September 1, 2005 (Vol. 25, No. 15)

Where Do We Go From Here? Reflections on the Past, Directions for the Future

Any number of perspectives would suggest that the business of drug development is in the midst of great evolutionary upheaval.

Where historically the pharmaceutical industry has been something of a big brother to the biotechnology industry, facilitating its smaller sibling’s efforts with everything from financial support to development expertise to market access, today the biotechnology industry would seemingly have a legitimate claim to equal industry stature.

Moreover, emerging trends would suggest that biotechnology is poised to displace large pharma’s long-standing industry dominance.

Biotechnology as Innovator

As depicted in Figure 1, through 2002 the drug industry’s collective “innovation index”, measured as the number of new medicines or biologics approved per billion dollars in R&D expenditures, had been in sharp decline. Despite significant scientific and technological advances, R&D expenditures simply had not been providing the same bang for the buck, with more dollars being spent to generate less revenue.

This disparity between R&D dollars in versus innovative pharmaceuticals out resulted in the emergence of what has been referred to as the industry’s innovation gap.

But as we scroll forward, over the past few years this trend toward a widening of the innovation gap appears to be (to some degree) reversing itself with the 45 new drugs that came to market last year, making 2004 one of the best years for NMEs in over a decade. In light of this shift, is the concept of an innovation gap as entrenched as has been previously suggested? For large pharma, not surprisingly, the answer appears to be yes.

On closer study of the data, the difference between the biotechnology industry and the pharmaceutical industry with regard to the number of new drugs produced is striking. From regularly generating 20 or more new drugs annually, the output of the world’s top 20 pharmaceutical companies has dropped precipitously to 12 drugs in 2003, and 7 in 2004 (Figure 2). This decline seems even more staggering considering the levels of R&D dollars involved.

At the same time, the number of new drugs originating from the biopharmaceutical sector has risen sharply. In 2003, biotechnology gave rise to 29 new compound approvals. In 2004, that number rose to 38, over 80% of all new drug approvals. This trend underscores what seems to be a growing reality: innovation today is decidedly not the domain of large pharma but is instead dominated by biotechnology.

This shift in innovation may be accounted for, to some degree, by the disaggregation of the pharmaceutical value chain, with large pharma increasingly focusing its resources on established downstream competencies. Yet it may also be indicative of the impact that the genomics revolution of the late 1990’s has had on these two industries.

So while a new rules-based paradigm for drug development has yet to emerge from the promise of the genomics revolution, a credible argument can be made that biotechnology has more successfully integrated these competencies into its own discovery framework than large pharmaor at least has been able to distance itself more effectively from the legacy of its past.

The Influence of the Capital Markets

Yet the biotech industry’s ability to sustain its increased prominence is not without its own set of challenges. Chief among them are the demands of the capital markets.

Not only are institutional investors shying away from investing in smaller publicly traded biotechnology companies, increasingly the more prominent investment banks are hesitant to bring the issues to market.

More and more, both sides of the capital markets equation are demanding companies with later-stage pipelines and more commercial visibility, as these are the companies that command the higher market capitalizations required to remain meaningful public companies.

The impact of this change in sentiment is most striking when comparing the last two peak years for biotechnology IPOs. In 2000, 53 biotechnology issues came public. Of these, less than 40% had even a single product candidate in clinical trials and only 15% had compounds in Phase III testing or beyond.

In 2004, 25 issues came publicitself a telling sign. More revealing though was that over 90% of these issues had compounds in clinical development and 60% of the companies had compounds in Phase III if not marketed products.

Notably, many of these clinical candidates were not compounds directed at new mechanisms of action for the treatment of hitherto intractable diseases. A number emerged from the growing category of specialty pharmaceuticals enhancements to existing therapeutics.

But in light of the fact that of the 38 new medicines brought to market last year by the biotechnology industry as a whole, half might well be categorized as specialty pharmaceuticals, could it be that investors are merely following what the industry itself may be considering a large part of its future?

It seems highly unlikely that biotechnology can sustain its new product appetite solely on a diet of new twists to old remedies and large pharma cast offs. But if this trend gains traction and remains dominant for any length of time, then who is to foster continued innovation? Not the venture community.

Venture investors have to continually adjust their investment strategy to dovetail with the public markets, often their preferred exit scenario. With the public markets requiring later-stage product stories, venture investors have to adjust their entry points accordingly.

But if therapeutic innovation falls outside the realm of the private sector, are we to expect it to become a matter of public policy, funded through public means? Perhaps public policy should be used to drive private activity?

For instance, public policy dictates might ascribe different financial benefits to novel breakthroughs as opposed to what some suggest is little more than specialty pharmaceuticals’ “clever arbitrage” (and to a degree already do). Yet it would appear highly unlikely that public mandates alone can remedy substantially reduced private sector involvement.

Such questions as these must be evaluated within the proper environmental context. So it is critical to have some level of visibility as to what is expected to happen to healthcare costs, in particular pharmaceutical costs, and how this expectation is likely to drive behavior.

As illustrated in Figure 3, the current decade is expected to experience an acceleration in the cost of healthcare with the greatest impact likely felt by the consumer. Spending on pharmaceuticals, in particular, is expected to consume an ever-increasing portion of the healthcare dollar.

With healthcare spending projected to approach 20% of GDP, with ballooning federal budget deficits, with the adoption of Medicare Part D, and because the drug industry has historically been so profitable and will continue to be a political target, we should at least consider how the effect of pharmaceutical costs might impact the future direction of the industry.

By way of example, let’s look at the new pharmaceutical arsenal against cancerAvastin, Erbitux, and Tarceva. While these treatments are truly revolutionary, with objective response rates often well below 50%, with life extension measured in months, with a questionable improvement in the quality of life given their use in combination with standard chemotherapy, and with treatment costs as high as $17,000 per monthagainst a backdrop of soaring healthcare costs and their implicationswill there be some backlash or will some alternative value proposition gain prominence?

Historical prescription volumes could in some sense be considered artificially high as healthcare providers had only limited means to qualify users with any degree of accuracy. In fact, “likely 90% of prescription medications work in only 3050% of the people who take them,” according to a geneticist with one major pharmaceutical company (San Francisco Chronicle; May 17, 2004)

Today that is changing with clinically validated gender and race profiling as well as pharmacogenomic profiling emerging to dictate use. Yet there also seems to be emerging an incongruity between therapeutic technology and economic self-interest in the manner in which pharmaceutical targeting may ultimately be implemented.

And Then There Was Vioxx

Vioxx only highlighted the reality that there is still a considerable amount that is yet to be known about pharmaceutical activity. This anti-inflammatory indicated for relief of osteoarthritis-associated pain had, in aggregate, 84 million users worldwide during its time on the market.

As a chronic treatment targeting a huge patient population, it was seemingly an ideal product for the business model of large pharma. Instead it has become the ultimate albatross with a potential liability exceeding $20 billion.

In light of the Vioxx experience and ever-advancing scientific discovery, the likelihood that such drugs, multi-billion-dollar revenue generators with a multi-million-user prescription base, will gain regulatory approval is increasingly uncertain. Also uncertain is the viability of the corporate infrastructures that have evolved to support them.

Is it the end of the (pharma) world as we know it?

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