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Pharma is looking to biotech to improve success rates in development and diffusion
missing image fileAs biotech enters its fourth decade, its enduring legacy will be as much in business innovation as scientific innovation.The central value-driver in the pharma industry is reimbursement for meeting unmet medical needs in new and existing markets. At the heart of this business is the development and diffusion (D&D) of innovative therapeutics.
 

Firms that are consistently successful in D&D of innovative medicines, improve patient outcomes, aid the medical profession, gain market share, reward shareholders and attract the best staff. Unsurprisingly, CEOs of pharma research firms vie for the crown of leading the most innovative firm, trumpeting billiondollar R&D investments, new chemical entity (NCE) approvals, and biotech alliances and acquisitions.

Innovation in pharma activity has traditionally been measured by R&D expenditure, R&D:NCE ratio, NCE submissions and approvals, number of total pharma projects, or novelty of the compound and therapeutic class. Under more scrutiny, no single measure is satisfactory; R&D expenditure by itself does not equate to efficiency, and an R&D:NCE ratio does not show the absolute productivity of a firm. Figures from Parexel show that from 1975-1995, total pharma R&D spend doubled every five years, but NCE submissions did not match the pace of this spend. Against this background of consistently rising R&D expenditure, the number of US NCE approvals has hovered around 25 per year since 1990 - apart from a spike in 1996/97.

Since 1990, however, the number of blockbuster drugs earning more than USD 1bn per year has risen inexorably, and one may surmise that the correlation between the risk-adjusted net present value (NPV) of NCEs approved and R&D spend is strongly positive, even if in absolute numbers NCE approvals have been static.

There is evidence to suggest that business measures of innovation - such as time to market, time to peak sales, expanding indications, market share and total sales - may be better than scientific measures because the market rewards innovation exploitation and not simply the invention of NCEs. A report by Cambridge Pharmaceutical Consultancy analysed three cohorts of NCEs and examined the speed at which products launched in Europe accessed all EU markets. It was found that the 2001 NCE cohort accessed a greater proportion of EU markets up to six to eight months quicker than cohorts of 1997 and 2000 launches. This appears to be a major factor resulting in almost 20 per cent higher revenues in the first two years after EU launch, showing that business innovations have an impact on the bottom line.

Innovation may be scientific, technical, or in business management, however as a minimum it ought to be protected by intellectual property rights (IPR), deliver value exceeding its investment and provide unique differential advantage.

Typically, scientific innovations are strongly protected by IPR, but more often fail at some point in the R&D process. Technical innovations, such as chemogenomics and bioinformatics, are often widely adopted throughout the industry and rarely confer sustained differential advantage to the firm. Although business practices can be replicated, they differentiate firms from one another, and can have significant impact on promoting strategies for innovation. Considering the challenges affecting the pharma industry, tomorrow's leaders will be those who can harness discovery efficiencies and innovations in the nascent biotech industry through a number of original strategies.

Pharma challenges

In 2006, figures from Parexel reported that global pharma industry sales grew by seven per cent to USD 602bn, and industry-wide profit margins in 2005 were 15.8 per cent, ranking fifth behind oil, banking, communications and information technology industries. Behind these robust figures are a number of disquieting industry trends requiring urgent and innovative solutions:

  • Rising R&D costs: R&D costs doubled every five years from 1975 to 1995, and doubled again from 1997 to reach USD 39.4bn in 2005. Over this latter period, the approval of NCEs has been, at best, static. The lastest estimates of the fully-capitalised cost, including post-approval, of bringing a new product to market, are between USD 899m to USD 1bn (at 2005 exchange rates).
  • Rising SG&A costs: According to Scrip, the 10 leading pharma firms spent 15.2 per cent of total sales on R&D and 32.1 per cent of total sales on selling, general and administration costs (SG&A) in 2005. Parexel's figures show that in other industries, companies such as Boeing, 3M, Ford, IBM, Microsoft, McDonalds and Safeway, spend half as much on SG&A as pharma firms.
  • Late-stage pipeline failures: Phase III clinical trials represent the single most costly expenditure in R&D, comprising 26.2 per cent of total R&D spend. Pfizer (torcetrapib, asenapine), AstraZeneca (NXY059, tesaglitizar), and Lilly (enzastaurin) all suffered high-profile phase III failures for small molecules because of safety and efficacy issues.
  • Patent expirations: In 2005, Ernst & Young reported that USD 23bn worth of products lost patent protection, representing the highest ever dollar value recorded. Pfizer and Merck combined have over USD 40bn of products exposed to patent expiration in the next 10 years, whereas Novartis and Roche combined have just over USD 10bn of sales at risk over the same period.

Reducing these challenges to the simplest terms, pharma executives need to reduce costs and increase revenues. Originally seen as the poor relation of the pharmaceutical industry, the biotech model is being taken seriously by leading pharma companies, seeking to replicate the entrepreneurial ethos and agility of biotech firms leading novel discovery and clinical programmes.

Biotech and innovation

According to Professor Gary Pisano at Harvard Business School, the biotech industry has attracted some USD 300bn in capital over the last 31 years and the impact has resulted in a transformation. Ernst & Young reported that the collective market capitalisation of the top 360 public biotech companies in the US passed the USD 500bn barrier in April 2007, with European public biotech alone valued at USD 78bn in 2006.

These figures do not include the thousands of private biotech companies in Europe, Asia, and North America, nor the values or revenues of biotech acquisitions reflected in pharma firms' capitalisations. Forward-looking pharma companies are engaging with biotech firms in research alliances and M&A activities earlier in the R&D process, as well as emulating their therapeutic focus and business structures, as outlined below.

Alliances

The variety of research agreements between pharma and biotech reflects the level of commitment from both parties, and the deal complexity. If relatively simple contract services reap rewards, pharma and biotech may engage in research collaborations, more formal joint ventures, or even a straight licensing deal.

At the core of alliance activity is pharma's recognition that biotech is more efficient at carrying out critical research and discovery. For example, the market capitalisations of Amgen (USD 74.3bn) and Genentech (USD 84.2bn) are within striking distance of Merck's, but compared to Merck's 60,000 employees, Amgen and Genentech's combined workforce is 30,000. Yet, compared to Merck, both biotech firms spend twice as much on R&D and book twice the revenue per employee.

This trend is seen at the macro level too; for the last six years, big pharma has spent twice as much on R&D than biotech, but in the last three years, biotech has consistently received more new product approvals. In 2006, 19 compounds were approved, 12 of which were in-sourced through licensing or acquisition.

In 2004, industry-wide figures showed that in-licensed and co-developed molecules as sources of pharma projects rose from nine per cent at the preclinical phase to 42.6 per cent by phase III. Datamonitor reported that overall, biologics, particularly focused on oncology, comprised 29 per cent of all pharma projects, compared to 71 per cent as small molecules. From 2005 to mid-2006, according to Novartis, the top 10 pharma companies closed 196 single product deals, with Novartis and Johnson & Johnson leading the pack with 32 deals each.

In recent years, typical pharma/biotech deals were made late in clinical development - phase II or phase III - to mitigate against risk. Competition between bidders and recent shareholder pressure to bolster pipelines has led to pharma looking at therapeutics in phase I and sometimes even at the investigational new drug (IND) stage. Data from US publication In Vivo suggests that the risk-adjusted, fully-capitalised cost to get to IND/phase I stage (screening to hits-to-leads to lead optimisation) may be as
high as USD 100m.

Biotechnology companies seek their partner's marketing expertise and external validation of their technology, as much as up-front and milestone payments, yet partnerships between biotech and pharma are often strained. A survey of biotech executives in 2004 revealed that 52 per cent of alliances failed for three main reasons:

  • a change in senior management
  • expected results were slow or failed to materialise
  • drastic changes in the business environment.

If a research partnership is successful, a sponsor may instigate an acquisition. For a sponsor, an acquisition might fill patent expiration gaps, boost R&D productivity, or bring in franchise expertise. Fear that a competitor might acquire the same technology may even drive the economics of a deal. For a biotech backed by venture capital, an acquisition may be a preferred exit for investors than an initial public offering (IPO) in weak public markets.

Merger and acquistions

Global biotech revenues grew from USD 63.1bn in 2005 to USD 73.5bn in 2006, when USD 41bn was traded in biotech alliance and M&A activities, according to Ernst & Young. Pharma companies paid 50-100 per cent premiums for biotech companies in public bidding wars to acquire platform technologies and bolster ailing pipelines.

Big pharma's slew of several high-profile phase III failures in 2006 were all small-molecule, and it seems no coincidence that most of the M&A activity was for large-molecule platforms which tend to fail less in the clinic, are less susceptible to generic competition, usually get to market faster and achieve higher pricing compared to small molecules.

These factors are giving biotech firms leverage in licensing negotiations and are driving up prices for deals made earlier in the R&D process, even for some molecules with no clinical data (see box 1, below).

In 2006, AstraZeneca purchased Cambridge Antibody Technology (CAT) for USD 567m at a 66 per cent premium. Both sponsor and acquirer had worked on discovery programmes together for some time but the decision by AstraZeneca to acquire CAT's intellectual property came as antibody-based biotech products were validated in the clinic and recognised by pharma as major revenue drivers. CAT remains a free-standing entity, as did Genentech in the defining Roche-Genentech deal.

Therapeutic focus

Biotech firms are historically funded by venture capitalists and have an unusually keen focus on the business of science because cash and time are often their limiting factors. For this reason, therapeutics with the following characteristics are favoured:

  • are profitable at peak sales of >USD 200m
  • have high value - USD 8,000 to USD 250,000 per patient per year
  • require shorter trials for smaller populations
  • are specialty drugs for high-severity patients
  • are to be prescribed by specialists in an intensive care setting
  • require smaller, more focussed sales field force.

Examples include infusion or injectable therapies used in oncology, HIV/AIDS, multiple sclerosis, or as blood factors. Most therapeutics being developed are in oncology because:

  • there is significant unmet clinical need in virtually all cancers
  • the demographics suggest that there is strong growth for the foreseeable future
  • regulatory opportunities exist for a fast-track review of oncology products
  • biologics are unique and strongly differentiated
  • there is a large market - Parexel reports that of the 18 leading pharma firms, 17 have a therapeutic focus in oncology.

The biotech strategy of producing therapeutics for specialties appears to have paid off. Data from Easton Associates predicts that these 'new engine' drugs will comprise 57 per cent of global prescription sales by 2012.

Business structure

In 2004, some commentators predicted that pharma needed to consolidate to insulate itself from patent expirations and to fill ailing pipelines. Indeed, by 2008, the industry was predicted to be consolidated to the point where the top three firms shared 40 per cent of the market by sales.

As of May 2007, this prediction seems unlikely to happen, however it does highlight the fact that R&D has been proven to work best in a leaner, agile environment, where people are invested in its success, and in competition for funding.

After the merger in 2000, GlaxoSmithKline (GSK) separated its vertically integrated R&D function into eight therapeutic centres of excellence where entrepreneurial 'biotech' development is encouraged. This enables economies of scale to be retained for discovery at one end, and clinical development and marketing at the other end. This is the model that mid-tier firms like Bristol-Myers Squibb and Wyeth are observing closely (see box 2, above).

Business developments

Rising R&D costs, phase III failures, and patent expirations are tractable challenges for pharma companies that engage with biotech firms. Pharma is adept at the development and diffusion of therapeutics, and should exploit biotech's crucial discovery and research efficiencies.

Investment by pharma in technical and scientific innovations made today may bear fruit in five to 10 years time, yet pharma companies that deploy strategic business innovations can transform practice and show results in much shorter timeframes. If pharma can wean itself off the blockbuster model, the economics of the industry will rapidly change.

Targeting high-severity populations with valuable therapeutics that have a higher probability of success in smaller, shorter clinical trials will reduce costs and decrease time to market. Monitoring biotech and pharma business developments will help pharma marketing executives make informed decisions in shaping pharma's future trajectory.

Box 1: Ideal of the year : Merck's $1.1bn acquisition of Sirna

RNAi is a next generation macromolecule platform that selectively prevents gene expression by knocking down mRNA (see PME May/June 2007, p52-53 R&D Prospect, Mastering the Gene). As early as 2003, Merck made a commitment to exploring the potential of RNAi as a new drug discovery platform by making the first major deal in this area with Alnylam Therapeutics in September 2003, and another deal in June 2004. In February 2003, Alnylam's competitor, Ribozyme, was valued at less than USD 3m when venture capital poured USD 48m into the company. In October 2006, Merck paid a triple-digit premium of USD 1.1bn for the renamed Sirna, a firm with virtually no clinical assets, but perhaps with GlaxoSmithKline (GSK) as another bidder. Merck is using this deal to integrate this new therapeutic modality into its discovery programme and to validate the technology commercially.

Box 2: GSK's productivity gains

GSK has an industry-leading pipeline. From a productivity viewpoint, the new structure for drug discovery has been a success. In October 2001, GSK had just 50 NCEs in the clinical and preclinical pipelines and in February 2006 it had 95 NCEs. In addition, GSK has a leading position, particularly in the late-stage pipeline (phase II and phase III). Its closest rival, sanofi-aventis, has more pharma projects in pre-clinical and phase I trials. Complementary to the re-organisation, GSK has extended phase II studies to fine-tune dosing ranges, despite intense pressure to get candidates into phase III fast. This gives products moved into phase III the strongest chance of success against an industry average of about 50 per cent success at this stage.

The Author
Gerhard Symons is 2006-07 Kauffman Fellow at the Institute of Biotechnology, University of Cambridge; gerhard@cantab.net

19th June 2007

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