Drug Truths

A site devoted to teaching about drug discovery and development.

Why Should Wall Street Dictate the Level of Pharma R&D Spending?

with 14 comments

Last February’s comments by Kenneth Frazier, Merck’s CEO, should have served as an inspiration for those focused on the promise of new medicines and perhaps acted as a beacon for other leaders in the pharmaceutical field.  As reported by Jonathan Rockoff in The Wall Street Journal (February 4, 2011), Frazier said that Merck will not focus on cuts, but rather focus on investing in drug development to drive growth.  He said that he wanted to reinvest some of the savings realized from the acquisition of Schering-Plough into advancing Merck’s last stage pipeline.  Frazier continued on this theme at his company’s annual shareholder meeting in May, where he shared his vision of success by using Apple, IBM and Starbucks as examples.  These companies succeeded through innovation and he said that innovation and research were key to his vision for Merck (Susan Todd, The Star Ledger, May 24).

Wall Street analysts, however, weren’t happy.  Les Funtleyder, a manager of the Miller Taback Health Care Transformation Fund, provided a typical response: “Merck could end up wasting billions of dollars probing compounds that don’t pan out.”  Analysts contrasted Merck’s approach to that of Pfizer, which was cutting its R&D budget drastically.  The result: Pfizer’s stock price advanced while Merck’s took a hit.  Frazier has relented a bit.  In late July he announced that Merck would lay off 17,000 colleagues.  “Spanked by Wall Street, Merck CEO Orders U-Turn” reported Jim Edwards on the BNET Blog (July 29th).  Frazier apparently plans to cut other parts of the company deeply; growth of the R&D division resulting from reinvested cost savings appears to be tabled.

The Merck situation is not unique.  John Lechleiter, Lilly’s CEO, has also committed to strong R&D investments for his company. He told Reuters (June 30) that: “It would be a mistake for us to disinvest in any significant way in R&D.”  He also realizes that such a strategy is frowned upon by Wall Street: “I never thought that I would live to see this, but investors are actually thinking to cut R&D – that’s the hot topic of the day.  This is kind of nuts, but this is what is being talked about.”  Analysts have been negative on Lechleiter’s stance.

Amgen is another company in the crosshairs of Wall Street.  Just last week it announced that it would be restructuring R&D, with an aim on improving focus and reallocating resources to key pipeline assets and activities.  Amgen is a success story.  Once a start-up company, it is now the world’s largest biotech. It has been used as an example of how to do this.  And what has been the response of the market analysts to this restructuring? Michael Yee of RBC Capital Markets told Reuters (October 12) that “The $3 billion R&D line item annually is high and investors see room to start to trim this.”

Now, I am all for monitoring R&D budgets to maximize the returns from these investments.  And I am all for accountability – asking the R&D organization to deliver new candidates to the pipeline, having formal goals with rigorous deadlines, and for running clinical trials as expeditiously as possible while keeping a close eye on costs.  But for Wall Street to reward a company for lowering R&D spending and attack those that want to commit to R&D is absurd.  Like it or not, R&D IS the engine that powers a pharmaceutical company.  It is also a high-risk endeavor.  Furthermore, given all of the hurdles that now exist especially with regard to ensuring safety and having sufficient novelty to justify pricing, R&D is more expensive than ever.  But, if you want to succeed, you have to invest – substantially.  There are no short cuts.

Analysts have said that, in the past decade, the return on investment (ROI) in pharma R&D has been poor.  I don’t disagree with that.  A strong driver for this has been the spiraling costs in carrying out comprehensive phase 3 trials – a major change from a decade ago.  However, this has largely been built into the R&D  process and there should now be improvements in the number of new drugs approved annually.  Evidence of this comes from an unbiased observer, FDA Director Dr. Janet Woodcock, who recently told Congress that the FDA is approving more new medicines than in the recent past and that these new drugs “work differently, or better, than existing drugs or tackle ailments lacking good treatments.”  My guess is that the drugs that will be launched over the next five years will greatly improve the return on investment statistics now used to skewer recent R&D investments, thereby resulting in improved ROIs.

But the decision on how much to invest in R&D, the lifeblood of a company, is the responsibility of the CEO and his Board of Directors.  For this to be influenced by Wall Street Analysts is, to quote Lechleiter,  “Nuts.”


Written by johnlamattina

October 18, 2011 at 5:39 pm

14 Responses

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  1. There are many at Wall Street who are Monday morning quarterbacks. If they are so smart to dictate what should be spent and where, then why are they not running the companies.

    Bottom line question is “are the analysts running the company or the management of the company”. It is disgusting to see comments from folks who think they know everything but have no/little clue of very little on R&D or manufacturing. Cheers.

    Girish Malhotra


    October 18, 2011 at 8:52 pm

  2. John,

    I agree with your comment concerning the increased costs of clinical trials. A great example of this is the first benzodiazepine approved, Librium.

    Leo Sternbach first synthesized chlordiazepoxide (Librium) in 1956 and the FDA approved it for sale in 1960. That’s literally four years between identification of the compound and the first patient taking the drug. What is it now? 12 years? More?

    Of course our standards for efficacy and safety are MUCH higher than in the 1950s, but one has to ask, is it the right degree of trade-off? Sure it’s only one example, but Librium is a very safe and very efficacious drug. And it wasn’t that expensive either. One has to wonder whether or not we’ve gone too far in one direction and whether there is a better way of doing this.



    October 18, 2011 at 10:06 pm

    • Mike,
      This is a tough call. Certainly, Sternbach’s landmark work occurred in another era. So much more is known now about the potential side-effects that a new medicine might have, that we can’t fault the FDA for setting the bar high. In my view, the problem is that most people don’t realize that the bar is, in fact, set VERY high. They believe the negativity in the press that pharma companies try to hide side effects or ignore them. This is not only untrue, it is also impossible to do given the transparency that now exists on all clinical trials. Thanks for your comment.
      – John


      October 19, 2011 at 12:42 am

  3. I never thought I’d introduce Dallas Mavericks owner Mark Cuban into a conversation regarding pharma R&D, but I’m compelled to in this instance. “Wall Street has nothing to do with creating capital for businesses, its original goal,” stated Cuban. “Wall Street is a platform. It’s a platform to be exploited by every technological and intellectual means possible.”

    While I’m no fan of Cuban, the man hit the nail on the head in this instance. If you buy into Cuban’s premise, than you’d have to say John Lechleiter is correct when he says that its nuts to be influenced by Wall Street analysts when it comes to R&D funding. Wall Street is interested in making the big score this quarter – everything else is conversation.

    No company has ever slashed its way to prosperity. For pharmaceutical companies to do so in the way Wall Street analysts suggest would be suicidal.

    John Schneider

    October 18, 2011 at 11:46 pm

    • John,
      I hadn’t heard that Mark Cuban said this, but I agree wholeheartedly with him. Thanks for your thoughtful comment.
      – John


      October 19, 2011 at 12:38 am

  4. Wall Street analysts serve up opinions based on historical results and their projections of future outcomes. Spreadsheet financial models are the bread and butter of these projections. Looked at solely on a ROI basis, pharma R&D spending over the past decade has been an investment with very poor return, hence the view that R&D budget trimming is wise. If a company has been plowing money into a particular line item for a very long time, and that investment has not yielded its intended returns, one can reasonably conclude that line item is a poor investment.

    But we all know that R&D is the engine that fuels the pharma industry’s product development pipeline. Why are CEOs bowing to the pressure of Wall Street analysts? That’s a very intriguing question, and I believe it’s tightly linked to the mantra that public companies must show improved bottom line results every quarter. When CEOs don’t adhere to this short term focus they are quickly shown the exit door, hence their willingness to abandon long-term vision in exchange for short-term satisfaction. CEOs crave job security as much as the lowly US scientists being laid off in droves, and appear willing to sacrifice long-term strategy for short-term gains.


    October 19, 2011 at 3:50 pm

  5. CEOs are humans especially little children who infront of their peers want to be recognized that they are delivering value and want to be rewarded through bonus and name being printed in press.

    Only way they can get this recognition is playing to the music of analysts who are just number music spinners. It is a mutual appreciation society that caters to greed. All of are in someway part of it. It is a sad reality. By the way my conjecture is that better then 50 percent of number spinners may not know an acid and base react to make a salt and water or how to turn a valve in a plant but they pretend to know it all and we believe them. Cheers.

    Girish Malhotra

    October 19, 2011 at 9:29 pm

  6. I actually don’t particularly disagree with your position that pharma shouldn’t be cutting R&D today, but I do take issue with the idea that it is somehow “nuts” for reasonable people to suggest as much.

    Given how poor the past decade plus has been for pharma returns – and here think not only of the ROI results mentioned above but also the stock performance of most of the leading companies in the sector – one could make a non-trivial argument that “Wall Street” has actually shown quite a bit of patience with these firms. Far from overreacting to a single quarter’s miss, current frustration with the sector stems from pipeline frustrations very long in the making. When I first worked on buyside in the late ’90s, Pfizer was near $50 a share and people were starting to wonder what would come after Lipitor. Now in 2011 Pfizer is worth <$20 a share and . . . people are still wondering how they will replace Lipitor.

    I agree there are reasons to hope that R&D productivity has turned the corner, and that the next few years may prove better than the recent past. But I hardly find the reasons for optimism dispositive – this period of frustrating performance may well continue.

    If there exist people who believe that the nominal levels of pharma R&D budgets should maximized beyond all else, they are welcome to set up an LLC, find like-minded individuals to fund it and proceed accordingly. In the meantime pharma managements are playing with investors' money, and – over time – those investors' opinion of what should be done with it matters mightily. The analyst comments you see reflect that fact.

    • Robert,
      The poor performance of the last decade is due to many reasons that this response cannot cover. Suffice it to say, there have been seismic shifts to the industry that are just now being overcome. But my points remain: this is a high risk – high reward business. The ’90s were an unbelievable time of prosperity for most of Big Pharma – prosperity that was never envisioned in the ’80s. A company’s decision to invest heavily in R&D these days should rest with the BOD and CEO. I agree that analysts have every right to challenge this. But the amount of influence that analysts have is unhealthy and leads to decisions that may deliver in the short-term, but which are detrimental to long-term success. The R&D process is 10 -15 years in length. If you want to be successful, you need to invest for the long haul.
      – John


      October 20, 2011 at 12:41 am

  7. Here’s the investor perspective, at least according to a new KPMG report that was apparently issued today.



    October 20, 2011 at 4:37 pm

  8. […] In the Pipeline, has some of the details and this complaint from Derek: And on a similar topic, here’s a post from John LaMattina asking what many people have at one point or another: how come Wall Street […]

  9. […] of drug developers laid off by pharmaceutical firms, which have been pressured by Wall Street to focus on “core competencies” and cut R&D. Last year, investment managers punished Merck for investing in research, while […]

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