CONFIDENTIAL R&D Productivity – The Road to Positive Returns Rodney W. Zemmel, PhD. McKinsey & Company May 26, 2010 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.
Summary • R&D productivity is failing. This is not “new news”, but impending patent expiries bring it into sharp focus • The search for the “new paradigm” of scientific solutions risks missing the point • Management solutions focused on cost, speed, and decision-making are sufficient to improve returns to a level where R&D is value creating, not value-destroying • Valuations can be increased 15%+ by increasing output within realistic ranges, or else by cutting expenditures if management teams do not see productive routes to improve 2
Ouch! Exponential growth in inputs with no numerical increase in outputs FDA NME approvals 1 Industry R&D spend $ Billions Number 45 60 40 50 35 30 40 25 30 20 15 20 10 10 5 0 0 1970 1975 1980 1985 1990 1995 2000 2005 1 Includes NCEs and BLAs. BLAs included 1986 onward; biologics approvals in prior years assumed negligible Source: NME data for 1966-1971 from Peltzman, S. (1973) Journal of Political Economy 81, no. 5: 1049–91. NME data for 1972-1979 as reported in Hutt, P.B. (1982) Health Affairs 1(2) 6-24. NME Data for 1980-2007 from Parexel’s 3 Pharmaceutical R&D Statistical Sourcebook 2008/2009, Food and Drug Administration, and Pharmaceutical Research and Manufacturers of America. Industry R&D spend data from the Pharmaceutical Research and Manufacturers of America, PhRMA Annual Membership Survey, 2008
Growth in talk of new research paradigms has matched decline in NME approvals PubMed occurrences of “new FDA NME pharmaceutical research paradigm” approvals Number Number 40 40 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 1998 2003 2008 4 Source: NME data from Parexel’s Pharmaceutical R&D Statistical Sourcebook 2008/2009, PubMed search for “new pharmaceutical research paradigm”. The term “cardiac surgery” was used as a control over the same time period to ensure trends were not simply due to changes in the number of publications available in PubMed over time
Pharmacos revenues are under pressure… Worldwide total prescription drug sales 2000-14 Sales growth $ Billions Percent +2.3% CAGR +2.3% CAGR 2008-14 2008-14 800 15.0 16 707 691 14 674 700 663 637 616 612 12 11.0 572 600 10.0 521 10 9.0 Analyst 479 500 10.0 8.0 441 forecasts 9.0 9.0 8 7.0 398 400 345 6 315 4.0 4.0 290 300 2.0 3.0 4 2.0 200 2 100 -0.7 0 0 -2 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 2014 5 SOURCE: EvaluatePharma; team analysis
…due to an unprecedented period of loss-of-exclusivity Share of 2009 total sales 1 at risk 2009 sales at risk due to U.S. patent expiries between 2010-17 due to U.S. patent expiry 2010-17 $ Billions Percent 54 25.3 45 18.7 15.6 39 11.0 30 8.4 34 17.2 42 12.4 43 72 22.9 79 16.4 9.9 52 5.9 40 Ø 48 1 Pharma sales only 6 SOURCE: Evaluate 01/14/2010
Traditional growth levers such as promotional spend are experiencing negative marginal returns Change in Share Change in TRx of Voice (2006-2002) (2006-2002) -100 million +$1.8 billion TRx An increase $1.8 billion in promotional spend between An increase $1.8 billion in promotional spend between 2002 and 2006 yielded 100 million fewer TRx 2002 and 2006 yielded 100 million fewer TRx 1 Based on aggregate of 14 companies: Amgen, Merck, GSK, J&J, Eli Lilly, Schering Plough, Roche, Astra-Zeneca, BMS, Pfizer, Abbott, Wyeth, Sanofi- Aventis, Novartis 7 SOURCE: IMS; Evaluate Pharms
Management is rethinking total R&D spend Worldwide pharma R&D spend, 2000-14 R&D Spend growth Percent $ Billions ~2% CAGR ~2% CAGR 2008-14 2008-14 14.0 14.0 150 14 142 138 136 132 128 104 123 123 12 11.0 11.0 116 12.0 11.0 93 10 100 10.0 Analyst 85 8 7.0 76 forecasts 67 59 6 53 4.0 50 3.0 3.0 3.0 4 2.0 2 0 0 0 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 2014 Note: This does not include any impact from Healthcare Reform 8 SOURCE: EvaluatePharma; team analysis
Pharmacos responding with many initiatives Maybes Sure bets Reduce Virtual trial trials complexity Make Value Reduce organization based R&D total more incentives spend nimble Push hard IT on cost enablement and speed Market Lean Improve R&D forces labs productivity Increase Improve variabilization R&D of costs and governance offshoring Increase risk Manage sharing and Prediction external minority markets spend stakes New R&D performance leadership metrics development 9 Source: McKinsey analysis
Ultimately, fewer launches lead to more company consolidation Consolidation by major pharmacos Percent of global sales 100% = $93B $244B $725B Top 10 25 36 47 Top 20 16 20 15 Other 59 44 38 1987 1997 Post-2009 mergers 10 Source: IMS World review; team analysis
We created a “per drug” model of industry productivity: Patented sales revenue example Off-patent sales $ Millions 529 490 Small 454 Small 420 414 389 336 262 molecules 249 molecules 191 190 176 166 111 34 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y11 Y12 Y13 Y14 Y15 Post-LOE decay assumes competition from biosimilars 1,024 964 926 858 837 772 757 692 684 654 578 460 Biologics Biologics 326 199 75 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y11 Y12 Y13 Y14 Y15 Note: Year 1-6 post-launch sales projections are based on historic performance of drugs launched in 2000-06; year 7-10 sales based on historic sales of drugs that were in last 4 years of exclusivity in 2000-06; sales during first 4 years post-LOE (years 11-14) based on historic data on drugs that lost patent protection in 2000-06; sales for year 15 11 onward expected to decline at 6% per year, based on historic performance of drugs that were post-LOE for 4+ years in 2000-06 Source: EvaluatePharma; team analysis
The average IRR of a typical biopharmaceutical portfolio is in decline … For a typical R&D portfolio of … projected returns have declined 50 compounds … ~30% over the last several years Portfolio IRR 1 Assume the portfolio is 75% small molecules and 25% biologics Percent • Declining IRR driven by Number of compounds 50 – Increasing attrition rates 38 12 (~5 percentage points) 1997- 14-15 – Increasing development 2001 times (~12-18 months) Small Biologic Total – Cost increases Molecule • Portfolios more heavily weighted towards Assume the portfolio is distributed 2002- 9-10 biologics will generate across phases as follows 2006 somewhat greater Number of compounds returns, driven 50 largely by higher sales 4 8 post patent expiry 25 13 Pre- Phase I Phase II Phase IIITotal Clin 1 Assumes 0% contribution margin in yrs 1-2, 50% in yrs 3-4, 70% in yrs 5-10; assumes margins on biologics are 5% lower than for small molecules; Year 10 value of post LOE contributions discounted to year 10 at IRR; sales ramps, 12 decay curves, and peak sales based on average historic sales of all compounds launched between 2000 and 2006 (see appendix for details) Source: Evaluate Pharma; team analysis
… and the average small molecule compound no longer returns its cost of capital Returns for an average compound Small IRR = 7.5% molecule NPV = -65 million Typical pharma 9-10% portfolio IRR Biologic IRR = 13% NPV = $1.26 billion Are biologics alone the answer? Probably not … • Not enough of them to compensate for declining small molecule returns (~20-25% of patented molecule sales) • Higher average peak sales and slow post-patent decay both likely to erode as biosimilar competition grows • Declining POS (~7 percentage points), especially in new biologic categories (e.g., cellular therapy, gene therapy, RNAi) 13 Source: Team analysis
Pulling Multiple Levers Can Help Move the Needle on Returns From R&D 13.0 1.0 1.0 IRR = 1.5 WACC = 7.5 2.0 9.5% Current IRR Cost Speed Decision Decision New IRR for for average making 1 making 2 average small small molecule molecule Reduce Reduce Increase Shift 4% overall time-to- phase III of cost per launch by POS 10% molecules molecule 18 months by from by 15% “taking” fourth attrition in quartile to Phase II first quartile 14
Achieving Cost and Speed Improvements Requires Transparent and Simple Metrics Guiding principles to measure and manage performance • Focus on select metrics, balanced across dimensions (e.g., leading vs. lagging, speed vs. cost) • Achieve simplicity in measurement and communication McKinsey’s Clinical Trial Impact cross- • Define metrics consistently and industry diagnostic tool establish primary data sources • Develops customized scorecards for • Establish clear accountability clinical operations based on an objective fact-base • Monitor performance regularly • Enables issue-based deep dives to • Determine root causes of facilitate decision-making to prioritize performance improvement opportunities • Collaborate with and learn from peers 15
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