Biotech Dwarfed by Pharma R&D

Posted in Pharma industry

Lots of folks have been talking about the demise of Pharma R&D spending, especially with the recent cuts at Pfizer, GSK, and others.  But the truth is far from that, as they still spend an enormous sum and dwarf the rest of the ecosystem.

The big players probably still spend far too much.  Legacy infrastructures and leviathan bureaucracies place an enormous tax on the utilization of those funds.  Also, Big Pharma R&D is so large that it probably crowds out more capital efficient investments by the smaller players in the ecosystem (e.g., “how can we compete when Pharma will throw hundreds of chemists at this…” or “we can’t recruit patients because Big Pharma XYZ’s studies are running…”).  I’d welcome seeing greater discipline around “doing more with less” and think it would be healthy for the sector.

A few reflections on the comparative statistics of Pharma R&D today:

First, although select companies are cutting, the industry’s overall R&D expenses aren’t shrinking.  It’s a slowdown in the growth of R&D spending from prior 10% year-on-year increases of a few years ago, but it’s not a cut.  According to a piece from JP Morgan analyst Tycho Peterson the Top 20 R&D consensus numbers are likely to be close to 0.2% and 0.3% for 2011 and 2012, roughly in line with where they were in 2009.  To lament the cuts is like hearing folks in Washington saying they’ve cut the budget when they’ve really just cut the growth rate of the budget.

Second, the aggregate R&D number is a huge amount of capitalthe “Big 20″ global drug companies spent $96B in R&D in 2010 according to CapIQ.  It may only be roughly 15% or so of drug sales, but its a huge amount of capital relative to other players; here are a few specific points on its relative scale:

  • The Big 20 spent 26x more than the total funding for all private venture-backed biotechs combined in 2010. That’s right, 26 entire private biotech universes.   According to the recent PWC/NVCA MoneyTree™ Report, biotech venture financing was only $3.7B last year in the US across about 460 companies.  Since this is an annual fundraising number that hasn’t grown much, and R&D is the bulk of private biotech costs, it’s fair to generously assume that venture-backed biotech annual R&D is close to that number.
  • Pfizer’s Global R&D budget in 2010 was close to 2.5x that amount, which by extrapolation is about 1000 venture-backed biotech companies worth of funding. Interesting to reflect on that comparison: PFE = 1000 private biotech units.  In fact, the proposed cuts in PGRD over the next couple years amount to close to $3-4B in annual R&D, which is the equivalent of cutting 2010 funds for all the VC-backed biotechs in the US today.
  • Several of the biotech companies I know well have facilities/utilities costs around 3% of the operating expenses.  I’d suggest a large legacy corporation is higher cost to run than that, but even at 3% that implies the Big 20 likely have as much in annual utilities & facilities costs for their R&D organization than all the funding for venture-backed biotech combined. So much for turning the lights on.
  • Taking a longer-term look at those numbers adds further perspective of the scale of Pharma R&D.  During the past 16 years from 1995-2010, biotech venture capital funding in the US alone amounted to just less than $50B over 5600 rounds of financing (PWC/NVCA).  That means in a single year the Big 20 spend close to 2x more than all of private venture-backed biotech funding since President Clinton’s first term.

I recognize the Big 20 are doing some mega-trials in Phase 3 that VC-backed companies wouldn’t come close to doing, but the scale difference remains enormous in research alone.  If research (discovery and early development) is 33% of the overall budget, they still spend 8x+.

Given the scale difference, either venture-backed biotech is completely irrelevant in the overall drug R&D ecosystem, or it’s punching well above its weight class.

Does the entire venture-backed biotech universe contribute more than 4% of the value in the global R&D pipeline today? I certainly think so.  That’s good value for money, but a seriously small David relative to the Pharma Goliath.

Lastly, taking an even wider lens than just venture-backed biotech, the entire publicly-traded global biopharma universe smaller than the Big 20 spent $27B last year (according to CapIQ this is about 700 companies on the major global exchanges).  So the Big 20, roughly 3% of the publicly traded drug companies, spent over 80% of the R&D dollars.  And 80:3 ratio is well beyond a typical 80:20 relationship; it’s a huge concentration of resources in relatively few hands.  And it seems to me those hands are unfortunately constrained by legacy infrastructure, aging assets, endless committees, burgeoning bureaucracy, etc…

Perhaps the Big 20 should be more aggressive about channeling capital to foster expanding networks of private and small-cap biotech to provide them with more innovation.   This would undoubtedly create a lot of long term value.  Sadly, I suspect the short term importance of stock buybacks and next quarter’s EPS is far too significant to overcome…

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  • Gor

    I agree that pharma should ratchet up its bus dev activities and do more early stage deals. But the people that I have interacted with at these pharmas don’t seem willing to put their asses on the line for riskier deals. If their superiors put out a strong message that some failures are OK and won’t impact someone’s potential rise in a company, more early stage deals might get done.

  • http://twitter.com/PatrickNelli Patrick Nelli

    Are there any numbers describing the magnitude of licensing arrangements between big pharma/biotech and life science startups? I feel like these relationships could sway the numbers slightly and it would be good to know their order of magnitude.

  • http://twitter.com/Chemjobber Chemjobber

    Great post. Is there any way of quantifying how many scientists all of this R&D funding is actually purchasing? (And also the difference in cost between a B.P. research and a biotech researcher?)

  • HelicalZz

    And what % of large late stage clinical trials (phase III of > 2000 patients) are run by ‘venture backed biotech’? I would guess a pretty small percentage. Late stage clinical R&D costs dwarf early stage development ones which is where venture backed firms tend to operate. I don’t disagree with the conclusion that pharma should do more venture-like investing, but not how you got there by comparing R&D apples to R&D oranges.

    Venture backed biotech only accounts for more than ’4% of the value in the global R&D pipeline’ if it has big pharma to partner with or be acquired by. Without, it doesn’t have the means to get to market and therefore not much value at all.

  • Cliff Meijer

    I would argue that maybe big Pharma should do LESS early stage R&D, and focus only what it does best – sales/marketing and distribution. They could then use the capital currently in their R&D budgets to fund (a) acquisitions and/or licensing deals, and (b) develop more robust trial processes for later stage indications. . Either that or use the money to lobby for restructuring the FDA to allow more clarity and accountability into the review process!

  • Anonymous

    Thanks Patrick. Not at my fingertips. But I’d doubt they would add more than 30% to the biotech #’s, so wouldn’t change the conclusions that much. I’ll look into it though.

  • Anonymous

    Good question, not sure. Unfortunately the data is weak on how many R&D FTEs exist in most pharma companies. Most of our venture-backed discovery stage companies have variable FTEs at partners/CROs/collaborators working on our behalf, so it’s not quite the same as hiring a full time local FTE.

  • Anonymous

    HelicalZz – thanks for the post and appreciate your point. Agree there’s lots of nuance in these #’s, hence why I made the “mega-trial” Phase 3 comment.

    But even comparing research and early development suggests the Big 20 are many multiples larger wrt R&D than a couple 1000 smaller companies combined. I’m simply calling that difference in scale out, especially in light of the ‘cuts’ in Pharma R&D at a few big players.

    And your point about value is very true and hits at the essence of the challenge facing biotech today: expensive late stage drug develop requires big sources of funds with low costs of capital. Unfortunately, in the absence of an accommodative biotech IPO market that used to fund later stages of development (think Vertex, Medimmune, Celgene, etc…), there’s only one real funding source – big players. Fortunately, they all need great assets so there’s typically multiple potential buyers to help with asset “price discovery”

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  • Will D

    Bruce – the end of your post suggests an interesting conundrum: that big pharma R&D is too constrained by the short term to invest in expanded innovation, but the greatest long-term need is greatest innovation. Do you think big pharma is able and willing to be direct with shareholders and make those investments? What do those structures look like (e.g., Lilly’s discovery funds, company-backed VCs, Pfizer-like incubators)? And is the problem the structure of these innovation cells, the mindsets and incentives endemic to big pharma (shorter term payoff, risk avoidance on truly disruptive technology), and/or something else?

  • Anonymous

    I just got a great set of comments from someone in Big Pharma biz dev who said their company doesn’t allow them to blog post. Raises some great points. So I’ve taken the liberty of pasting it here to share the dialogue:

    “While I agree that Big 20 spend a lot on R&D and could probably do with some efficiency, what you don’t seem to take into account is the post-marketing trials that companies are required to do. For instance, 40% of [my pharma]’s R&D budget goes to marketed products. We are gearing up for more safety assessment for [product xyz], a product that has been on the market for 15 years. Still—the 60% remaining is still a gi-normous amount of cash and it can be better spent on small innovative companies. And in fact it has—perhaps with less than stellar results in most cases (because it is still drug discovery with its inherent failures) lest we forget transactions such as Novocardia/Merck, Ilypsa/Amgen, or the mother-of-all ‘what were we thinking’ Sirtris/GSK. So the good news is that pharma still has cash to spend (particularly off-shore) however there will probably be a continuing trend toward ‘sharing the risk’ type of transactions. Unfortunately where pharma really needs the help (besides innovating), is regulatory and economic, with the FDA, CMS, NICE, etc. Show us some love there and the $$$ will flow your direction.

    ….It still is a crazy amount of money and there must be a better solution for everyone around the table: profits for pharma, VCs and good, affordable drugs for patients. In addition to the ‘creative deal structures’ which include your new corp structure, we need to find a better way to partner between pharma/biotech (and I mean earlier than The Deal). The internal selling required to bring something in from outside is really tough so when there are flame-outs then research point to it and say “See! They sold us a bill of goods! If we just had that $400M……” Of course they don’t understand the accounting and hit to the P/S price. And I delicately remind them of how much money they are already getting and that our shareholders still aren’t pleased with the results. So I’m working to remove the ‘us-them NIH’ sentiment. But frankly I do think it is a good time for biotech—the quality ones with good investors!”

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  • CMCguy

    Love the description “Legacy infrastructures and leviathan bureaucracies” as apt reflection of Big Pharma and when you add in most of growth has been via M&As there does seem to be huge waste in both capital and potential. It used to be that most drug companies had enough people around in the necessary disciplines that really knew how to collaboratively discover and develop drugs that success would follow in spite of those constraints, albeit still unpredictable and inefficient, however wonder if that is still at the core of many Pharmas. More so leadership focus has changed to follow profit so as noted by Gor there is risk aversion that runs counter to what is required for innovation to occur. Smaller companies will have own bureaucracies and the lack of legacy/experience can be problematic although many often at least have decent leadership and sense of desperation that while frequently remains uncertain and suffer inefficiency I agree contribute more value for the money.

  • Mjay

    What is the average cost of capital for a VC backed life science company vs. the same for a typical Big Pharma?

  • Anonymous

    My guess is Big Pharma has a 7-10% cost of capital given their enormous balance sheets and tax structures. Early stage VC has a 30%+ cost-of-capital (e.g., 5x over 5-7 years is straddles 30%). So a 2000+ basis point spread on cost-of-capital.

  • Mjay

    But I would guess the ROIC for biotech dwarfs that of big pharma….or do the cheap and highly liquid internet portfolio companies cover up the negative returns on biotech, on average?

  • Anonymous

    Certainly over the last 10 years. Pharma has looked really bad, and biotech not-quite-so-bad.

  • Mjay

    Agreed.

  • Anonymous

    The best part about the creative destruction of Pharma R&D is that lots of talented, experienced R&D veterans are being liberated from the bureaucracy and are available to work in biotechs. This helps to solve some of the “lack of legacy/experience” issue that has historically plagued shoot-from-the-hip biotech. All of our companies have Big Biotech/Big Pharma veterans associated intimately with them.

  • CMCguy

    I agree bringing on experienced people can provide valuable boost at small biotech however it is not always smooth/panacea as certain veterans may not really adapt to working in different environment (especially wearing multiple hats) or in cases the good advice the veterans provide go unheeded or worse is brought in too late to impact positively.

  • Pwoitach

    Re: Big Pharma experts – spot on – adaptation to small is a problem – and in my experience only a small portion make good small company consultants becuase they lack the mix of big picture and hands on along with ability to develop small company approaches rather than belt and suspenders they were reared on. Functional specialization within big pharma. Often those that have been successful in both big and small are the best fit

  • Pwoitach

    There’s some figures I can dig out but it’s on the development side where a big pharma can assume a certain # of programs at certain stages and can then budget on an FTE basis to support their portfolio – the discover side is less straightforward. Let me know if there’s a need and I’ll dig them out…

  • Bruce

    Good point – very clear that not all Pharma veterans are able to make the transition to a small, less layered organization where degrees of ‘delegation’ are far fewer

  • http://twitter.com/exMBB exMBB

    Exactly the Valeant model.