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Virtual Drug Development has been around since the 1990s with little fanfare. In this model, only the key personnel to manage the core operations of a project are retained, while all other functions are outsourced. Roche (OTCQX:RHHBY) was an early adopter of virtual drug development, forming a subsidiary called Protodigm in 1996 consisting of only nine members, and responsible for taking three drugs through clinical trials. Though successful - money was saved and projects were completed faster - Roche ultimately decided against the plan, spinning the unit off into a separate entity, Fulcrum Pharma Developments. Biotechs also experimented with the idea, but the easy access to capital at that time encouraged the formation of bigger, more integrated companies rather than stripped down, virtual ones.
In this past decade, attitudes have changed substantially. Among large pharmaceutical companies, patent cliffs and lack of growth have forced companies to reevaluate their new drug development models; one which has received renewed attention is virtual drug development. Eli Lilly (NYSE:LLY) took a bold step when it formed its experimental Chorus division in 2002, an independent unit comprised of just 22 people. It was responsible for the development of compounds Lilly had previously deprioritized, from preclinical to proof of concept (POC). POC is the point where there is sufficient evidence in humans to believe a compound is active. Arriving at this conclusion usually requires the completion of a Phase II clinical trial. The group designed the trials and experimental plans, but all the work was outsourced to CROs.
Over the course of five years, nine out of nineteen of these compounds reached POC stage. Chorus now has 24 employees with the capacity to handle 10 compounds at any one time.

Chorus appears to have accomplished its initial goals. According to the company, it was able to achieve POC 1.5 years faster than the industry standard, and at as little as 10% of the cost. Of the nine compounds that reached POC, two were selected by Lilly for further development. With a small crew, two compounds that had been sitting in the drawers have now been given a second chance to prove themselves, with minimal upfront costs.
At Chorus, the strategy was to push as many compounds through as fast as possible with the belief that most are destined to fail. Management spent as little as possible on processes not directly related to reaching its goal of POC. Long term toxicology studies, manufacturing processes, formulations- anything extraneous was put off until the goal is reached. After POC, the compound is returned to Lilly to complete its development. If Lilly decides to go forward with a compound, it’s researchers complete the work that Chorus had skipped over.
The virtual model may be well suited for biotech start-ups. Biotechs already outsource significant amounts of work to CROs on a regular basis. Few have the size and ability to perform all the necessary preclinical studies, CMC work, and clinical trials. CROs and consultants have allowed biotechs to perform this work without the expense of building up all the internal capabilities. With the increasing numbers and sophistication of CROs, almost all the functions a typical biotech performed can be outsourced. The key to making a virtual biotech succeed is a superior leadership team able to select the right CROs and manage those relationships to build enough trust so they can perform their work with minimal supervision.
Biotech startups have begun to embrace the formation of virtual companies now that access to capital has become difficult and IPOs have dried up. With the end of easy money, many VCs prefer to fund companies with low fixed costs and short time to exit. A virtual biotech fits the bill perfectly. With limited personnel and no need for laboratory space, virtual biotechs have very low fixed costs. Because practically all services are contracted out, nearly all costs are variable. On average, 25% of costs are fixed, 75% are variable- the opposite of a standard biotech. The small structure and low fixed costs allow a high degree of flexibility- companies are able to respond rapidly as opportunities arise and situations change. A fully outsourced model also allows a small group of individuals to work on a larger number of projects simultaneously.
Virtual biotechs typically bring in compounds at the preclinical stage, progressing them to POC. Reaching POC is a major value creating point in the life of a compound. At this stage, companies have the option of selling themselves, partnering with a larger company, or licensing their compound. If this point can be reached quickly and with little capital, the company’s backers stand a better chance of recouping their investment in a reasonable time. This compares to the large sums and long timelines required for a traditional biotech to develop its compounds to a stage where investors can obtain a sufficient return on their investment.
One example of a virtual biotech is Flexion Therapeutics, founded in 2007 by two of the creators of Lilly’s Chorus program. With a track record of cutting costs and expediting early drug development processes, they have found significant financial backing and have in-licensed compounds from major pharmaceutical companies. Flexion has seven employees and four compounds in development. The company specializes in anti-inflammatory therapeutics, with candidates for Autoimmune Disease, Ulcerative Colitis, Tinnitus, and Osteoarthritis. Its stated goal is to take a compound to POC for under $5 million and in less than two years, after which it will likely be licensed out. In certain cases, the company plans on taking their compounds through Phase III testing on their own.
As the number of virtual biotechs increase, it will be interesting to see how their success rate compares to that of the traditional, more integrated biotechs. It is already clear they have the advantage in bringing compounds from preclinical to POC. In January 2005, Pfizer (NYSE:PFE) acquired the virtual biotech Angiosyn, in a deal worth up to $500 million. Angiosyn had spent only three years and less than $5 million dollars to develop a compound for macular degeneration to the POC stage. Time will tell if this approach will speed the delivery of drugs to market- the ultimate goal in drug development.
If it is proved that virtual biotechs are indeed more efficient at bringing drugs to market, then one must wonder if traditional biotechs are overstaffed. It would make no sense having 30 people develop one or two compound when a group of less than ten can test several times that. And right now, there is no shortage of compounds to test. Industry consolidation in Big Pharma has led to the abandonment of many overlapping or redundant projects. Company restructurings, M&A activity, have all left compounds for the astute scientist/entrepreneur to comb through. And as always, many novel compounds continue to come out of the world’s academic research labs.
The changes are already occurring, with Big Pharma outsourcing their research to biotechs and now biotechs outsourcing to CROs. As more research has been taken over by contractors, their abilities have grown enormously. It will be up to managers of virtual biotechs to ensure critical IP is protected and core expertise remains in the company. Managers must strike a balance in sharing enough data with contractors to keep things running smooth without divulging too much. They must determine which skills are critical and which ones can be outsourced. Investing in a virtual biotech is truly an investment in its management team.
Multiple events have conspired this past decade to force change upon the biopharmaceutical industry. Significant outsourcing by Big Pharma and virtual biotechs appear here to stay. To what extent however, remains to be seen. But it is a near certainty that the glory days of IPOs followed by multiple secondary offerings is coming to an end.

Disclosure: Long RHHBY.PK
Source: Virtual Biotechs Are Here to Stay