's likely to be correct. Pfizer has not, I think it's safe to say, achieved any sort of self-sustaining "take-off" into a world where it discovers enough new drugs to keep its own operations running steadily. And this, I think, was the implicit promise in all that merger and acquisition growth it undertook. Just a bit bigger, just a bit broader, and those wonderful synergies and economies of scale would kick in and make everything work out. No, we're not quite big enough yet to be sure that we're going to have a steady portfolio of big, profitable drugs, but this next big acquisition? Sure to do the trick. We're so close.
And this doesn't even take into account the problems with returns on research not scaling with size (due to the penalties of bureaucracy and merger uncertainty, among other factors). Those have just made the problems with the strategy apparent more quickly - but even if Pfizer's growth had gone according to plan, and they'd turned into that great big (but still nimble and innovative!) company of their dreams, it might well still not have been enough. So here's the worrisome thesis: What size drug portfolio is big enough to avoid too high a chance of ruin? Bigger than any of us have.
Here's de Vany's book on the economics of Hollywood, for those who are interested. That analogy has been made many times, and there's a lot to it. Still, there are some key divergences: for one thing, movies are more of a discretionary item than pharmaceuticals are (you'd think). People have a much different attitude towards their physical well-being than they have towards their entertainment options. Then again, movies don't have to pass the FDA; the customers get to find out whether or not they're efficacious after they've paid their money.
On the other hand, copyright lasts a lot longer than a patent does (although it's a lot easier along the way to pirate a movie than it is to pirate a drug). And classic movies, as emotional and aesthetic experiences, don't get superseded in quite the same way that classic pharmaceuticals do. Line extension is much easier in the movie business, where people actually look forward to some of the sequels. Then there's all the ancillary merchandise that a blockbuster summer movie can spin off - no one's making Lipitor collectibles (and if I'm wrong about that, I'd prefer not to know).