In the July 2017, Life Science Leader magazine we will be publishing the article — Balancing Biopharma’s Bright Future Against Its Tarnished Image — 6 Retired CEOs Share Insights For Today’s Industry Leaders. The story features six former CEOs: Mike Bonney (Cubist); Hank McKinnell, Ph.D., (Pfizer); Francois Nader, M.D., (NPS Pharmaceuticals); David Pyott (Allergan); Stephen Sherwin, M.D., (Cell Genesys); and Henri Termeer (Genzyme). As each of these executives were gracious enough to give us an hour of their time, we encountered a slight problem — too many great insights to be included within all the pages of a print publication. This is not the first time we have encountered such a problem, and one of the main reasons we created a special online section — Beyond The Printed page. If you like what you read and want to become a subscriber —that way you can read the upcoming feature with these six industry icons — you can do so here. In the meantime, we hope you enjoy this free bonus content.
Life Science Leader: It is widely believed that internal rate of return (IRR) on R&D investments has been below 8 percent cost of capital for about eight years. How can this be fixed?
Mike Bonney: An increasing percentage of true innovation is coming from companies that have a cost of capital substantially north of 8 percent. I haven’t looked at industrywide statistics in some time to assess what the actual return on deployed capital is in that part of the ecosystem, but my sense is it’s very bimodal. There are companies with a promising technology that, for whatever reason, doesn’t bear fruit, and they end up either as the walking dead or just close down. Then there’s a group of companies that can successfully navigate such a problem, and in those companies you see substantially greater returns on invested capital above that 8 percent. Large companies get very low cost of capital, and their strategy is to basically take as much risk as they can out of a program. This is why they are willing to pay an up-front premium for companies that have de-risked R&D. But they also run into internal problems regarding resource allocation and late-stage failure. This is not to say that small companies are not immune to these problems, for we have seen plenty of situations where everyone ‘drank the Kool-Aid’ and wanted to look at only the good stuff of a mixed Phase 2 clinical trial while downplaying all the bad. But in general, if we can select patients and technologies and better match them up, I think we can improve productivity. If we can get two out of 10 molecules to patients compared to the one out of 10 today, what would that do for the return of invested capital? By getting more products to patients with lower costs, we wouldn’t have to price as high to generate a return on investment. This is where we should be focusing our efforts (i.e., improving the likelihood that something being taken to the next stage of development will succeed), because these step-up costs can be enormous. How can we make sure that we’ve done everything to answer the questions about risk versus benefit, so when we get to those more expensive stages we have decreased the risk of failure?
Hank McKinnell: To understand today’s biopharmaceutical industry, you have to first understand where it was 12 to 15 years ago. It was a period where individual, brilliant chemists had discovered and developed “a” new medicine, as almost nobody was successful at doing more than one. These are the products being introduced to the markets today. But we were moving into an era where the leaders of research (unfortunately) never envisioned how to industrialize certain R&D processes given the tools now available. Genomics, high throughput screening, combinatorial chemistry, and a number of other new tools have provided new ways to better target treating disease. In the past we heard “shots on goal” talked about a lot, which turned out to be wrong. While some of the old approaches proved valuable, in general biopharma R&D is more of a creative process than many people realize. Everybody seems to think it is simply a disciplined scientific process. And while science is at its base, the discovery development process has historically required passionate advocates of the unpopular theories of science who turned out to be right (e.g., the Australian group that treated ulcers using medications). Within the scientific process there has to be a role for the individual genius, the commitment to allow them to explore unpopular ideas, while trying not to necessarily industrialize the process. Billions of dollars were invested in the past to try to do just this, and its failure is one of the reasons why IRR has been exceptionally low. Today we are armed with better knowledge, and as such, are going to become better at matching drugs to patients. This will change the way medicine is currently practiced (i.e., eliminating the trial and error approach to prescribing treatment). Further, less patient-to-patient variation will make conducting clinical studies much easier, requiring fewer patients, and as a result, significant improvement in IRR.
Francois Nader: While it is clear that the IRR in R&D investment has been very low, I would probably answer the question by saying ‘it depends.’ This is because for some emerging biotechs the IRR has been extremely rewarding, while for most Big Pharmas it has been lagging behind. In other words, the IRR being less than 8 percent for the last eight years is probably factually correct when you combine everyone together. But within this space, the IRR is very dependent on the business model, company focus, company cost-effectiveness, and so on. As for how to fix the IRR is an interesting question. Emerging biotechs tend to deal with innovation more efficiently than their large pharma counterparts. As a result of their size they tend to have very small teams. These smaller companies don’t necessarily think in more cost-effective ways to do business, they just are more cost-effective by default of their size. Large pharma on the other hand, are heavier administratively, and seem to reorganize often. This is because they have an entirely different focus, as well as a different level of commitment. From my perspective, determining how to improve IRR in R&D is really a large pharma question and involves figuring out how their R&D business models could be rendered to be more effective, starting with not changing the business model every other year, which unfortunately seems to happens way too often.
David Pyott: In most companies there is an 80/20, or perhaps 85/15 rule, where a majority of the R&D costs fall in clinical trials. If you can make an impact there, you can have a huge effect on IRR. But we can’t forget about the regulatory side of the equation. We need to work to improve negotiations with the FDA during Prescription Drug User Fee Act (PDUFA) renewal to prevent the agency and biopharma from being held hostage by past decisions. In other words, newer technologies are allowing for better targeting of disease. Certain standards that were put in place only a few years ago may be obsolete today, causing an excessive and costly burden of proof for industry. If the FDA can adapt its regulations, this will not only improve IRR for the industry, but also speed the availability of new medical technology to patients.
Stephen Sherwin: I didn’t know these specific numbers, but let’s assume that’s the case. This goes back to the ‘D’ part of R&D and the need to bring down the cost of clinical trials, which is not going to happen until we shorten the drug-development timeline. People are beginning to realize that this is something that can be addressed now because of the advances we are seeing in the areas of precision medicine and the use of biomarkers to drive drug development. If you believe these technologies are going to have a favorable impact on the time and cost of clinical trials, then by default it has to benefit the IRR on investing in R&D in this industry. While we don’t want to get too trapped in the numbers, the roots of this industry are first and foremost value creation through the development of transformative technologies or products.
Henri Termeer: It’s too generalized a question, and I don’t know what it really means. I know what it means to treat a disease that doesn’t currently get treated, and I can assure you that any time you come up with a solution for such a disease it will provide a return. If you don’t believe you can come up with a solution because you think the R&D is too risky, then don’t spend the money on R&D. This was the belief of the former CEO of Valeant Pharmaceuticals. His approach to R&D was to buy it, as well as the finished product. But he would then cut out the future by killing the R&D, figuring that the marketing of the product would provide enough payback. But when you pay for a finished product by acquiring a company, you almost always pay too much. This is because you are not only paying for the finished R&D but the ability behind what got the asset there. By cutting out R&D, and thus, your company’s future, you for certainly end up with an asset that is declining in value. That’s why Valeant had to continuously find ever-larger companies to acquire, as well as take shortcuts and price increases when it couldn’t. R&D is an essential ingredient to growing a company, and because Valeant took a different approach it was destroyed (i.e., company’s stock price declining from $257.53/share in July 2015 to under $10 today). I don’t think there is a formula for R&D spending, and just because you spend doesn’t mean you are going to be successful. But when you are an innovative company, if you don’t spend on R&D, it is certain that you will not create your future. If you want to work without R&D, create a generics company and get paid for manufacturing and distribution. I was on the board of Allergan when it got attacked by Valeant. We did all sorts of analyses and could not figure out how they could get a return on where they were investing. Bottom line is this: Don’t become set on having to generate an 8 percent return on IRR for R&D, because to do that calculation you can only do it in the abstract (e.g., McKinsey doing a macro analysis of the entire industry). When you are a small or midsize company, you have to take risks for the future, and these risks are extraordinary. This is why if you are successful and make a real breakthrough, society allows you to earn a good return. However, chances are, you may not get there, and in such cases the return may be less than 8 percent.