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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: derekb.lowe@gmail.com Twitter: Dereklowe

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May 23, 2014

Two Looks At Drug Industry Productivity

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Posted by Derek

Matthew Herper has a really interesting story in Forbes on a new report that attempts to rank biopharma companies by their R&D abilities. Richard Evans of Sector and Sovereign Health (ex-Roche) has ranked companies not on their number of drugs, but on their early-stage innovation. He counts patents, for example, but not the later ones defending existing franchises, and he also looks to see how often these patents are cited by others. As for a company's portfolio, being early into a new therapeutic area counts for a lot more than following someone else, but at the same time, he's also trying to give points for companies that avoid "Not Invented Here" behavior (a tricky balance, I'd think). The full report can be purchased, but the parts that Herper have shared are intriguing.

Ranking the companies, he has (1) Bristol-Myers Squibb, (2) Celgene, (3) Vertex, (4) Gilead, and (5) Allergan. (Note that Allergan is currently being pursued by Valeant, who will, if they buy them, pursue their sworn vow to immediately gut the company's R&D). At the bottom of his table are (18) Novartis, (19) Regeneron, (20) Bayer, (21) Lilly, and (22) Alexion. (Note that Evans himself says that his analysis may be off for companies that have only launched one product in the ten years he's covering). I'm not sure what to make of this, to be honest, and I think what would give a better picture would be if the whole analysis were done again but only with the figures from about fifteen years ago to see if what's being measured really had an effect on the futures of the various companies. That would not be easy, but (as some of Herper's sources also say), without some kind of back-testing, it's hard to say if there's something valuable here.

You can tell that Evans himself almost certainly appreciates this issue from what he has to say about the current state of the industry and the methods used to evaluate it, so the lack of a retrospective analysis is interesting. Here's the sort of thing I mean:

Too often, Evans says, pharmaceutical executives instead use the industry’s low success rates as an argument that success is right around the corner. “A gambler that has lost everything he owned, just because he now has a strong hand doesn’t make him a good gambler,” Evans says. . .

True enough. Time and chance do indeed happeneth to them all, and many are the research organizations who've convinced themselves that they're good when they might just have been lucky. (Bad luck, on the other hand, while not everyone's favorite explanation, is still trotted out a lot more often. I suspect that AstraZeneca, during that bad period they've publicly analyzed, was sure that they were just having a bad run of the dice. After all, I'm sure that some of the higher-ups there thought that they were doing everything right, so what else could it be?)
Evans%20chart.jpg

But there's a particular chart from this report that I want to highlight. This one (in case that caption is too small) plots ten-year annualized net income returns against R&D spending, minus the cost of R&D capital. Everything has been adjusted for taxes and inflation. And that doesn't look too good, does it? These numbers would seem to line up with Bernard Munos' figures showing that industry productivity has been relatively constant, but only by constantly increased spending per successful drug. They also fit with this 2010 analysis from Morgan Stanley, where they warned that the returns on invested capital in pharma were way too high, considering the risks of failure.

So in case you thought, for some reason - food poisoning, concussion - that things had turned around, no such luck, apparently. That brings up this recent paper in Nature Reviews Drug Discovery, though, where several authors from Boston Consulting Group try to make the case that productivity is indeed improving. They're used peak sales as their measure of success, and they also believe that 2008 was the year when R&D spending started to get under control.
NRDD%20chart%201.jpg

Before 2008, the combined effects of declining value outputs and ever-increasing R&D spending drove a rapid decline in R&D productivity, with many analysts questioning whether the industry as a whole would be able to return its cost of capital on R&D spending. . .we have analysed the productivity ratio of aggregate peak sales relative to R&D spending in the preceding 4 years. From a low of 0.12 in 2008, this has more than doubled to 0.29 in 2013. Through multiple engagements with major companies, we have observed that at a relatively steady state of R&D spending across the value chain, a productivity ratio of between 0.25 and 0.35 is required for a drug developer to meet its cost of capital of ~9%. Put simply, a company spending $1 billion annually on R&D needs to generate — on average — new drug approvals with $250–350 million in peak sales every year. . . So, although not approaching the productivity ratios of the late 1990s and early 2000s, the industry moved back towards an acceptable productivity ratio overall in 2013.

I would like to hope that this is correct, but I'm really not sure. This recent improvement doesn't look like much, graphically, compared to the way that things used to be. There's also a real disagreement between these two analyses, which is apparent even though the BCG chart only goes back to 1994. Its take on the mid-1990s looks a lot better than the Evans one, and this is surely due (at least partly) to the peak-sales method of evaluation. Is that a better metric, or not? You got me. One problem with it (as the authors of this paper also admit) is that you have to use peak-sale estimates to arrive at the recent figures. So with that level of fuzz in the numbers, I don't know if their chart shows recent improvement at all (as they claim), or how much.

But even the BCG method would say that the industry has not been meeting its cost-of-capital needs for the last ten years or so, which is clearly not how you want to run things. If they're right, and the crawl out of the swamp has begun, then good. But I don't know why we should have managed to do that since 2008; I don't think all that much has changed. My fear is that their numbers show an improvement because of R&D cuts, in which case, we're likely going to pay for those in a few years with a smaller number of approved drugs - because, again, I don't think anyone's found any new formula to spend the money more wisely. We shall see.

Comments (28) + TrackBacks (0) | Category: Business and Markets | Drug Development | Drug Industry History


COMMENTS

1. Hap on May 23, 2014 8:25 AM writes...

(Semi-)stupid question: Did they (or has anyone) compared R+D spend from 10-15 years before to some measure (peak sales, new drug approvals, etc.) of current economic health? Clearly current R=D spending leads (if it works to future revenue, or not; cutting it now would improve yields on current R+D spending but would would likely cut yields in the future. Since R+D and drugs are shifted in time from each other, measuring them at the same time doesn't tell you much, unless you're an investor in for the short term, which in a long-term business, seems like a recipe for oblivion.

The problem is that no one has found ways to find drugs better; we can make them cheaper (in the short- to medium-term) by outsourcing everything we can and by cutting R+D, but if people don't know what's important, they can't cut the right things, and if we don't know better methods, then cutting R+D is just cutting future revenue. Maybe you need to keep a flow of capital to stay alive until you can figure something out, but if it prevents you from figuring anything out (because of differences in purpose and timeframe), then you're just looking at a lingering death (and so will some of us).

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2. exGlaxoid on May 23, 2014 8:32 AM writes...

I would like to see a similar chart that breaks the spending down by R and D separately. I would guess that the rising cost of clinical trials is really at the heart of the problem, not the cost of discovering drugs. So if that could be clearly shown, perhaps people would be more willing to look at redesigning clinical trials to be more cost effective, as clearly the bigger they get, the more the diminishing the return, but the FDA keeps wanting them to be bigger every year.

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3. Alex S on May 23, 2014 8:53 AM writes...

I believe the economic return data (with caveats), but I agree the time frame should be longer. The patent- and citation-derived metrics, however, I'm skeptical about.

Are those numbers really proportional to R&D productivity? Do all companies publish/patent/cite with the same frequency per dollar of return? Or in proportion to the numbers of successful targets, projects or molecules in development? That doesn't sound right to me. Evans should analyze those correlations.

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4. Anonymous on May 23, 2014 8:58 AM writes...

i'm not sure reducing large ($5B+) R+D budgets is a bad idea. A large beaurocratic organization is a great killer of innovation and risk taking.

We have all seen the number of innovative NCEs drop as budgets go up. Be interesting to see whether the inverse is true. Human disease biology is so complex and what we learn changes almost every few months. You must have the ability to rapidly change direction, which is very hard in a massive organization.

Throwing more money at a problem does not typically improve outcome, espescially in an area like this.

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5. Pete on May 23, 2014 9:03 AM writes...

Would you prefer to be treated with an innovative medicine or an efficacious one?

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6. Johnjohn on May 23, 2014 9:05 AM writes...

Without any 95% CIs, chart 2 (and to a smaller extent, chart 1) is completely worthless. The 2005-2013 differences are almost certainly not significant. Moreover, the peak sales/R&D spending metric sounds very hocus-pocus.... a sensitivity analysis would be good.

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7. Anonymous on May 23, 2014 9:12 AM writes...

innovative of course means more efficacious than standard of care.

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8. Anonymous on May 23, 2014 9:13 AM writes...

"I would guess that the rising cost of clinical trials is really at the heart of the problem, not the cost of discovering drugs"

...as well as:

1. Worse decision making and project selection, driven by warped incentives to make the numbers and push projects forward regardless of quality.

2. Worse quality of compounds coming from discovery.

3. General law of diminishing returns for the overall R&D model.

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9. Hap on May 23, 2014 9:14 AM writes...

@4: Throwing more resources at a problem may not solve it, but taking parts out of the engine randomly to see if it works better seems like a bad idea, too. Unless you have some idea what the problem is (where good management or perhaps management with deic status comes into play), cutting things will probably hurt. It also makes it hard to avoid the self-preservation tendency of large bureaucracies; the useless people good at bureaucracy will try to save themselves, which makes it likely that cutting spending will cut things you need and probably won't cut what needs to be cut.

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10. Erebus on May 23, 2014 9:24 AM writes...

@4-
Large, inflexible bureaucratic organizations are a problem. And many of the pharmaceutical companies mentioned are nothing if not bloated and bureaucratic... But the FDA stands over those companies like a taskmaster with a whip, and the FDA does everything in its power to ensure that drug development is as slow and as expensive as possible. We are well past the point where only large organizations can shoulder the expense. If the regulatory framework is changed from the ground-up, drug development shall become a swifter and more innovative process, and this shall certainly create more value. As things stand, regulations and red-tape (and all the costs they entail) are driving the entire industry into the dirt.

Merck, Valeant, Pfizer, etc. have all evolved -- they've adapted to our current regulatory environment.

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11. simpl on May 23, 2014 9:55 AM writes...

It looks like a good cocktail starter, which tries to avoid the biases of age and size, and gets around the weaknesses of the usual Market penetration and Potential max sales metrics.
I'd have liked to see a measure of launch efficiency; after all, launches cost more than R&D. I suspect this is what is behind the strange Merck evaluation.
A low NIH measure is a real help, I think - I know our company has fought hard over decades to be a serious licencing partner, and feels it is a necessary step to becoming a leader.
The patent figure is less helpful, suggesting that everybody spends at a similar standard except Vertex and Allergan. There are surely correlations with the size of target markets (HIV overvalued?), and the proportion of of biologicals R&D, too.
Less seriously, where are the classic KPIs of mobile telephony, RPU and churn?

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12. AUGcodon on May 23, 2014 9:57 AM writes...

@10
Putting everything on the shoulders of the FDA is a bit myopic. The FDA did not become what it is today in a vacuum. Pharma companies are partially responsible for tightening regulations and higher standards with some of the scandals they caused. For better or for worse, the FDA is a political body in a society that takes a dim view of the Pharama industry. Being a government agency, they more or less have to play a reactive role

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13. chemistloser on May 23, 2014 9:59 AM writes...

Everyone has their head in the sand, there was only one time in history where any given company could enjoy patent exclusivity on such widely used, profitable drugs.

It's come and gone, wasn't anything anyone could have done about it.

Even 2500 automatons at WuXi won't change that.

The only thing that could save us would be to invent some new magic pill that everyone would have to take, every day, forever, for some new problem, we never new we had.


The business types know this and that's why they don't seem to care that much about research.

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14. schinderhannes on May 23, 2014 10:15 AM writes...

Am I the only one who when he looks at the ranking of those 22 companies feels like something is completely wrong here?

It´s either my perception as an industry insider or it is this study! But my order (by gut feeling) is completely different to this one.
I belive the metrics must be off!
Just like with lots of computational methods in drug discovery, if their results contradict my gut, I tend to ignore them and trust my instincts.

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15. anon on May 23, 2014 10:28 AM writes...

Hap: "taking parts out of the engine randomly to see if it works better seems like a bad idea"

Can an MBA fix a radio?

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16. anon on May 23, 2014 10:33 AM writes...

The chart #2 is bogus. Look at '94 to '96 period. Did productivity really double within a year? Nearly quadrupled in two years? However the great minds at the consulting company came up with these numbers, they represent nothing but noise (both the numbers, and the consultants.)

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17. Bernard Munos on May 23, 2014 10:50 AM writes...

The BCG calculation is bogus. How about a drug company that spends $5.4 billion per year in R&D (average for the top 13 companies), and produces 1 NME per year (top-13 average for 2000-2013) that yields $300 million in peak sales. Over a 12-year period, the company would not even recover its R&D investment, let alone pay for manufacturing, and SG&A.

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18. Pharma Doc on May 23, 2014 10:54 AM writes...

Additional correlative data can be found here:
http://www.buzzfeed.com/kjh2110/the-10-most-bizarre-correlations

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19. Marzuki Adz on May 23, 2014 11:05 AM writes...

Has anyone published a longitudinal M&A returns study that would be analogous?

It would be great to see how those two match up industry-wide in an effort to gain a broader understanding of how to divide revenues

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20. xechem on May 23, 2014 1:10 PM writes...

I dispute the assertion that innovation has any relationship to the number of patents filed. When we switched from old-fashioned drug targets to all new, exciting, cutting-edge ones, it took us years to work out how to screen them let alone what kind of compounds could be used to drug them. My conclusion? The more innovative you, are the fewer patent filings you get (QED). You could just as well invert that table, it'd be equally meaningless...

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21. aa3 on May 23, 2014 1:34 PM writes...

Even if those large bureaucracies became productive, they might have simply been the ones who discovered the molecules that were otherwise discovered by the likes of Vertex and Gilead.

Which would change which company had the better returns on R&D investment, but not change the overall industry returns.

I would say there is only two paths left. Either keep the system as is and as less molecules are discovered each year, the industry will naturally downsize until R&D spending becomes protifable again.

Or increase the amount charged per drug, so the declining productivity or R&D is matched or surpassed by the increasing amount charged.

Or I guess 3; some combination of the two, which I believe we are seeing.. both research downsizing and price increases.

Permalink to Comment

22. Erebus on May 23, 2014 1:45 PM writes...

@12-
Any conversation about drug industry productivity has to touch on the fact that the drug industry in the USA exists under the FDA's thumb, and the FDA keeps throwing up expensive new barriers to drug development. They've been directing the development of the industry, and they have led it to where it is today.

What people are saying -- that many of the corporations on that list are too big and too bureaucratic for their own good -- is true. But small, innovative, and fast-moving companies simply cannot release new drugs (on their own) in the current regulatory environment. The process, under the sole auspices of the FDA, is too slow, too costly, and too risky.

There's nothing wrong with any of the companies on that list -- they should be congratulated for surviving these lean days. Heavy-handed regulators (to say nothing of out outdated patent system) are simply failing the industry.

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23. DCRogers on May 23, 2014 2:16 PM writes...

Whatever the ROC of R&D, as long as the ROC of financial engineering is higher, the 'smart' executive will optimize the latter.

Until you can't; but then it's some other schmuck's problem - likely a 'turnaround artist' demanding twice the pay.

What a world.

Permalink to Comment

24. Anonymous on May 23, 2014 3:01 PM writes...

Am I the only one who when s/he looks at the ranking of those 22 companies feels like something is completely wrong here?

This is akin to a meta-analysis. Some are interesting and turn up new correlations, others are hogwash and confuse cause and effects, or even worse. Using patents as a criteria was once a useful measure, less so now. CoM patents are regularly infringed upon, and process patents are simply recipes for doing the infringing. Thus, some companies are delaying patent applications until the last minute. It is a changed and changing landscape.

Also, nowhere is scientific staff passion and morale mentioned. Perhaps because it is not measurable. But immeasurable damage to the pipeline occurs when the scientific staff is demoralized.

Another easily measured interesting statistic might be impact of CEO longevity vs. the number of launches in a given time frame.

And who defines "productivity? and "innovation?" The only metric that matters is the number of times a company launches a product - all the other metrics don't matter if you fail the launch metric.

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25. P.K. Peedee on May 24, 2014 10:43 AM writes...

@11 and @24 hit on something that is likely very important, but probably unknowable due to trade secrecy. Given that the "D" in R&D includes not only clinical development, but also marketing, it might be instructive to parse out the returns on advertising and other marketing efforts relative to incomes. Let's take a look at how the MBAs have performed in the one area their efforts are NOT linked to the lab/clinic, shall we?

Another stat that is likely more relevant to the average taxpayer is the relative value of Rx drugs compared to hospitalization. Since the cost of in-patient and other high touch healthcare has also skyrocketed, perhaps these data need to be normalized for changes in population and disease demographics(i.e., a baby boom struck by chronic disease, cancer, and AD)?

Lastly, to @13, Calling anyone an automaton is perhaps the best example ever of a dehumanizing sentiment. Bad things happen when people are reduced to "the other."

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26. Anonp on May 26, 2014 10:56 PM writes...

I'd like to see a chart over time of R&D salaries vs. non-R&D salaries.
I'd also like to see individual plots for research alone, clinical development alone, legal department, and advertising.

The reason being, I already know what I will see. I'd just like for others to see it as well as who jumps up to defend the outliers.

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27. Jack Scannell on May 27, 2014 12:08 AM writes...

Regarding the rate of financial return on pharmaceutical R&D, the Richard Evans approach (top chart) appears very sensible.

I also tend to agree with his conclusion; that returns are probably below the cost of capital.

While it is very difficult to calculate the returns on today's industry-wide R&D investment bottom up, it is easy to ask what future profits current R&D should generate if one expects a specific rate of return on current investment. This can be done by flipping the analysis from a product-based view to a time-based view; slicing industry R&D spending by year and treating each year's investment as a bond. The bond pays back as the profit streams that depend on the R&D flow through. We can posit various realistic time-courses for future profit streams. We can then ask what the sum of the profit streams from several years of R&D investment should look like, for any given rate of financial return. For example, how big should the incremental R&D-dependent profit be in, say, 2022 given the cumulative R&D investment in 2014-2021, etc.

The uncomfortable result of this analysis, when I last did it (in 2010), was that the size of the future profits looked implausibly big if one assumed a decent rate of return on the R&D investment. It is not clear to me that a great deal has changed since then, although it is possible that it has.

Regarding the BCG analysis (lower chart), there are at least two features worth pointing out. First, the returns metric is unnaturally "lumpy" (as per comments 6 and 16) given the fact that R&D project costs and profits tend to be smeared over many years. The lumpiness is a logical consequence of the way the BCG metric is calculated. However, if BCG produces a noisy / lumpy metric, then it pays to be cautious about what one calls a "comeback" (again, as per comments 6 and 16). If a "comeback" is the reversal of a negative trend, then I see ~8 "comebacks" in the lower chart between 1994 and 2013. The second feature is that BCG has used a consensus of analyst forecasts for future sales to estimate very recent years' financial returns. As a former analyst, I have no illusions about the quality of analysts' forecasts. For example, analysts tend to have far more "buys" than "sells", which says that optimism, rather than pessimism, is the norm. However, BCG do suggest, in their supplementary analyses, that consensus forecasts have, in recent years, been too low so perhaps optimism is not a problem.

Permalink to Comment

28. simpl on May 27, 2014 10:57 AM writes...

As well as launches, another downer in recent years has been the reduced contributions from financial transactions. (Some years that can beat the profits from selling pharmaceuticals!)
In the good example of a report attached, p.11 shows that last year's low interest rates weren't great for financial profits, but this company was able to pay off one third of its debt, which was equivalent to almost half their costs for R&D.

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