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  • A Disturbingly-Declining Rate of Return in Pharma R&D?

    Posted by David Foster on May 5th, 2018 (All posts by )

    Here’s an interesting analysis

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    8 Responses to “A Disturbingly-Declining Rate of Return in Pharma R&D?”

    1. Mike K Says:

      Interesting comment.

      @Anonymous – they used to say that’s why penicillin was not commercialized (Fleming did not patent it) and later government R&D had to step in to commercialize it.

      It may have been the war that influenced government support. Most of the time government screws things up but, during the Second World War, businessmen ran the procurement and priorities program. Like Knudson who FDR got to help in spite of vilifying him in the 30s.

      Working first for the Ford Motor Company and later for General Motors from 1921,[6] Knudsen became an expert on mass production and a skilled manager. Knudsen was president of the Chevrolet Division of General Motors from 1924[7] to 1937, and was president of General Motors from 1937[7] to 1940.

      In 1940, President Roosevelt, at the recommendation of Bernard Baruch, asked Knudsen to come to Washington to help with war production. Knudsen was appointed as Chairman of the Office of Production Management and member of the National Defense Advisory Commission, for which he received a salary of $1 per year.[8]

      In January 1942, Knudsen received a commission as a lieutenant general in the U.S. Army, the only civilian ever to join the Army at such a high initial rank,[9] and appointed as Director of Production, Office of the Under Secretary of War. In this capacity, he worked as a consultant and a troubleshooter for the War Department.

      He probably had more to do with winning the war than 50 generals.

      Penicillin was a war necessity and sulfa before it.

      I was given penicillin for scarlet fever in 1943. It was very rare, especially for civilians. The patient’s urine was often saved to recover the penicillin which was not metabolized.

    2. David Foster Says:

      I’m not so sure about the methodology of this study. He uses an overall measure of profitability…EBIT….which subtracts all corporate costs except interest and tax…thus, selling costs and overhead costs reduce this number as does R&D costs. So if selling & overhead costs per dollar of gross margin are increasing at the same time that R&D costs per GM dollar are increasing, the analysis might not disentangle these effects.

      An alternative approach would be to calculate a specific return on R&D costs by calculating a number which subtracts out the lagged R&D costs, as this guy’s analysis did, but not the selling and overhead costs. This would not yield an ROI that could be compared directly with a company’s Cost of Capital, but it *would* provide a trend line, and maybe a more meaningful one.

    3. Ginny Says:

      OT anecdote: Family lore: My father was in the Corps of Engineers sent to the Pacific fairly early in the war. An army doctor (apparently without Kennedy’s skill or just with bad luck) decided he needed a hernia operation; he left the hot & humid operating room so ill he became delirious or entered a coma (a friend wrote to my mother, his fiancee). The army used penicillin on him – it was still somewhat experimental, I guess, in 41 or 42 – and he clearly survived to father four children. I’ve always felt especially grateful for that discovery – and for what it did when each of my children had infections and one shot was all they needed. Probably it happened only once or twice with each child – but what would have been the percentages before pencillin?

      Questions from someone who knows nothing about it:
      What policies would make pharmaceuticals more profitable?
      Will the current opiod crisis affect laws that affect profitability?
      I’d assumed that our (well, scientist’s) greater understanding of DNA would cut costs. No? (Last week a friend took me to a DNA exhibit – 20 or so graduate students stood before posters explaining their research.
      Many were medical, about markers and how they could be used for either medicine or early detection. Doesn’t that specificity of information cut out some steps?)

    4. Brian Says:

      Here’s a question–how much of pharma money now, compared to a decade or two ago, is VC money dumped into startups whose explicit goal is to get publicity and then to be acquired by a big company that can fund the field tests to see if they actually have a product or not, making an immediate profit for the founder and the VCs and quite likely nothing for the acquiring company? Theranos is notorious–$700M(!!!) in VC money completely flushed down the drain, and at least they only lost their investor money, but near any university with a medical center you can find tons of startups with a business model that consists of raising a few million dollars from suckers, I mean investors, who find the concept being pitched compelling, in order to sell to a big company. It’s the perverse VC world notion that the fact that someone gave you a bunch of money means you are valuable. I understand why the VC who gave you money would think that, but I don’t see why the rest of us should.

    5. David Foster Says:

      Brian….I don’t think the ROI analysis included startups, it was based on publicly-available info for publicly-traded companies. However, your comment raises an interesting question: How did the analysis take into account the effect of acquisitions?…because of lot of the product-acquisition effort of major pharmas is done via acquisitions.

      It makes sense that pharma startups are typically acquired before full-scale trials are conducted: the Phase III human studies are extremely expensive and can last for several years…and they often result in a ‘no, sorry it doesn’t work’ or ‘it has unacceptable side effects’…that’s the nature of the beast. I’ve met quite a few pharma startup CEOs and other founders, and they are very often taking huge personal risks to market something they believe in. There are surely some who just care about cashing out, but I don’t think those are at all typical.

      Interestingly, it is apparently now materially faster in most cases to gain approval in Europe than in the US.

    6. Brian Says:

      Yes, I am wondering both about whether/how the cost of trials has changed, and whether the frequency/size of acquisitions has changed. It seems like you see a lot of cases of universities promoting “companies” based on patents their bio researchers develop that are clearly just designed to advertise and then monetize the patent, but not actually to bring a product to market, because as you say, that’s beyond the ability of a new and young company. And it seems like buying a VC-backed company like that is going to have a much, much lower ROI than if you were to develop something internally. The VCs want their 10-100x return, which won’t leave much likelihood of the acquirer having additional large returns.

    7. Mike K Says:

      Two comments. Three, really.

      On startups, I was a small scale VC participant, investing $50,000 in a laser company that had a very good product, a dental laser the size of a typewriter. The people running the company screwed it up. The product was very good, not penicillin, but very good.

      The role of biologicals is getting very large now. They are very expensive but maybe economies of scale will help. The cure of Hepatitis C is now one injection, but the injection costs $65,000.

      DNA is going be be large but it is very early. Gene editing is probably 30 years away as a practical therapy.

      I would suggest, as a primer, a book titled, “The 10,000 Year Explosion”, which is ten years old but, I think, a pretty good introduction to DNA. It is about evolution and such things as white skin and blue eyes.

    8. David Foster Says:

      GE appears to be doing a lot in biologicals. Interestingly, it seems that new CEO John Flannery, usually portrayed as a pure financial manager, played a leadership role in this while he was still running GE Healthcare:

      https://www.fool.com/investing/2018/03/10/is-general-electrics-future-in-biology.aspx

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