Drug Truths

A site devoted to teaching about drug discovery and development.

Should a Big Pharmaceutical Company Invest in Internal R&D?

with 13 comments

On the surface, this appears to be a strange question.  After all, the pharmaceutical industry prides itself on its ability to discover and develop new medicines.  Yet, this ability is being challenged as the industry’s productivity didn’t live up to expectations in the last decade.  The complete outsourcing of R&D was recently put forward in a November 2 article on Investopedia by Stephen D. Simpson entitled: “Should Pfizer Forget R&D Altogether?” Here is what Simpson had to say:

“Maybe the answer is for Pfizer not to worry so much about its own pipeline.  Spending billions of dollars in R&D doesn’t change the fact that the odds of any single compound making it to market are long, indeed.  Perhaps it makes more sense, over the long run, to save on R&D and wait to license, or acquire, drugs (or companies) once they have either made it to market or shown strong enough signs of efficacy and safety to de-risk the proposition.  It would be a bold and potentially risky strategy.  But then, is it really riskier to pay a heavy premium for Celgene, Biogen Idec or Shire than to invest over $1 billion and 10 years in a competing drug whose odds of success are likely below 15%?”

Before getting to the specifics of Simpson’s proposal, it is important to understand the nature of a company’s R&D budget line.  First of all, everything is included in that figure, not just internal R&D costs but also things like the expenses generated in running co-development programs for clinical candidates partnered with other companies and milestone payments made to small companies whose early stage candidate it has licensed.  Second, the size of an R&D budget is largely driven by “D,” not “R.”  The research component of a pharmaceutical company’s budget tends to be only about 15% of the total due to the tremendous costs involved in developing a clinical candidate from Phase 1 through NDA approval.

In addressing Simpson’s proposition, it must be noted that companies are already outsourcing a significant part of their pipeline.  Martin Mackay, President of AstraZeneca’s R&D division, has recently said that their goal is to have 40% of their pipeline generated through licensing of compounds.  My sense is that this is a goal shared by a majority of pharmaceutical companies, and, as I’ve previously written on my blog, I support this strategy.  But should a company like Pfizer be totally dependent on outside sources for its future?

Simpson’s comment that companies would be better off acquiring drugs that have shown enough signs of efficacy and safety to de-risk the proposition is, frankly, naïve.  A compound can show promising signs of efficacy in Phase 2 studies and you can license it at that point.  However, you will still need to invest heavily in the Phase 3 programs needed to get the drug approved.  Given the needs these days to perform very costly outcomes and differentiation studies, the bulk of the development costs remain in this aspect of Simpson’s strategy.  Furthermore, a program is never totally de-risked – there are a number of examples of drugs that prove to be disappointing commercially because of adverse events found post-launch when the drug gets used by millions of people.

So perhaps then, Big Pharma should forgo the licensing of compounds and simply buy companies, as Simpson suggests.  This strategy has been used by Pfizer with its acquisitions in the last decade of Warner-Lambert, Pharmacia and Wyeth.  History teaches that this strategy has its issues. Beyond the internal disruption not just to your entire organization but also that of the acquired company, these mergers have not been viewed as being financially attractive due to the premium that the acquiring company must pay and the lack of sustainability of the merged pipeline to meet long-term growth targets.  Besides, you cannot just assume that the smaller company will automatically roll over and let itself be purchased, nor can you assume that smaller companies will be available on-demand.

While Simpson didn’t directly address the complete shut-down of a company’s early research activities, others have.  I also find this problematic.  As noted above, the “R” component makes up only a small percentage of the overall R&D budget.  And, when internal efforts deliver new products, you own them completely – no milestone payments, no royalties, no co-marketing deals.  Thus, these products are more profitable.  Even Simpson acknowledged that “Pfizer has some encouraging drugs that should come out soon” and most of these are internally derived.  But it is also important to have a strong internal cadre of scientists to help evaluate the strength of the supporting data of compounds being considered for in-licensing.  A good research organization provides this.  Many a deal has been squashed by internal scientists based on their rigorous reviews.

Any company forgoing internal R&D risks its future.  It is not something I would recommend.


Written by johnlamattina

November 8, 2011 at 10:46 am

13 Responses

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  1. I fully agree for all the reasons you mention, John. On the other hand, there are companies like Forest Labs, which seem to be quite successful in licensing and building up a reasonable portfolio of marketed products.


    November 9, 2011 at 11:41 am

    • Thanks for your comment. This sort of thing would be difficult to do with companies with $60 billion in annual revenues. – John


      November 9, 2011 at 1:22 pm

  2. This is one of those concepts that might sound plausible on paper/in accounting ledgers but doesn’t really translate well in the real world. The point raised in the second to last paragraph is a major key IMO as need the right people to perform the due diligence and those people must have appropriate experience and solid awareness with integration of company’s goals and capabilities (places can not totally rely on paid Consultants, which may benefit for certain highly specific reviews, but in general its not an equivalent perspective and typically is costly). I would elaborate further that in conjunction with any good R assessment many of the D functions (Process Development/Manufacturing, QA/Reg, Clinical) are critical to in-licensing. These areas are no longer as strong as once where at many Pharmas because the outsourcing trends for the functions has been happening for decades.


    November 9, 2011 at 7:02 pm

  3. The outsourcing of discovery research and the de-risking of drug R&D sound like clever solutions to the pharma innovation crisis, but they betray a deep misunderstanding of what it takes to manage science and innovation. Just to set the record straight, nearly all therapeutic breakthroughs have historically come from engaging in high-risk and unconventional research. Companies (and societies) that want breakthrough therapies must come to grips with this, and find ways to fund breakthrough research. The pharmaceutical industry did not become one of the greatest contributors to health and welfare by shunning risk and playing safe. On the contrary, it did so by embracing risk and disrupting itself repeatedly. One may take for granted the incredible scientific and technological accomplishments involved in turning insulin, antibiotics, advances in organic chemistry, rDNA technology, etc, into commercial products. If the industry leaders in those days had embraced the de-risking mantra, these breakthroughs would have not taken place, or taken far longer. It would have been much easier to plow money into the existing ‘marketing franchises’ of the time (tonics, elixirs, herbal remedies, etc), but ultimately less meaningful and profitable. In fact, I would argue the industry got in trouble when it lost its appetite for disruption and replaced the culture of innovation that had dominated it by a process culture which has been very destructive of innovation. That change, by the way, was not spearheaded by scientists, but largely forced upon them by a generation of hubristic non-scientist leaders, who should have been more careful about interfering with something they did not understand. The short of this is that risk is a necessary (but not sufficient) ingredient of scientific breakthroughs. It should not be avoided, but embraced. The drug industry certainly needs better models to fund high-risk R&D, and better tools to mitigate (but not eschew) risk. Encouraging progress is being made towards these goals. But the industry must also give itself leaders who have a passion for innovation, and understand and can manage its challenges. It has some, but needs more.


    November 9, 2011 at 11:57 pm

    • What sort of funding models for high-risk R&D did you have in mind? What is your take on some of the current corporate VC models that some pharma companies are developing?


      November 10, 2011 at 3:49 pm

      • There has been interesting work done by Mike Scherer at Harvard, and, more recently, Andy Lo at MIT. Scherer showed that because drugs sales are heavily skewed towards a few blockbusters, the normality assumption that underpins portfolio management is grossly violated. This is why PM has failed to protect against patent cliffs. It cannot really work for pharma. Again, according to Scherer, PM does achieve a degree of risk mitigation, but too little to be an effective risk-management tool. Lo has taken that work further, and tried to figure out the breadth of the portfolio of R&D assets one needs to diversify risk. His work is still on-going. I attended several meetings where it was discussed. As these were not public meetings, it would be inappropriate for me to report it. But his team is taking a very open approach, and promised to put its data and draft papers in an open-access website so that scientists can check it out and enrich it. This is expected to happen within the next year, barring any snag. If you are interested, I would encourage you to contact him directly. From what I know, it looks very solid and promising. Bernard M.


        November 16, 2011 at 12:44 am

    • Brilliant. No one could say it better.

      Used to be a scientist

      November 17, 2011 at 1:10 pm

  4. Hi John,

    Im a postdoc in Boston with an interest in the life sciences industry…from R&D to business strategy. I follow you on twitter and I read your blog, and I wanted to thank you for the great posts! I have an interview tomorrow and I’m trying to get up to speed on various industry issues and your posts have really helped. Thank you again.

    Derek D

    Derek DiRocco

    November 10, 2011 at 5:41 pm

    • Derek,
      Thanks for the kind feedback. More importantly, good luck in your interview tomorrow. – John


      November 10, 2011 at 6:01 pm

  5. Great post. The question centers as much on “how much R&D should be done in-house versus external” as whether to choose one or the other. This would be very different across the spectrum of companies. No easy answers but finding leading scientists, in both academia and industry, and identifying unique capabilities and assets at various organizations would certainly inform an individual company’s strategy. We see much of this from those looking for Rutgers research collaborations and other universities.

    Thomas P. Richardson

    November 18, 2011 at 1:21 pm

  6. […] – get more in LaMattina’s post […]

  7. It seems to me that outsourcing has been taken too far in most sectors and this carries serious enterprise risk, even business continuity risk. If we are to address this systemic problem, we have to understand how it arose.

    My reading is that this mania for outsourcing even competencies which are critical to a corporation’s core business strategy – eg Big Oil outsourcing deep sea drilling – is a natural management response to the context of “shareholder value fundamentalism”. Natural because execs are heavily incentivised, as a result of positive share price movement and mega bonuses, to get costs off the balance sheet. As Duke University economists have shown, corporate execs will do whatever they need to meet the quarterly number: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=871215

    If we don’t address this drift, we’ll see more and more “preventable surprises”. Some will be slow-burn (as in innovation failure or the ethical failures of NewsCorp) and others dramatic (as in Gulf of Mexico & Tepco catastrophes). There ARE ways to better manage these risks, ie prevent/mitigate the wealth destruction, but it requires investors to acknowledge their role as co-creators of this system. But who will make them do this?

    Readers may be interested in a new project called Preventable Surprises – see http://www.preventablesurprises,com

    Feedback is very welcome.

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