The New Age Pharma Business Model: Part 3 - The Case of the No-Exit Biotech

With virtually no R&D department, no blockbusters, and stifling generic pressures Big Pharma is not in a happy place today. Many multinationals have gone the licensing and acquisition way, but increased crowding on the shop floor is resulting in largely over-priced deals. Vaccines are a seemingly hot area of acquisition, whilst oncology has seemed to be all the rage for the past three years. Amgen paid a whopping US$ 1 billion to the vaccine specialist BioVex for its OncoVex cancer vaccine in 2011, Biogen acquired Stromedix for US$ 562 million and Gilead acquired Calistoga for US$ 600 million—all relatively over-priced deals, even for unmet niche targets.

In fact, the average takeover premiums for biotech companies are nearly double the premiums of acquisitions in other industries in the current markets. The game of panicky music chairs occurring in the industry is generally indicative of the multinationals’ desperate efforts to explore cost-cutting alternatives in the R&D department, as well as to access new areas of growth.

Big Pharma Eager to Acquire

The number of licensing agreements has also increased by a substantial 16% in the last five years. Notably, in anticipation of the patent cliff, the majority of licensing deals struck in Q2 of 2010 involved molecules in marketing stages of development; leads in phase III trials were the second most popular licensing target. In-licensing cost Big Pharma US$ 25 billion in 2010, and sales from licensed products amounted to ~26% of total sales. In the US, venture-backed Life Science M&A exits massively soared last year, and exit volume reached unprecedented levels, even in comparison with biotech’s 2007 peak (Fig 1). 

Figure 1. Exit volume & number for US Biotech, 2005-2011

Source: Silicon Valley Bank, 2012

In-licensing activity stats show that oncology and neurology currently dominate the target disease field (by licensing activity - Fig. 2). Interestingly, in line with vigorous pharmerging expansion, infectious disease has made a comeback hit last year. All of this is in stark contrast with the biggest blockbusters of the last decade, who have for the most part targeted pervasive “first world” conditions such as stroke, heartburn and asthma. Because like the likes of Lipitor have now gone generic, cardiovascular health has dropped to the bottom of the popularity rankings.

Figure 2. Licensing activity volume by therapeutic area, 2011

Source: Deloitte Licensing Deals, 2012

The Biotech Declaration of Independence

With shrinking pipelines, Big Pharma are left with little choice but to streamline efforts towards partnerships and licenses. Bristol-Myers’ “String of Pearls”, and Lilly and Merck’s novel aqcuisition-focused business models, discussed in our previous post, serve as testimony to that. However, the visible whithering of the pharma giants’ power is also strong incentive for smaller players to challenge industry leaders and to dodge “Pharmocracy’s” sphere of influence. 

Enough lone biotech examples have now emerged to conclude that the No-Exit trend is now a dawning reality, rather than mere speculation.  Beside the fact that US equity valuations already prefer Biotech to Big Pharma, there is now an impressive collection of biotechs valued between US$ 500 million and US$ 3 billion who have chosen the independent route, with impressive results. Big Pharma are uncomplexed when it comes to making obvious their objects of desire: GSK recently placed a whopping US$ 2.6 billion bid on Rockville, while everyone else is visibly eyeing the San Diego-based Amylin Pharma, who could potentially dig any large pipeline out of the ditch in the current markets. But the lone wolves are standing proud - for now, at least. 

Why Big Pharma Has Lost its Appeal

Intuitively speaking, the traditional exit model postulates that a biotech’s value is commonly created, and indeed dictated, by “the exit”—a highly coveted event for a small player. But in the current industry scenario this may no longer be so. For starters, Big Pharma are now nowhere near as intimidating in terms of scientific capital and IP as say, ten years ago—which means that biotechs now have a realistic chance at competition with conglomerates. Secondly, investor confidence in the lone biotech is growing as markets are beginning to fathom the actual benefit ratio of a modern Big Exit.

All factors considered, today, a small player transfers substantially more value to Big Pharma in a licensing deal than it receives in return. After all, both are now likely to use the same tools in reaching the market—Contract Research, Manufacturing, Sales and Marketing organizations. Even the famous marketing departments—the force Big Pharma could proudly boast to exit anticipators—are on a visible decline. In turn, the CRO (contract research) and the CSO (contract sales) industries have grown at lightning speeds since the onset of the Patent Cliff, as they have received the shifting volumes of Big Pharma’s R&D projects and became a viable, affordable option for small biotechs. Almost all of the future growth CROs are poised for is expected to be driven by biotechs, rather than by pharma multinationals.

Access to Global Markets

Luckily for Big Pharma, the CSO market at the moment is still heavily concentrated in developed economies. In China, only a small number of CSOs are currently in operation; leaders include NovaMed, with 500 representatives, and Invida with roughly 600. In India the number of CSO players is lesser still. For the most part, this is due to lack of appropriately skilled personnel on the ground, but global talent migration is likely to compensate for low volumes in the not-too-distant future.

It is because of their pharmerging market presence that pharmaceutical giants remain confident that their lingering, unbeatable allure rests with their global coverage. DIY biotech strategies may pay off in local markets, but the chances of unpartnered companies reaching global markets are still rather slim. Needless to speculate, burgeoning service provider industries are just as eager as Big Pharma to reach foreign shores, and the lone player may be granted global market access sooner than multionationals would like to believe.

Raising Capital the DIY Way

In terms of financing, Big Pharma are now in much lesser possession of cash flows than before they went on a cliff-induced panic shopping spree. Furthermore, pharma executives are naturally shopping around the therapeutic areas which are highly lucrative on their own, namely areas of unmet need and with well-defined patient populations which would warrant a lesser marketing force. In the charts of investors’ priority lists, clinical trial success and FDA approval are fast becoming top hits, pushing out the traditional value-creating partnership. As investors are beginning to understand that clinically and comercially sound lone players have the potential to generate more value than partnered ones, the markets are beginning to reward the DIY system, generating more cash for biotechs who would otherwise have no choice but to resort to the exit.

Crowdfunding

Governments are likely to play a role in Biotech survival too. France has had a crowdfunding  scheme, titled “Fonds Communs de Placements dans l'Innovation”—roughly meaning the Communal Innovation Fund—for over 15 years, raising around US$ 6 million from the crowd for the greater scientific good. The British Bioindustry Association has recently picked up and improved on the idea, initiating the “Citizens’ Innovation Fund” which promises lucrative tax breaks and reasonable returns for those supporting the bio-industry with investments of over £15,000 a year. Crowdfunding is probably a rather infantile notion as of yet - but with schemes such as the CIF this way of raising capital likely to play an increasingly crucial role in safety-netting the lone biotech arena. 

It seems the giants may be under a realistic over-shadowing threat from audacious young biotechs eager to go it alone. Perhaps it is too early to tell who will win out in the long term, but Big Pharma could certainly do with a disruptive business strategy in order to regain its appeal in the eyes of the biotech--and the world. Change is undeniably in the air, but only time will tell whether Big Pharma will be able to gracefully regain composure, or whether the industry will once again return to its very foundations of lone players and great innovations.

The New Age Pharma Business Model: Part 2 - The New Big Pharma Business Models

Amidst mass generification of history’s bestselling drugs, Big Pharma is extensively finding itself cornered by aggressive competition from generic drugs which only recently ceased to be their very own blockbusters. As market share and annual revenues plummet off the patent cliff, pharma multinationals have resorted to a series of radical changes to restore the precarious equilibrium between the ever-battling yin and yang that are the originator and the generics industries.  

Our last post addressed the trend of the visibly shrinking R&D departments, particularly what has become of them, and how their lingering potential could still be of interest to downsizing pharma.

This week we will be looking at the colourful abundance of individual strategies companies are adopting in these austere times. Some trends may be more fashionable than others, but one thing seems certain: no pharma player has remained unmoved by the industry’s desperate cries for change.

In-licensing and later-stage acquisitions

There is an undeniable R&D productivity crisis in the pharmaceutical industry. Output of in-house R&D has been at its lowest in the past 5 years, despite an increase in the number of projects and in the availability of funds. The ratio of the number of FDA-approved NMEs to R&D spend for nine Big Pharma companies (fig 1) demonstrates a harsh reality that in-house R&D as it is conducted in the industry today is simply no longer sustainably efficient.

Figure 1. Number of total NMEs approved by the FDA versus R&D spending by: AstraZeneca, Bristol-Myers Squibb, Eli Lilly, GlaxoSmithKline, Merck, Novartis, Pfizer, Roche and Sanofi-Aventis-Aventis, 2005-2010

Source: “The significance and apparent repercussions of the 2009-2015 pharmaceutical patent cliff”, Bioassociate, 2012

It has been argued that R&D turnout has been so poor in recent years due to the decreasing number of “easy targets” - that is, companies are addressing less well-elucidated disease pathways in a tunnel-vision search for the next blockbuster, increasing the risk of their ventures. In other words, basic research has apparently not caught up with the demands of the industry.

Pipeline collaborations, partnerships and in-licensing as a way to dilute the costs and potential hazards, and 91% of industry executives believe that in the next decade the industry will be riddled with pharma-biotech mergers; 69% also believe that consolidation amongst small biotechs will be on the rise.

Notably, in anticipation of the patent cliff, the majority of licensing deals struck in Q2 of 2010 involved molecules in marketing stages of development; leads in phase III trials were the second most popular licensing target. Most pharma executives anticipate a significant influx of later-stage, clinical molecules into their pipelines over the next two years (Fig. 2).

 Figure 2. Pipeline changes anticipated by pharma executives over the next two-three years (2011—2014)

Source: Life Science Strategy Group and William Blair & Co, 2011

GSK, Merck, Novartis, AstraZeneca, Pfizer and Roche have announced that in-licensing is to become a core part of their business strategies, and have already secured over 50% of all Top 20 Pharma in-licensing deals struck in the 2005-2010 period. The number of licensing agreements has increased by 16% in the last five years, and the majority of licensing deals struck in Q2 of 2010 involved molecules in marketing stages of development; leads in phase III trials were the second most popular licensing target.

Companies who strongly oppose diversification, such as Bristol-Myers and Roche, have divested from their non-Rx portfolios but have streamlined their efforts towards partnering and in-licensing rather than towards in-house innovation. Bristol-Myers’s “string of pearls” strategy is exclusively aimed at partnerships and licenses which would address a vast array of target disease niches and compliment the company’s existing pipeline. . As part of “pearl acquisitions” the company purchased the immuno-oncology specialist Medarex for US$ 2.3 billion, obtaining an abundant cancer and biologics pipeline in the process. Other pearl acquisitions included Kosan Biosciences and the protein biologics developer, Adnexus Therapeutics.

Similarly Merck’s chief licensing officer, Dr. Barbara Yanni, has revealed the company’s “scientific scout” model, as part of which licensing “detectives” are trained to hunt for lucrative deals amongst academia, small biotechs and even large multinationals. In 2009 the scouting strategy has lead the company to close 51 licensing deals.

Shifting Therapeutic focus

Based on the in-licensing activity in the industry, oncology, central nervous system disorders, cardiovascular health and autoimmune diseases currently dominate the target disease field, whilst the biggest blockbusters of the last decade have for the most part targeted pervasive “first world” conditions such as stroke, heartburn and asthma.  With Lipitor going generic, Pfizer declared that the company will no longer focus on cardiovascular health in their pipelines, shifting resources to oncology and Alzheimer’s disease instead. GSK is also set to diversify into oncology, cardiovascular health and vaccines, whilst Takeda will focus on metabolic & central nervous system disorders and oncology.

The ageing population of the world, which will reach 19% of the global population by 2030, is becoming pharma’s most faithful client. In the US, prescription use is sizeably dominated by the 65+ age group and R&D focus is shaping accordingly, with diabetes, osteoporosis, Parkinson’s disease and other chronic illnesses becoming the target of choice for applied research.

Outsourcing

For companies who chose to retain a certain level of home-brewed innovation, scientific outsourcing with contract research organizations (CROs) appears to be a more cost-effective alternative to in-house R&D. Global CROs such as Quintiles, Charles Rivers Laboratories, ICON and Parexel are expected to profit lavishly from the current industry turnaround.

In 2011, pharma companies have outsourced US$ 36.6 billion worth of R&D expenses to contract organizations - up 6.6% from 2009, and have as a consequence lowered their research expenditures from 74% to 62% in the past year. 

Smaller pharma and biotechs are expected to be responsible for the majority of outsourcing activity, as in-licensing will remain a priority for large pharma. The shift towards outsourcing has been made inevitable by expanding pipelines and shrinking R&D departments, and rates of outsourcing are expected to increase by 10% across all research areas by 2015, with growth rates exceeding 60% within the next decade.

Commercial Outsourcing

Drug commercialization is a process with a bulky price tag for Big Pharma, and one which is strongly dependent on an array of ever-shifting variables - i.e. fluctuating markets and exclusivity times. Occurrences like patent expirations may suddenly make obsolete massive product-specific sales teams, resulting in redundancies or substantial amounts of resources spent on product re-focusing. Essentially, pharma commercial teams have an “on and off” switch which begs for immense flexibility not afforded by the current pharma model. Since marketing is astonishingly as costly a process as R&D itself, it invariably possesses an equally large potential for cost cutting. 

CROs like Quintiles and Charles Rivers are beginning to develop specialized commercial outsourcing units, and numbers of global Contract Sales Organizations (CSOs) are on the rise, having already secured some Big Pharma customers. Sales outsourcing potentially eliminates the danger of post-expiration redundancies and the uncertainty which surrounds commercial matters in the industry. By 2016, the global CSO market is expected to be worth over US$ 9.2 billion, up from US$ 3.7 billion in 2009, and the US$ 200 billion Big Pharma spent on marketing in 2010 testifies to the potential of this niche. 

Diversifying into the generics, biologics, biosimilars, consumer healthcare and vaccine markets

As pharmaceutical innovation is decelerating due to a decreasing number of target diseases, diversifying into a competitor’s realm is continuously becoming a more attractive strategy for multinational pharma. According to Roland Berger Strategy Consultants, 78% of pharma executives perceive generics to be the most important area of diversification, followed by consumer health (50%) and vaccines (42%). Importantly, the strongest potential of generic and consumer health diversification is perceived to be in pharmerging markets.

Pfizer’s acquisition of Wyeth was in part motivated by the diversification potential of the deal, which gave Pfizer access to the established vaccines, consumer health and biologics departments of Wyeth. On a similar note, Sanofi-Aventis announced plans to become a diversified global healthcare leader in 2009 increasing non-patented drug and other product sales from 5% to 12% in recent years. GSK, who faces losses of US$ 9.3 billion during the patent cliff, was one of a select few multinationals to report Q3 2011 sales growth, for the most part due to a 21% increase in the sales of vaccines and a significant consumer healthcare sales growth in emerging markets.

Diversification is not on every multinational’s agenda, however. Eli Lilly and Bristol-Myers Squibb, for example, remain dedicated to their Rx programs, as investors and analysts are weary that conglomerates are likely to trade below the sum of their parts.

The Unmet Need Arena

In the current context, new innovative drugs entering the market must not only demonstrate that they are en par with or better than their marketed competition, but to differentiate enough from growing numbers of cheaper generic alternatives, and to justify the price premium over them.

Of particular importance over the next few years will be novel action or delivery mechanisms in major disease areas to accommodate those patients for whom current methods are unsuitable. Novel classes of diabetes drugs, such as the new SGLT-2 class, will be particularly prominent. Drugs targeting orphan diseases will also be on the rise, but will not be a significant source of revenue.

“Pharmerging Markets”

Currently, major global drug consumers are the US, Japan and the EU, but the growth rate of these markets is predicted to slow down to as low at 1% in the next decade. In contrast, pharmerging markets, such as the BRIC countries, South America and Eastern and Central Europe, have the potential to grow at 14-17% and to rake in up to US$ 180 billion annually for the pharma industry. Growth of income in these markets, which is normally 80% correlated with growth in affordability of and spend on medication, is extremely robust, and serves as the primary allurement for major pharma investors.

Defined by IMS Health as a “Tier 1” pharmerging market, China presents the greatest opportunity, with a predicted annual growth of 20% in terms of pharmaceutical demand, in contrast with the average global growth of only 5-8% through to 2014. China’s immense market growth is predicted to be mainly due to a significant rise in chronic illnesses, which currently amount to 80% of total deaths in the country. The IMS “Tier 2” Brazilian, Russian and Indian markets are expected to grow at 13-16% in the next five years, even despite the lack of adequate governmental patent protection. “Tier 3” countries such as Egypt, Indonesia, Mexico, Pakistan, Turkey, Romania and Ukraine, among others, are also steadily picking up pace. By 2014 pharmerging markets will represent 49% of the global pharmaceutical demand, in contrast with only 8% in 2001. 

Befriending Academia Still in the Cards

Basic research happening in the academic arena and government facilities has been identified as a profitable force by Big Pharma for some time now. Companies have nurtured academic links through the building of research incubators, offering of industrial placements, funding of PhD projects and sponsorship of individual labs. In the new era business model, however, friendship with academia has seemingly waned as a result of diminishing in-house R&D and increased outsourcing. According to latest research by the Association of the British Pharmaceutical Industry, industrial placements have been on a steep decline: from 530 in 2007 to 355 in 2009 and 268 in 2011. But this is simply the result of less in-house work, as other numbers show that industry has in no way lost interest in keeping in touch. In 2009, the number of sponsored PhD partnerships was 384, whilst in 2011 this number rose to 644.

This seems to re-iterate the notion that pharma is “down but not out”—in other words, declining annual revenues have called for more economical ways of maintaining contacts, but companies are  by no means less enthusiastic about scouting potential “socially”.

The trends the industry is following today are a result of a single apparent variable: lesser funds. With less money to throw against the conservative R&D model, companies have been able to isolate and target the root of pharma’s problem: the unproductive beast that the in-house R&D strategy has become along the way.

In-licensing and outsourcing may eventually lead to a new pharma “shell” model, whereby giants merely reign over countless contracts and licenses. But there may yet be a hindrance to this development. Come back to the Bioassociate blog next week for Part 3 of the New Era Pharma Business Model: The Case of the No-Exit Biotech.

For more in-depth details and numbers of the shifting trends, have a look at our report: "The Significance and Apparent Repercussions of the 2009-2015 Pharmaceutical Patent Cliff"