By Scott Fishman, serial entrepreneur, investor, market/technology analyst, CEO, Envisage
Lots of people in our industry are wondering how to simultaneously bring value to patients and the organization. It’s a reasonable aspiration, but one that faces an environment emphasizing lucrative opportunities among small but desperate populations and stratospheric prices.
Informing company decisions with patient input sounds great but doesn’t shift internal priorities when it is being treated as a tool to enhance revenue instead of a fundamental driver of financial performance. We need to redirect attention from the tactical marketing tactic of patient-centricity to the foundational proposition of customer-centricity. If a business develops things that create great value, and it does so for lots of people, then it doesn’t have to fight for customers, credibility, or profits.
It’s worth taking a close look at just how the industry is going about sourcing these things of great value, and more specifically, how the products of early-stage discovery find their way into clinical and market development within pharma.
My co-author and I noted in our book, Preserving the Promise: Improving the Culture of Biotech Investing, that the primary reason something gets funded or dies in the early stages of development is the ability of the innovation to support an investment thesis that stakeholders will buy into. Whether that’s an internal or external assessment, the opportunity is going to be subjected, at some level, to a process of due diligence.
That process has everything to do with establishing and self-reinforcing the perception of a good bet and little to do with the reasons stuff usually gets invented (e.g., scientific curiosity, passion to solve a personal or societal problem, search for a clinical solution). Investment motives are complex — neither solely rational, emotional, nor financial. But because they are always underpinned by a calculation about ROI, the potential is real for important discoveries to go unrealized while shaky clinical propositions get funded.
DUE DILIGENCE IS SUBJECT TO COMMON HUMAN BIASES
Most people understand due diligence conceptually as a process of pressure testing an opportunity. That opportunity has to pass muster scientifically and in market potential. It also has to offer an attractive payout, such as an internal rate of return for an internal development opportunity or an ROI for investors.
But this apparently rational analysis masks the foibles of human decision making. I’m looking at something right now in which I have limited domain interest and am fairly equivocal about the technological prospects, but it’s got an absolute surge of interest from colleague investors because the CEO just made a lot of money for a lot of people with a high-multiple exit in a completely unrelated therapeutic domain. The impetus for investment here has relatively little to do with the intrinsic clinical value of the technology, its prospect of scientific validity, or an admittedly enormous potential market. Instead, it’s all about the ability of a particular CEO to attract money.
Despite the presumed formality of the due diligence, the diversity of opportunities and practical constraints of timing can favor intuitive attraction over hard analytics and inductive over deductive decision making. It’s not crazy that investors “bet on the jockey” and rely heavily on a leader’s prior accomplishments; experienced people are more likely to be able to adapt, know how to solve problems, and have a network of connections. But it’s still crucial to know if the horse the jockey is riding is a champion or lame.
Due diligence consistently overweights variables other than the clinical implications of new healthcare technologies, and that’s where the patient-centricity argument breaks down. Value from a human-health perspective may be entirely disconnected from value as an investment proposition. Value pricing may be a hell of an argument for funding a development program, but no amount of feinting to patients’ “interests” is going to convince them you’re on their side when you’re planning to charge the cost of their house for the therapy.
GETTING ON PHARMA’S RADAR
In the world of early-stage technologies, seed-funding decisions may happen very quickly. It’s painful to inventors but unsurprising that a “no” can be sudden and final, because there is a huge disparity in risk for founders and investors. Everything is at stake for the inventor, but considerably less is on the line for pharmaceutical business developers or angel investors whose financial stake in an early-stage company is hardly going to break the bank. As any primer on negotiation will tell you, leverage is always a function of who has more to lose, and here’s the prospect facing an early-stage company: Inventions at this point are not significantly differentiated by the nature of the technology but by the strength of their promise of financial return. They’re collateral.
Yet they need to be nurtured and sustained long enough to even appear on the pharma industry’s radar. Here’s how it goes: Tech transfer offices filter what comes out of the university based on scientific reputation and serendipitous interest from prospective investors. Business advisers or transitional CEOs get attached to the venture with a promise of equity and deferred compensation. The same companies make the same rounds to prospective investors in a region. The gatekeeping mechanism is a 15- or 20-minute presentation followed by a Q&A session and maybe due diligence by a committee impressed enough with the pitch to volunteer time. The decision to commit is often dependent on the presence of a lead or co-investor. A good impression, a relatively large target population, and apparent technical and operational skill go into the plus column. An uninspiring pitch, a lack of obvious customer need, a small target population, or a lack of backing by capable people may doom the investment.
And this is just to get to due diligence — a subjective process that examines not just the science but also the founders’ motives, competence, and ability to succeed. Ultimately, what is available for pharma to invest in, what has even a possibility of getting onto a genuine commercial development track, is the result of scientific credibility, financial cogency, whim, and serendipity. You could argue that this applies to much in life, but is that really the way we want to address human health?
WE NEED TO REDEFINE DUE DILIGENCE
I believe a redefinition of the parameters of due diligence could be helpful. Consider three traditional areas of due diligence: unmet need, size and growth of addressable market, and sustainable competitive advantage. These are crucial to an assessment of opportunity, yet the component most often missing from pitches and even fully developed business cases is solid understanding/ characterization of market opportunity.
First, what if we think about unmet need as what is good for the most number of people? Is that a poor basis for a business model just because it echoes the concept of distributive justice (fair distribution of scarce resources)? Or is it a disruptive and potentially game-changing definition? What happens if we concentrate scarce development resources on whatever rises to the top as a crucial human and societal problem, instead of what sorts to the top of a net present value (NPV) spreadsheet? Wouldn’t we potentially make even more money by doing the most good for the most people? And wouldn’t that intrinsically make a stronger and more sustainable value proposition than a multibillion dollar windfall on an overpriced drug sold to a few thousand people that is ultimately going to experience formulary refusal?
Or what about size and growth of addressable market? I’ve spent decades advising people on optimal development based on the largest and most receptive targets. But what if we recast that slightly and make our target the biggest human need in a particular category? Maybe it would make more money, maybe less in the NPV calculation. But what would be the intangible value of resurrecting the stature of pharma as the singular industry focused on making us healthier? What’s the relative value of next quarter’s dividend against being the company that provides a massive public good and mitigates instead of increases the cost of good health?
And how about sustainable competitive advantage? What’s the sustainable advantage of a nearly six-figure drug to cure hepatitis C, raced after by other similarly priced drugs that do the same thing because everyone’s chasing that gigantic margin? I’m not taking anyone to task here, just wondering what would be the worldwide financial, societal, and yes, industry public relations impact of solving a huge problem with an affordable solution.
A recasting of assessment priorities is a realistic proposition and could form the basis of a better business model. I’m talking about a fundamental rethink that would begin at the earliest stages of a development decision, not as some post-launch marketing strategy. It follows that assessing an opportunity by due diligence would mean accounting for a broader range of criteria, not all of which are subject to green-eye-shade analysis.
The case I’m making here includes three primary recommendations: