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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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January 9, 2014

Three Options With Five Billion to Spend

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Posted by Derek

Here's a discussion on a tricky question:

If you had $5 billion to invest, which is the current average R&D spend required to develop and launch just one new drug (without any guarantee of reimbursement and market success), how would you invest it:

1. Directly into your internal R&D pipeline, based on established approaches to drug discovery and development which are currently giving an ROI of only about 5% (and rapidly declining)?

2. Acquiring new product candidates externally, at full market price in an increasingly competitive environment?

3. Building a portfolio of say 50 independent projects to explore completely new and different approaches to drug discovery & development, each with a 2% probability of doubling your ROI indefinitely into the future?

Those alternatives are not exactly phrased in a neutral manner, but they're hard to be neutral about. My take on them is that option (1) is the one that's least likely to get you removed by your board of directors, because it spreads the blame around. Option (2) would be insane, if it were the only thing you did, but perfectly reasonable as a complement to either (1) or (3). And option (3), well. . .the problem with that one is finding 50 "completely new and different" approaches to drug R&D. I don't think that there are that many, honestly. And I also doubt (very strongly) if they all have as much as a 2% chance of succeeding.

So if I were a CEO, and God forbid, I would do enough (1) to buy me some cover, enough (2) to try to keep the Street happy, and spend whatever I had left on (3). I would not, of course, phrase my decisions in those terms. Sound good?

Comments (41) + TrackBacks (0) | Category: Drug Development


1. anon on January 9, 2014 12:22 PM writes...

cryptocurrency - much better ROI than drug development
(flippant, yet semi-serious comment)

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2. Tuck on January 9, 2014 12:28 PM writes...

They're asking you to pick one.

I'm guessing from your answers that if forced to choose it would be 2?

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3. Useless Molecule on January 9, 2014 12:32 PM writes...

The best answer is 2)

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4. Hap on January 9, 2014 12:34 PM writes...

1) Where does the $5G/drug number come from? It seems less ludicrous than $43M/drug, but is there any (published?) evidence for it being that high? If that's accurate, If so, that might be a problem. $5G over 20 years is probably worth at least $7-8G, and with the risk involved you have to make more than that to be worth it to invest ($20G?). How many drugs will make that much in profit (over cost of goods, I guess) over their lifetimes? The number is nonzero, I assume (Lipitor, for example), but not all that high.

2) There are probably more than 50 approaches left, if you're counting new targets as well as new methods. I don't know how you assess the probability of success of an unknown, though.

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5. bigredbruce on January 9, 2014 1:46 PM writes...

In other words, you'd employ a portfolio approach to spread risk and hopefully earn acceptable returns. It works for other forms of financial investing and could easily work here -- if your portfolio is representative and balanced.

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6. Ghost Chemist on January 9, 2014 2:01 PM writes...

You're right Derek, pharmaceutical companies are using an all of the above approach to the strategy in varying percentages, like 1) 50%, 2)40%, and 3)10%, etc. Internal R&D pipelines (re 1) include more antibody drugs against CD-XXX etc. and other biologics than the remaining focused small molecule programs.

I'd wish biotech startups with small molecule programs would form collaborations with big pharmaceutical companies to take advantages of the resources they could offer, like their enormous chemical libraries to screen new chemotypes. Some companies are already forming these types of collaborations with academia like GSK's DPac initiative, but small biotechs could take advantage of these partnerships as well.

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7. anon the II on January 9, 2014 2:15 PM writes...

I'd hire a bunch of my friends (but not all of them) who have been laid off from big pharma and are either out of work or doing something menial. I'd pay us well, not an outrageous amount, but something like we made in the late 90's. And I'd start a drug company. We would try to discover drugs because it's a fun and worthwhile thing to do. We wouldn't have problems with hubris, ambition and arrogance since it's been beat out of us over the last decade. We'd try to rekindle that spirit that we had the first week of doing drug discovery in Big Pharma before the first management meeting. I think we might just succeed.

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8. Anonymous on January 9, 2014 2:40 PM writes...

You're a management - oh sorry, an "innovation and productivity" - consultant, with 5 billion big ideas in your well-coiffed little head. Do you:
1) Share your big ideas with an established big pharma company's R&D executive team ?
2) Invest in your big ideas by forming your own pharma startup ?
3) Spend your big ideas on some pointless LinkedIn discussions ?
4) Forget your big ideas and go do something useful, like gardening or baking bread ?

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9. Moneyshot on January 9, 2014 3:14 PM writes...

I would invest it all in equities,and go sit on the beach. Hard to beat average of 7-10% return in a no load M fund that requires little or no oversight. Why bother?

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10. entropyGain on January 9, 2014 3:19 PM writes...

I'd be careful of buying into the premise, especially here on this board where we should all know better. How much of that $5B is really phase IV marketing studies, research handouts to "KOLs", inflated layers of "management", allocations to overhead to buy fancy buildings etc? How much of that $5B is due to investing way too long on way too stupid of projects ($B insulin bong anyone?).

@7 has the only real solution. Large companies will increasingly be forced into option #2, because of inability to execute on either #1 or #3.

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11. Bruce Hamilton on January 9, 2014 3:40 PM writes...

I'd choose 1. The internal R&D pipeline should contain potentially valuable drugs. If not, you should have resigned years ago. Unfortunately, "fail fast" only ever applies to unloved projects, never incompetent highly-paid management.

Pharma company management is unable/unwilling to technically assess drug proposals, and instead advances people with good skills at interviews and presentations.

The management builds pretty and expensive R&D centres for the fast-talking researchers, but will petulantly destroy the costly infrastructure when the expected drugs don't appear in time for the next bonus/share issue.

For the other options,

2. The people selling you the drug candidate know far more than you, hence most purchased candidates are lemons, and you hate lemonade.

3. 50 independent projects will produce 50 project leaders whose sole aim is to separate from you the maximum amount of your money. They will prolong their project for as long as they can. If you couldn't fill your internal pipeline by picking winners, you're unlikely to weed out the losers quickly, and thus will spread your funds too thin for any winners to ever reach the finish.

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12. Cellbio on January 9, 2014 3:51 PM writes...

If I had an R&D pipeline, then the company already exists and this is a new infusion of money? I would assume the pipeline was well chosen and not a house of cards to obtain the money, so this cash would support those programs in ways that would accelerate or better inform decisions. I'd try to get more clinical exploration (indications, patient selection) than allowed under a more constrained budget. I'd keep a large sum available (1-2B) for option 2) to try to buy molecules in those pathways/targets that the pipeline is hitting with the belief that the programs were chosen as the best options from a field of many, so further investment remains warranted. This also means the licensing or purchase of these clinical molecules would be well supported by a technical team that can identify value. For the remaining money I would fund option 3), at at least 30M, to run a phenotypic screening program up to the point of generating clinical candidates.

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13. Wage Slave on January 9, 2014 4:16 PM writes...

If my goal was strictly ROI, I would not invest it in the pharmaceutical business. I've been in this business for 12 years and am shocked to hear myself say that, but I have a problem with the commercial people who are all about ROI. If you want to make money - go to Wall Street or other investment firms. If you want to make the world a healthier place, have a reasonable amount of grounded idealism that you CAN make a difference and turn scientific advances into public benefit, than stay here. Yes, this is a businesss - but it is a special one for sure.

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14. Anonymous on January 9, 2014 4:23 PM writes...

@10 Are there hard numbers available on the distribution of the $5 billion into overhead and actual drug development? I assume now that most of the billion dollar calculations take "Money spent in period X" and divide by "drugs approved in period X" to come to a development cost. But as recently mentioned, it just seems as many of the companies crashing were right in the process of building new headquarters...

Maybe the $5 billion then spent on R&D (Up to approval), will get you a lot further in option 1, than just one drug. I guess that is also the core of the disbelieve many non-scientist have when learning the cost of drug development: The number is astronomical, but how much is actually spent on the development, they wonder.

Again, are there reports on these numbers somewhere to be found?

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15. anon on January 9, 2014 4:43 PM writes...

questions like that can never be answered without actual hard data into what the different research options are...

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16. CMCguy on January 9, 2014 6:15 PM writes...

As #13 WS points out this discussion should start with what the ultimate goal and time requirements are (or perhaps should be): if Business strictly chasing max ROI/profits then might reflect choices (such as #13 suggests) verses an actual mission directed to provide new drugs to patients. This is the old unanswerable struggle between the MBA and R&D types in short term vs long term focus. I think the assumption behind question is that you can only pick one option but like Derek suggest need the hedge this since all the baskets will end up with broken eggs (and in the end will likely need and want spend additional for any compound(s) that do make it to market).

If want to develop and launch a drug I would guess for most of Pharma 1)internal R&D likely has highest probability of successful drug introduction providing organization has legitimate capabilities and infrastructure that has not been purged by past mergers and reorganizations (thus question does any such exist now?). As would hope part (large) of the mission is for novel drugs/diseases would include appropriate due diligence in acquiring some 2)s to augment internal programs (although how and why would want to tie this to keeping Wall Street happy is beyond me, especially if keeping in that state for more than about 5 minutes was even possible). Indeed should be efforts directed toward innovative 3) type projects although would structure to remain independent as external organization element unencumbered by internal conflicts (Does the Gates Foundation fit this model?). Although again trust appropriate and sufficient internal folks remain in place to properly evaluate the most promising, with consultants added to mix, and then guide or take over development.

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17. annon on January 9, 2014 6:23 PM writes...

option 4: give it to the stockholders

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18. CMCguy on January 9, 2014 6:26 PM writes...

There is also a 4th option to consider: Start a Generics company to produce (or outsource) and sell drugs already invented by others. While by definition does not mean getting any new drugs the quicker and easier profits will likely have decent ROI relative to other options.

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19. entropyGain on January 9, 2014 8:17 PM writes...

@14 - unless Pfizer is far more efficient than average, then something is fishy with $5B.

For fun, I just took a quick look at Pfizer’s financials for 2012
(2013 isn’t available yet)
They had 3 drugs approved that year (Inlyta, Bosulif, Xeljanz) for oncology and RA.
In their income statement they spent $7.8B for R&D in 2012.
The simple math would be $2.6B each compared to the $5B thrown around. (Wow!, PFE must be really good)

However, dig a bit deeper and you find a nice table breaking down “R&D” expenses by Operating Segment on page 25. Only $1.4B was spent on Specialty Care and Oncology (the source of their approvals that year). The first footnote says “Our operating segments, in addition to their sales and marketing responsibilities, are responsible for certain development activities. Generally, these responsibilities relate to additional indications for in-line products and IPR&D projects that have achieved proof-of-concept. “
Established Products and Emerging Markets = $400MM (clearly not R&D)
The “Other” operating segment includes $693MM for animal health and to purchase over the counter rights to Nexium (hardly a R&D expense in my opinion!)
The “Worldwide R&D/Pfizer Medical” segment is $2.8B and supports pre-POC studies and Medical Affairs (ie technical sales).
The Corporate and Other segment is $1.5B and includes facilities, IT, restructuring costs (sheesh! Restructuring is a R&D expense???)

So cleaning that up, ~$5.2B (66%) might actually be associated with things that might be R&D but includes all the marketing studies and medical affairs. Divide that by 3 drugs and get $1.7B

$5B doesn't pass the smell test to me

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20. dogbertd on January 10, 2014 4:13 AM writes...

The difference with option 2 vs the others is that you're buying something that you know works. If you've picked up something in Ph 2 with a known response rate, your chances of making it a success in Ph 3 go up astronomically. Think JNJ with Ibrutinib or abiraterone.

The downside to this approach is that the upfront outlay may mean you can't afford to do anything else until "Wonderdrug" hits the market, but once it does, you have a revenue stream from which to build your internal pipeline.

And I don't know where this $5B comes from, either - a few years back it was close to $800M and I'd say most people would consider $1B quite a generous estimate.

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21. YOSSARIAN on January 10, 2014 4:44 AM writes...

@ 13 and 16, you've raised the key point - what is the ultimate goal? For almost all Pharma the stated primary aim is to deliver treatments (or should that be outcomes?) to patients.

Unless one can make a good case that existing drugs/molecules/candidates aren't being made available effectively to patients, it takes option 2 out of the equation (unless you take a portfolio approach to the investment and spread it around, in which case you could justify it as a source of ongoing funding for your own R&D).

I wonder what J. Michael Pearson's response to this question would be...

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22. Anonymous on January 10, 2014 5:10 AM writes...

I think the $5 billion per NME ($4 billion, but close enough for me) comes from here:

Option 1: While I agree it's critical to focus on meeting patient needs before profit, if the ROI is not high enough then there is no sustainable business model and investors will stop to invest so R&D will gradually shrink to nothing through successive cuts, which is what we're seeing. So this is not a viable option.

Option 2: It's easy to say that you can just go out and shop around for the best drug candidates, but in reality:
a) You really don't know as much as the company you're buying from, so it could turn out to be a lemon (and does more often than not).
b) If it's really a great drug candidate that will surely work, then this is already factored into the price (you get what you pay for), so little opportunity to add/create value, which is what we're trying to do.
c) Also, if it's a good candidate, then many big and desperate pharma companies will compete for it to fill their pipelines, increasing the price beyond what it is really worth (winner's curse), increasing the chances of actually destroying value.
So this also is not a viable option.

Option 3: If you can double you ROI from 5% to 10%, then again you have a sustainable business model. This is not guaranteed by Option 3, but at least there is some chance of it working, if the assumptions are reasonable.

So if I had to choose only one option I would go with Option 3, absolutely.

Otherwise, I agree with the portfolio approach proposed by Derek, because if you really don't know which option is best (and let's face it, we don't!), then it's better to put a few eggs in each basket to spread your risk, and then hope for the best.

I would go for a 40 / 30 / 30 split to keep all stakeholders happy, though I would be looking at Option 3 to save the day.

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23. Kelvin Stott on January 10, 2014 5:30 AM writes...

Hi Derek, thanks for posting this, and great to read your thoughts, and many of the comments on this.

It's especially interesting to read such varied opinions, so clearly it's a good/important topic for discussion. If anything, that's what the question was designed for: to provoke a bit more thought and debate about what we're doing...

Keep up the great blogging!


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24. Henry's cat on January 10, 2014 6:02 AM writes...

The best part of the whole article is where the french sounding guy keeps calling the instigator of the discussion 'Kevin'.

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25. simpl on January 10, 2014 9:23 AM writes...

The short term ROI drop of 50% in 3 years will not continue long at that pace or we will all be bust by 2018 - I'd suggest it is a reflection of the patent cliff.
The other suggestions in the comments - sell out and give to shareholders, found a finance company or do generics instead, are all short-term and not garanteed to work over time. If you want your company to stay around, the aim is to reduce your risks to below average, so you should play your strong suit(s). 1) Good research companies should continue to research, or even expand. 2) don't buy just any new molecule, but one you know how to sell, or will support a key brand, e.g. as a combination. 3) (and 2 again) can be mitigated by things like buy-outs or venture funding, where you help smaller companies with your expertise and money, including your ability to take their ideas to the world market.

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26. Anonymous on January 10, 2014 10:01 AM writes...

"The short term ROI drop of 50% in 3 years will not continue long at that pace or we will all be bust by 2018"

ROI has been decreasing by 50% every 9 years for the past 60 years, yet Pharma has does nothing radical enough to change course! Why would now be any different?

This is a slow train crash!

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27. Cellbio on January 10, 2014 10:57 AM writes...

From my personal experience, I find it interesting to reflect upon 25 years in biotech, as we started with option 1 as the sole investment model, then after success filled the coffers but not the clinic with robust new molecules, we moved to option 3, as did the industry. Remember antisense, aptimers, *omics, antibodies (that was a good one!) and of course at biotech, we'd do small molecules too, only better! (oh, the innocence).

Option 2 arose as the way to solve the rising pressure of the above efforts not working sufficiently. As many have pointed out, finding an available asset with clear demonstration of efficacy that someone wants to sell and that you can obtain in competitive bidding is going to be tough. 5% billion definitely helps, but the big boys have more than that.

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28. MDACC Grad on January 10, 2014 11:10 AM writes...

The point that everyone is missing is if the merger/acquisition/licensing groups are broadly valuing everything outside as greener (like what is suggested in Option 3) than they are mismanaging their own R&D units. This problem grows when the M&A activity happens among established large cap companies. As programs are shifted between these companies they are disrupted and delayed as is the accompanying R&D. At the end of the day the business units of each company have just traded risk (which I would argue is a zero sum game in this situation) while the R&D is being disrupted, negatively affecting their ROI.
Now acquiring startups/biotech is a different situation where value can be created (we all know these small companies can't do it all and need regulatory, financial, marketing etc. help)...but that goes back to option #1 where you have to ask why your big pharma DPUs aren't matching the ROI of the equivalently staffed biotechs (or are they?).

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29. Hap on January 10, 2014 11:26 AM writes...

Well, if you're busy trading research back and forth, disrupting it all the while, that can't help how much the research produces, as you said.

A chunk of small companies (and their initial investors) are looking to get to payout and not necessarily to drug or established company, which gives those companies an incentive to avoid research that might tell them what they don't want (or don't want potential buyers) to know, and to sell what they've got hard. If you can't recognize the duds in your own research, with lots of information, how you going to recognize them when you don't have all the information (and probably not the most important parts)? That makes option 2 potentially more risky than option 1.

All these options depend on how good management is - if they don't know what they're doing, or don't care, then none of the options will work. If they do, then internal research with side bets on the others (or similar bets on 1 and 3 with a side bet on 2) makes the most sense, because if you're competent, and you have or can get the best information, you should be able to place good bets. If you can't, then (as 11 said) you should have been gone.

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30. Anonymous on January 10, 2014 11:31 AM writes...

Here's the likely source of the $5B cost of developing a drug.

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31. medchemist on January 10, 2014 12:08 PM writes...

You need Option 1 to be able to better evaluate compounds from option 2. Having internal programs can definitely give you a better feel on how good is the molecule.

Option 2 is the easiest. You just sit back and relax and let other companies do the risky work. You just come with a big load of money and hope you chose a winner.

Option 3 is the most innovative one but the chances of success are even lower. All the low hanging fruits have been taken. So you must prepare for a hard and long road before you can come up with real innovation however on the long run, you have made the biggest contribution to science.

So if I a 5 billion dollar, I am a CEO of a company. What would I do ?
I would spend:
20% on option 1
30% on option 2
50% on option 3

On my way to become the most innovative company :)

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32. jbosch on January 10, 2014 2:48 PM writes...

having no experience in pharma, I would opt for option 3, simply because it would take a while to go through the 5 billion and we might innovate and discover something along the way while having fun.

Aren't all these companies branding/marketing themselves with innovation ? How innovative is it to buy a startup ?

My 2 cents

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33. steggy101 on January 10, 2014 4:01 PM writes...

Echoing #4 Hap’s question, could Derek double check this $5 billion spent per new drug number? A Dec. 2012 Reuters report stated that the average cost of developing a new medicine is $1.1 billion and it has remained fairly constant.

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34. Hap on January 10, 2014 5:01 PM writes...

I think the $5G number comes from a Matthew Herper article in Forbes, as linked in comments 22 and 30. It seems kind of high, still.

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35. Anonymous on January 10, 2014 5:43 PM writes...

The $5 billion per NME is based on a top down calculation of total R&D spend / total NMEs during period, and is more complete as it includes all the hidden costs and overheads like platform technologies and general admin salaries which may not be split by project.

The $1.1 billion per NME is based on a bottom up calculation by di Massi at Tufts, and misses all these extra costs. Also it is based on many individual figures submitted by Pharma companies, who give the numbers they are asked for, but don't realise how they are used so again many of the costs are missed out of the calculation.

Therefore $5 billion per NME is a more reliable figure, and it also agrees with Jack Scannell's paper showing that R&D spend per NME is doubling every 9 years (Eroom's Law).

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36. Nuclear Option on January 11, 2014 3:00 AM writes...

More and more I sense that companies who stick to option 1 eventually will resemble or be owned by companies who embrace the reality that is option 2. Option 2 allows for growth that is critical to all corporations and is realistic to admit the centrality of deep domain specific knowledge that is absolutely required for innovation, especially in this uncertain research activity. Observing Celgene from a close distance of late has really impressed me that this is a highly evolved business and research strategy. In oncology most of the likely blockbusters for patients (BRAF, now PD1, BTK, IDH and DOT1L...) are rising out of biotech. But I could be proven wrong by all those incredible PI3K, MEK and best in class ABL, mTOR and EGFR inhibitors in big pharma...

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37. Anonymous on January 11, 2014 7:42 AM writes...

@36: Except that buying growth does not create value like real innovation does, it just hits the balance sheet. In other words, you get more revenues, but lose a huge wad of cash or have to pay back more debt for the original acquisition, so that you're actually not much better off, except in terms of buying and selling power through sheer size, while efficiency improvements through economies of scale rarely work when the organizations are already very big. In fact you often decrease efficiency because greater complexity is required to manage a bigger organization, rather like governments.

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38. entropyGain on January 11, 2014 12:14 PM writes...

Lies, Damn Lies, and Accounting

@35 - I think that stance is a bit naive. "Hidden Costs" are hidden because someone wants it so.

As the quick analysis of the PFE financials showed, the admin types stash sales expenses and corporate acquisitions in the R&D burn that should be recorded elsewhere, artificially inflating the reported R&D cost.

This is beneficial to the company because they can show how much they are "investing" in R&D and how hard the FDA is on them because it costs so much to develop a drug now.

In the example above, should the purchase of marketing rights for generic Nexium really count as R&D?

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39. Anonymous on January 11, 2014 2:10 PM writes...

Sounds like auditors are not doing their jobs properly. Hiding costs so that people don't understand how well or badly their business runs is exactly the kind of issue that caused Enron, WorldCom, Lehman's, and all the rest...

Who is PFE's auditor? Just so that I know who not to trust.

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40. Petros on January 12, 2014 6:55 AM writes...

Forest provides the clearest example of the option 2 approach.

Its 2013 figures show R&D spend of $1 bn and revenues of $3.1 bn. But since Lexapro it hasn't managed to (or have the financial clout to?) bring in a blockbuster in its deals.

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41. Hap on January 14, 2014 10:28 AM writes...

@36: I don't think the pool of people willing to work at small pharma is going to be enough to sustain the research option 2 is counting on (as a pharma-wide option). I imagine the prospect of having a steady job doing something useful and worthwhile attracted lots of chemists and biologists to their studies (which require lots of time and work - upfront cost), or helped them to justify their love of those fields to themselves. Without that possibility, you're selecting for people who are both willing to put in lots of time to study something (more so than most other jobs) and who want to ride the rollercoaster that is small pharma. (Risk/reward plays into this, but the funding of small pharma probably limits the reward for most researchers - the funders get most of the money.)

Unless small pharma is much more efficient at generating drug candidates (and not just buyouts) than big pharma, the reduced number of people here is not going to find enough drugs in the long term. China and India may be able to find enough people to do it, but eventually they will want the money from drugs they find for themselves and not allow big (foreign) pharmas to have it.

If you ignore these issues, you still have a highly competitive environment (lots of pharmas looking for someone else to make their drugs and lots of VC funders looking to get their investment and vig out). The originator pharmas have more info than buyers and may have different goals (payout, not drug). Big companies will want to share the risk of failure (to mitigate the difference in ends), but that means either paying more fixed costs upfront or the smaller companies companies either not selling candidates and/or not wanting to form to take less money for risky endeavors. I don't think that will work as a business model.

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