Fixing Big Pharma Research: The costs of delays need to be properly valued

For the Pharmaceutical industry, the foregone revenue created by delays in bringing a drug to market can be surprisingly high — from $50,000 to $2,000,000 per day, depending on the phase of the pipeline. Such costs are often under appreciated.

Pharma companies the world over are suffering from low R&D productivity. As a consequence they are streamlining their organizations, automating, cutting headcount, outsourcing, and trying to become as efficient as possible. You can debate the relative scientific merits of particular cost-cutting strategies, but one thing that often isn’t included in the calculation — especially for early stage R&D projects — is how much a leaner operation delays progress on active programs.

One key feature of the pharma industry is that its products essentially expire — because patents have a limited lifetime. Before expiration, a pharma company can charge a high price due to patent exclusivity. Those high prices allow the company to make a profit (typically 15-20% return on equity after all expenses), and pay for development costs of not only the successful drug, but all the failed ones. Afterwards, the price drops very quickly (especially for small molecule therapeutics), heading much closer to the marginal cost of production, which can be quite low. To first approximation, in the final days of patent exclusivity sales act like a step function, so if a successful drug with $3.65 billion in annual revenue were to lose patent protection one day earlier than necessary, $10 million would be lost.

Now $10 million 20 years in the future has to be discounted to present day dollars. At a 7% cost of capital (a typical value for today’s industry), that $10 million is actually worth roughly $2.6 million today. But as pharmaceutical industry experience shows, it takes upward of 50 early stage projects to produce the one successful project that actually makes it onto the market. So, for every active early stage project, one day of delay costs over $50,000.

Here’s a table of the costs of a day of delay per project for the different pipeline stages (I’ve used some of Bruce Booth’s crowd-sourced estimates of the amount of time spent in the different phases of drug discovery, and the overall success rate of each phase). You can build your own model using the Excel formula indicated and change any of the assumptions.

(Click on the image below for a full size view)

pv_table

As you can see time IS money. Even at very early stages, a day of delay can cost more than $50,000 per project in present day dollars, which quickly rises above the $250,000-500,000 range in Phase I and II. By the time you hit Phase III, it’s close to $2 million. In Phase III, this sort of thing is on everyone’s mind and that’s one reason why so much effort can be/is spent enrolling patients as quickly as possible (besides the race to, you know, save lives). However, in the early stages these costs are often ignored.

The take away lesson: If you’re going to make a change that slows down all your company’s projects significantly, that change better save you a LOT of cash outlay today. Otherwise your operation will actually be net MORE expensive after the change.

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