2/8/2018
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`Bringing pharma R&D back to health - Bain & Company
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`Bringing pharma R&D back to health
`March 30, 2009 Bain Brief
`By Patrick O'Hagan and Charles Farkas
`
`It's no secret that pharma's traditional approach to R&D is not working. But exactly how broken is it? Bain's drug-
`economics model shows that the situation is untenable. In the late 1990s, pharma companies spent $1.1 billion, on
`average, to develop and launch a new drug. Today, just a decade later, the investment has doubled to $2.2 billion.
`During this period, R&D productivity, as measured by new molecular entities and biologic license applications per
`R&D dollar, has declined by 21 percent annually. More important, pharma companies have struggled to create value
`from their investments in innovation. The return on invested capital (ROIC) for new-drug development has dropped
`from 9 percent in 1995-2000 to an anemic 4 percent today.
`
`Recently, several pharma companies have tried to resuscitate innovation. They have experimented with new R&D
`organizations, partnerships and technologies. However, no pharma company has truly transformed the traditional
`R&D approach. Instead, most still rely on scale-more is better-to pursue R&D success. They spend an increasing
`number of dollars to fund labs and clinics that generate stacks of proprietary knowledge about targets, pathways
`and compounds. And they still measure success with scale metrics-typically, the number of "shots on goal" that they
`
`hope will translate into new products.
`
`But this scale-based approach to R&D is unsustainable. With blockbuster sales slowing and expected to remain sluggish for the foreseeable future, pharma
`already feels the economic pinch of weak innovation. Revenues for the top 15 global pharma companies grew by a 10 percent CAGR between 2003 and
`2008, but are expected to drop sharply to just 2 percent over the next four years. So, the urgent $60-billion question (the amount bio-pharma companies
`spent on R&D in 2007) facing the industry is this: is there a better approach to R&D?
`
`Fortunately, the answer is yes. While success won't be easy given the magnitude of change required and the tough business climate-regulators remain wary
`of new drugs and payers question reimbursements-change is possible. Despite the hurdles, pharma companies can successfully invest in a new approach
`to R&D.
`
`Returns-driven R&D: Three steps away
`
`The world needs pharma R&D to succeed. According to the World Health Organization, heart disease, stroke, cancer, chronic respiratory diseases and
`diabetes cause more than 60 percent of all deaths worldwide. With major health problems still unsolved, pharma companies need to prime their innovation
`pump and achieve better results.
`
`Step 1: Take the customer's pulse
`
`In R&D, successful results are never guaranteed. But a number of companies, across industries, have found that involving customers early in R&D improves
`the odds of success. SAP, a worldwide leader in business software, constantly churns out new products for more than 82,000 customers in 25 industries. In
`2007, SAP invested almost $2 billion-nearly 14 percent of its revenues-in R&D at 13 research centers around the globe. SAP involves customers very early
`in the research process by forming customer advisory boards for each industry segment. Board members are appointed for two-year terms, and they include
`not just SAP customers but also the competitors' customers. Board members articulate their needs, and then SAP aligns its R&D priorities to match those
`needs.
`
`Historically, in pharma, customer-led R&D has not been practiced so rigorously. Pharma companies set R&D priorities based on the opportunity for scientific
`discovery combined with long-term revenue forecasts-notably, not profit forecasts-that promise attractive commercial gains. They seek the customer's input-
`from physicians, payers and patients-usually only after a product reaches the late-stage pipeline; even then, the feedback influences only launch strategies
`and market positioning. Moreover, such customer input is heavily focused on physicians, such as the factors that influence their prescriptions. The payer's
`perspective is largely restricted to reimbursement negotiations. It is rarely an input for setting R&D priorities, and almost never in the early stages of the
`pipeline-in the labs and clinics. In effect, pharma companies seldom undertake a rigorous assessment of what payers will be willing to pay for-compared with
`alternative treatments-before deciding what to research.
`
`In the future, pharma companies will need to listen early in their R&D efforts to the voice of customers-especially payers. While a pharma company cannot
`design products tailored to customer specs, as SAP does, it can guide its R&D closer to customer needs. That shift is imperative. As payers consolidate,
`they are becoming more powerful and cost conscious, demanding hard evidence that their reimbursement dollars are well spent. By identifying which health
`outcomes payers are more willing to reimburse, pharma companies can more closely align R&D priorities with market realities. This new approach will be
`challenging, and even a little frustrating, because payer priorities change over time. But pharma companies must listen, respond and evolve based on what
`their customers are saying. (See figure 4.)
`
`The payoff will be substantial. Pharma companies will have more confidence when funding R&D projects that have passed the payer test-a rigorous
`evaluation of the improvements in health outcomes that will be valued by payers and are likely to earn attractive reimbursement. From the get-go, these
`projects will have a greater probability of commercial success despite the alternative treatments available, budget constraints and changing healthcare
`priorities. It will also be easier to stop projects that dip below the bar set by payers, whether on safety, efficacy, or affordability. Pharma companies will find
`this new approach quite achievable: they already have extensive relationships with payers, as well as deep knowledge of reimbursement systems around
`the world. It's now a matter of using that payer input early enough to set research priorities.
`
`Novartis is blazing a trail in that regard. It underwent a long and arduous process to get approval in the UK for Lucentis, a wet age-related macular
`degeneration treatment. The UK's National Institute for Health and Clinical Excellence (NICE) took two years for an appraisal, including a legal battle when
`Novartis appealed its initial decision. In the end, a risk-sharing agreement was struck between Novartis and NICE. But Novartis turned that difficult
`experience into a positive one. In December 2007, even as the legal battle waged, Novartis engaged NICE as a consultant to provide guidance on an
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`http://www.bain.com/publications/articles/bringing-pharma-r-and-d-back-to-health.aspx
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`1/3
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`Abraxis EX2071
`Apotex Inc. and Apotex Corp. v. Abraxis Bioscience, LLC
`IPR2018-00151; IPR2018-00152; IPR2018-00153
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`

`

`2/8/2018
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`Bringing pharma R&D back to health - Bain & Company
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`upcoming Phase III clinical trial. The "Novartis 001" pilot ensured that Novartis designed better studies, assessed economic value more accurately and laid
`the groundwork for a smoother NICE appraisal process. Although final results are pending, both Novartis and NICE have praised the collaboration, and
`Novartis is now talking to national agencies in many countries, including Sweden and the Netherlands, about similar pilots.
`
`Novartis is actively encouraging payer collaboration. Yet this first step in the new R&D approach will require pharma companies to go even further.
`Successful companies will collaborate with payers earlier than late-stage clinical trials. They will expand the dialogue from single products to a portfolio of
`products. And they will broaden the mix of payers to reflect a wider range of reimbursement options, including the expanding segment of self-paying
`patients.
`
`Step 2: Scan for outside innovation
`
`Increasingly, across industries, innovation springs from diverse sources. As a result, leading companies are looking outside their four walls for new ideas to
`propel growth and stay ahead of the latest innovations. Procter & Gamble (P&G), the world's largest consumer goods products company with 2008 sales of
`more than $83 billion and an R&D budget of $2.2 billion, realized it had a problem when its innovation success rate-the percentage of new products that met
`financial objectives-stagnated at about 35 percent. The company prided itself on its R&D prowess-boasting it had more PhDs than the combined science
`faculties at Harvard, MIT and Stanford and more than 3,800 patents a year to its credit. But clearly, that was not enough. In 2000, P&G adopted a bold
`approach called "Connect + Develop" to access 50 percent of its innovation from outside the company. It required a major shift in attitude from "not invented
`here" to "proudly found elsewhere"-and it worked. Today P&G counts its R&D community as 7,500 engineers and scientists inside the organization along
`with seamless access to 1.5 million outside the organization. By 2006, the company's innovation success rate had more than doubled, the R&D budget as a
`percentage of sales had fallen, and about 45 percent of the products under development were based on innovative ideas from outside the company.
`
`Pharma companies, in contrast, too often prefer to look inside their four walls for sources of innovation. Confident they have the best talent and technology
`inhouse, they rely on them selves to generate new products. To be sure, pharma companies license and acquire a large number of compounds, but the
`impetus usually comes from business development-often a compulsion to plug gaps in revenue projections. The net result: the full landscape of external
`innovation is seldom fully evaluated and integrated into pharma's R&D priorities.
`
`For pharma, it's time to eliminate that internal bias. To generate a steady stream of successful new products, pharma companies must throw open their
`doors and bring home outside innovation. The best scientists always keep tabs on new science; it's part of their DNA. But in this new approach, they need to
`do more in three ways. One, they must commit to constantly scanning the external landscape with depth and rigor. Two, they must look beyond what's
`familiar because the future of healthcare will most likely involve a convergence of different treatments. For example, medical device companies are already
`testing new products to treat migraines-currently, the domain of drug therapy. What stops a pharma and a medical device company from jointly conducting a
`clinical trial on a mix of drugs and devices to optimize treatment? Third, and most important, they must act on their insights regarding external science-
`including stopping internal projects that rank poorly against outside research. Pharma's goal is to improve health outcomes. In the future, it will be even more
`important to be open-minded about how to get there. (See figure 5.)
`
`Pharma companies can expect significant benefits from objectively scanning outside innovation. Internal R&D projects will be more carefully scrutinized
`against external alternatives-counter-balancing the cheerleading of internal project teams. Less good money will be thrown after bad because "trailing edge"
`research projects will be more quickly identified and not as easy to justify. Also, pharma companies will be able to double down on the most promising R&D
`projects, whether internal or external. Resources will flow more to whichever sources of innovation appear to have the highest potential for success. This
`new approach is a major shift in mindset. But, it plays to a pharma company's strength: their teams of top-caliber scientists who have the ability to judge
`external science. Now, it's time to act on their judgment, even when it means choosing the external over the internal.
`
`GlaxoSmithKline (GSK) is embracing such external innovation. It launched the Center of Excellence for External Drug Discovery (CEEDD) to access "best
`from anywhere science." By establishing CEEDD, an independently managed group with a dedicated budget, GSK's goal is to put external and internal R&D
`on the same footing and make objective choices about the most-promising products to fund in late-stage development and commercialization. Eli Lilly is also
`tapping external innovation. In 2001, it launched InnoCentive as a wholly-owned subsidiary to explore outside solutions to problems identified by its
`scientists. Doing so proved so successful that by 2006 InnoCentive was spun off as a multi-industry platform to connect "seekers" of R&D problems to
`"solvers" in a virtual marketplace.
`
`GSK and Eli Lilly are making bold moves to benefit from outside innovation. But to completely embed this second step in the new R&D approach, a pharma
`company will need to open itself up even more. It must constantly scan outside innovation as a core R&D activity. It will need to widen the lens to include
`industries such as devices, diagnostics and services. Finally, it will have to fully integrate that information into every R&D investment decision.
`
`Step 3: Act on the right numbers
`
`Private equity firms achieve high returns, or not, based on their ability to make disciplined investment decisions. The top firms succeed repeatedly, not
`randomly, over long time periods by systematically acquiring companies in specific sectors, increasing their value and exiting at the earliest possible date to
`achieve their target returns. Success in this approach comes because the management team at the private equity firm is fully aligned on key decisions-which
`include not acting when the price is not right. The tight link between performance and compensation within the firm reinforces discipline in investment
`decisions. Most pharma companies focus on revenues instead of R&D returns. Revenues are relatively easier to project-plug in the patient population,
`market share and product price, and the formula yields sales. By contrast, projecting returns is far harder because it requires a complete accounting of
`costs-costs that are sprinkled across separate budgets such as pre-clinical, clinical, regulatory, manufacturing and marketing. It also requires considering
`opportunity costs: would investing the next R&D dollar earn a higher return elsewhere? With little focus on expected relative returns, pharma companies end
`up funding undeserving projects too long.
`
`Instead, pharma companies need to employ the same financial rigor as top-tier private equity firms. Both manage large portfolios of assets that must deliver
`attractive returns over very long cycles, and for both, discipline in investing is the key to success. For pharma, it starts with projecting revenues based on a
`realistic set of assumptions, accounting for a marketplace that is increasingly crowded and shaped by the availability of high quality generics. In addition, it
`means calculating total costs based on the entire length of the project, from the lab to the marketplace. Such analysis of revenues and costs will yield the
`expected ROIC and allow R&D decision makers to fund projects against the appropriate hurdle rates. Tracking these hurdles is a constant process:
`disciplined funding decisions must be made at the outset, but also at every major stage to ensure that dollars are spent only on the most attractive projects.
`(See figure 6.)
`
`Pharma companies will reap rewards from such financial discipline. For one, this new approach increases the transparency of R&D costs and puts greater
`pressure on actively reducing them. For another, it leads to a more efficient allocation of resources by turning the capital spigot on and off. In this approach,
`only the most deserving-not necessarily the most high-profile-projects get funded. Fortunately, pharma companies have the necessary financial
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`http://www.bain.com/publications/articles/bringing-pharma-r-and-d-back-to-health.aspx
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`2/3
`
`Abraxis EX2071
`Apotex Inc. and Apotex Corp. v. Abraxis Bioscience, LLC
`IPR2018-00151; IPR2018-00152; IPR2018-00153
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`

`

`2/8/2018
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`Bringing pharma R&D back to health - Bain & Company
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`sophistication to pursue this returns-based approach. The challenge is calculating the right numbers and acting on them.
`
`AstraZeneca demonstrated such financial discipline recently. Even though the company continues to invest in novel ways to treat gastro-esophageal reflux
`disease (GERD), it stopped investing in the development of other gastrointestinal drugs. The problem was not revenues-Nexium and Prilosec accounted for
`more than $6 billion in sales in 2008-the problem was returns. AstraZeneca felt it was unlikely to discover new and differentiated drugs in that area
`compared with existing therapies. Instead, it could earn better reimbursement in areas like diabetes and obesity. Using similar logic, Pfizer recently decided
`to exit cardiovascular R&D.
`
`AstraZeneca and Pfizer exemplify decision making based on the right numbers. This third step in the new R&D approach, though, will require even greater
`discipline by pharma companies. They will have to apply stringent ROIC hurdles from the outset. Then, they will have to reallocate R&D dollars across
`projects as value forecasts change. And most important of all: they will have to set a high bar on expected ROIC in order to improve the rate of return from
`the current lackluster 4 percent.
`
`How to get started
`
`At first sight, focusing single-mindedly on returns-driven R&D might seem a marked departure from the past. But in practice, it builds off existing skills and
`strengths, and several pharma companies have already begun to experiment with aspects of returns-driven R&D. Fully implementing this new approach will
`require careful, sequenced implementation of all three steps. A helpful starting point for any pharma company is to review the existing pipeline against three
`filters:
`
`Is each R&D project a priority from the payer's perspective? To facilitate this exercise, a pharma company can convene a payer panel and
`subject each pipeline compound to its scrutiny. Non-disclosure agreements will ensure confidentiality and foster a frank discussion about
`which compounds have the most promising future-as seen through the payer's eyes.
`Is each R&D project based on the best available science? This filter requires thoroughly scanning innovation inside and outside the company.
`To reduce the burden, the pharma company should concentrate only on projects the payer panel found promising. The goal: to identify
`projects with the strongest scientific merit, regardless of source.
`Is each R&D project above the ROIC hurdle? It's time to do the math. For all projects that pass the payer and innovation screens, project
`teams need to forecast ROIC-taking into account realistic assumptions and total costing. R&D management can then rank and assess the
`portfolio.
`
`Pharma managers will be surprised how asking these questions quickly leads to clarifying the R&D priorities. Even rough answers will yield a list of potential
`winners-and laggards. The pharma company will then be able to stop or accelerate projects accordingly. It will also have the opportunity to choose the best
`plans. For example, by modifying the designs of its trials, a pharma company can deliver clinical data that payers will most value in their reimbursement
`calculations. R&D leaders will emerge more informed, focused and energized by their effort.
`
`However, a pipeline review is only an initial step. As a follow up, pharma companies will need to invest in new capabilities. While the specifics will vary by
`company, these capabilities could include setting up a global network of trusted payers to provide input; forming an innovation team to routinely refresh the
`wide-reaching assessments of external innovation; and creating a financial advisory board to offer disciplined, outside-in views of investment opportunities.
`Along with new capabilities, pharma companies will need to clarify who makes decisions. Tough calls are central to this new approach, but they won't get
`made unless it is clear who has the authority to make bold returns-driven decisions.
`
`Successfully transitioning to returns-driven R&D, therefore, will depend on leadership. The right leaders will need to be both "bench scientists" and "business
`scientists"-possessing the confidence and ability to engage payers, tap outside innovation, and exercise rigorous financial discipline. In turn, their new
`behaviors will cascade through the R&D organization and catalyze change at all levels. To be sure, every step forward will be challenging-but doing things
`the old way is no longer an option. Given the low yield of today's drug development, it's time to breathe life back into pharma R&D.
`
`Patrick O'Hagan is a partner with Bain & Company and a leader in the firm's Healthcare practice. Charles Farkas is a partner with Bain & Company and
`leads Bain's North American Healthcare practice.
`
`http://www.bain.com/publications/articles/bringing-pharma-r-and-d-back-to-health.aspx
`
`3/3
`
`Abraxis EX2071
`Apotex Inc. and Apotex Corp. v. Abraxis Bioscience, LLC
`IPR2018-00151; IPR2018-00152; IPR2018-00153
`
`