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

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 29^th).  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.”

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