Reality not insanity

A popular definition of insanity is repeating the same task over and over again while expecting a different result. It would appear, therefore, that many people in the contract services industry think the major global bio/pharma companies are insane. This is because they expect these major companies to continue to seek new drugs the way they have previously; throwing a lot of money at a lot of new drug development candidates in the hope that a few of them will make it to commercial approval.

Jim Miller

Are the major drug companies really that crazy?

The dismal track record of the bio/pharma industry for new drug development is well known; since 1996, the number of drugs in development has doubled and R&D spending by bio/pharma companies has tripled, but the number of new molecular entities (NMEs) approved by the FDA has halved. The cost of developing a new drug has soared to more than $1 billion and the phrase 'R&D productivity' has become an oxymoron.

Until recently, the failure of R&D at major bio/pharma companies has largely been a failure of strategy; their pursuit of the next blockbuster led them to undervalue a candidate with a mere $500 million market opportunity. They maintained their historical focus on technologies that were reaching their limits of efficacy and safety, such as nonsteroidal antiinflammatory drugs, while ignoring the promise of monoclonal antibodies and other large molecules. They pursued economies of scale in R&D operations, but wound up building unwieldy and unproductive bureaucracies.

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Reducing pipeline dependence

In recent years, however, global pharmaceutical companies have made dramatic moves to reduce their dependence on the new product pipeline. Through mergers, acquisitions and licensing deals they have diversified their business portfolios into new business opportunities, such as emerging markets and generics, that are not dependent on new products. They have also addressed technology gaps in their pipelines — especially biologics.

Simultaneously, large bio/pharma companies have hacked away at their traditional R&D model by closing R&D facilities, terminating large numbers of development candidates and exiting entire therapeutic areas. They are experimenting with new organizational structures, such as Lilly's Chorus initiative, that are aimed at finding ways to spend less on drug discovery and early development, where a high percentage of candidates fail. Identifying unpromising candidates sooner, and killing them quicker, is now a major objective of the drug development process.

Recent developments in the commercial environment will drive bio/pharma companies to reduce their spending on new products even further. Regulatory bodies are making commercial approval of new products more difficult out of concern for patient safety and to encourage drug companies to develop products that are better than what is already on the market. In the meantime, pressure on drug prices is intensifying, making it increasingly difficult to make a financial return on new drugs. The insurance companies and governments that pay most of the tab for new drugs are refusing to reimburse payments for certain new drugs, demanding use of generics, stiffening price controls and, in some countries, paying for some drugs only if the patient shows progress.

Venture capital pullback

While major drug companies are looking to reduce their drug development spending, they must also come to terms with the fact that a major source of R&D funding is also likely to decline. Venture capital has fed the growth of the early development pipeline for the past 10 years, pumping more than $1 billion per quarter into US bio/pharma startups. However, the global financial crisis has changed the outlook for venture capital dramatically by making major investors in venture capital funds, pension funds and university endowments much more risk averse. It has also highlighted the fact that returns on venture capital in the past 10 years have not been significantly better than returns on much less risky investments, including stocks and bonds. This is a direct reflection of the fact that far too much venture capital has chased too many lowvalue opportunities.

Coming to terms

The contract services industry needs to come to terms with the fact that the new product gravy train is coming to an end. The number of candidates in development is shrinking and the amount spent on them is falling. R&D spending by small bio/pharma companies dropped 20% in the first half of 2009 and the large and midsize companies have also slowed their spending. We may get an upturn in the second half of the year as some delayed programmes are accelerated, but the trend seems pretty clear.

A decline in R&D spending will hurt smaller CROs and CMOs the most because it will be concentrated in the discovery, preclinical and Phase I segments of the pipeline. Those are the segments of the pipeline that will feel the greatest effects of the venture capital pullback, and the venture-backed bio/pharmas are the most dependent on contractors.

Large public CROs and CMOs will also feel the heat. Their stock prices were driven up to record levels during the middecade, as high doubledigit revenue and profit growth rates became the norm. Those growth rates have slowed dramatically and aren't likely to reach their pre2008 levels. The Phase II and Phase III research programmes have been well supported thus far, but the efforts to kill likely failures more quickly will ultimately shrink the latestage pipeline.

Contract services will benefit from the increased willingness of the major bio/pharma companies to outsource more of their development activities. However, much of that benefit will accrue to large CROs and CMOs, and to service providers with operations in the emerging markets. Owners and investors of contract service providers must come to terms with this new reality. The venture capitalists and executives of the major bio/pharma companies are not insane; they have already turned away from the practices that fuelled the great pipeline explosion this decade. CROs and CMOs will now need to find other ways to fuel their growth.

Jim Miller is President of PharmSource and a member of Pharmaceutical Technology Europe's Editorial Advisory Board.