The Real Reason for Lilly's R&D Outsourcing

| About: Eli Lilly (LLY)

Tuesday's Wall Street Journal ran a story on Eli Lilly (NYSE:LLY), all about how the company is outsourcing a lot of their drug development work. Since Lilly signed a big deal with Covance (NYSE:CVD) in 2008 to do just that sort of thing, the first thing you have to wonder is, "Is this news?"

But some of the spin in this piece is interesting. Here, see what you think:

Not long ago, a big pharmaceutical company wouldn't have considered farming out the development of a compound found in-house. But expiring patents on top-selling drugs and high-profile failures in finding their replacements have pushed the biggest drug makers to "externalize" much of their R&D, said Peter Tollman, who advises drug makers at Boston Consulting Group. . .

Lilly is relying on outside firms called contract research organizations to do the work. Company researchers, Mr. Tollman said, can get too attached to their own compounds to know when to let them go.

I'm not buying that last part at all. To me, the main reason that Lilly has been using CROs so much (through an R&D unit named Chorus) is that they feel that they can do the job more cheaply. The next most important reasons after that one are (1) that they can do the job for less money, (2) that they can do the job without Lilly spending so much cash, and (3) that they can do the job at lower cost. Have I left anything out?

As a correspondent put it, once you get into the clinic, "the data are the data", whether you're attached to the compound or not. The bigger danger is in how you set up the trials in the first place, whether you've done them in a realistic fashion, and a CRO can fall victim to that just as much as anyone else can. The same incentives are there to fool yourself. So I don't see any special magic in outsourcing clinical work, other than the fact that CROs tend to work their people harder and pay them less money.

To be fair, the rest of the article does show the flip side:

Skeptics say such results may cut R&D costs, but don't address big pharma's main problem of finding new therapies that pan out.

"You get more negative results faster and cheaper," said James Niedel, a former GlaxoSmithKline (NYSE:GSK) executive who is now a partner at New Leaf Venture Partners fund. "But the problem with the industry is they're not getting enough positive results and that depends on knowledge and insight about biology and disease" that might be lacking among CROs. . ."Neither the cost cuts nor the structural changes help R&D productivity," said Keyur Parekh, a UBS analyst who thinks Lilly might need to make acquisitions to replenish its pipeline.

Indeed. It's important not to spend money where you don't have to, but it's also important to have things to spend the money on in the first place.