Big Pharma: M&A Spells Disaster for R&D

Includes: LLY, MRK, PFE
by: The Burrill Report

By Daniel S. Levine

The pharmaceutical industry has engaged in much handwringing over the poor performance of R&D productivity in recent years as measured by what has been a steady increase in spending with a relatively flat or declining return on new drugs. Everything from corporate decision-making to increasing scientific complexity of new targets has been blamed. Now the former president of Pfizer’s (NYSE:PFE) R&D offers an additional culprit: industry consolidation.

In a commentary in Nature Reviews Drug Discovery, John LaMattina, former president of Pfizer Global Research and Development and now a senior partner at Puretech

Ventures, Boston, argues that the effects of merger and acquisition activity on R&D productivity has not been well documented mostly because cuts to these programs are done out of public sight. But LaMattina argues that despite the short-term benefits that might be used to justify M&A deals, “their impact on the R&D of the organizations involved has been devastating.”

He notes that of the 42 companies that were members of the Pharmaceutical Research and Manufacturers of America in 1998, only 11 still exist today. Gone with those companies is the greater diversity of large portfolios that could increase the overall chances of developing new drugs. “Now, with so many fewer major companies involved in pharmaceu¬tical R&D, the chances of success in the industry overall are likely to be dropping precipitously,” he writes.

LaMattina is correct that mergers today are resulting in the wholesale elimination of research sites. He points to his former employer as the prime example of this. Pfizer acquired Warner-Lambert in 2000, Pharmacia in 2003, and Wyeth in 2009, as well as many smaller companies. The company has closed research sites once operated by Upjohn and Warner Lambert in Michigan, as well as a former Searle site in Illinois. It is also closing a major research site in the United Kingdom. All of this has displaced thousands of researchers who discovered drugs such as Lipitor, Norvasc, and Viagra, he writes.

And, the industry that had a history of growth in R&D spending year to year has reversed that long-term trend. Pfizer and Wyeth in 2008 spent a combined $11.3 billion on R&D. This year, the combined company expects to spend between $6.5 billion and $7 billion.

LaMattina notes there are CEOs of Big Pharma, notably Eli Lily’s (NYSE:LLY) John Lechleiter and Merck’s (NYSE:MRK) Kenneth Frazier, who see R&D rather than M&A as the key to their future success, but he is probably right in saying that merger and acquisition activity is likely to continue.

What LaMattina doesn’t seem to take into account, though, is a broader change underway in the industry. Pharmaceutical giants are not just consolidating, but they are quite consciously moving away from early-stage research in part because they have acknowledged that innovation and good ideas can come from many places.

This year, we’ve actually seen a pick-up in new drug approvals. By the end of July, the U.S. Food and Drug Administration had approved 21 drugs, as many as were approved during the entirety of last year. Though not a detailed analysis, a quick review showed that no more than five were for unpartnered drugs developed by Big Pharma and another two were developed at companies that had been acquired by Big Pharma and operate as divisions.

The business model for Big Pharma is evolving and a reduction in R&D activity is a part of that evolution. No doubt this is painful to someone who once headed global R&D operations for Pfizer.

But there are many who believe that these companies will rely more on in-licensing innovative products and using their muscle for late-stage development, regulatory approval, and marketing.

A Morgan Stanley report from January 2010 predicted “material cuts” to internal R&D spending and a reallocation of capital to in-licensing. In fact, Morgan Stanley analyst Andrew Baum has forecast pharmaceutical companies that externalize their research could get three times the return by investing in mid-stage assets of biotechs.

The problem, according to Baum, is that about 40 percent of R&D spending goes to pre-phase 2 clinical development, where the likelihood of a drug reaching market is less than 10 percent. At the same time, new discovery tools, such as high throughput screening that some thought would industrialize the R&D process, haven’t done so yet.

Baum advocates pharmaceutical companies move away from traditional research and development to a strategy of “search and development.” He says companies would be wise to cut R&D spending and expand business development and licensing. The goal would be to focus on late-stage development and commercialization, areas where large pharmaceutical companies, despite some notable stumbles recently, have traditionally been strong.

While LaMattina is right in his observation that M&A is bad news for R&D within Big Pharma, I don’t think it’s necessarily bad for R&D overall. With a new mindset, the opportunity is there for the industry to tap a broader world of ideas and discoveries and get more bang for their buck.