Just as the number of blockbusters has multiplied, so has the sales potential of new drugs. In 1998, when pharma valuations were flying high, the 39 new drugs brought to market represented a total sales potential of $26.3 billion. In 2002, the number of new drugs fell by a third to 26, but the sales potential of those drugs rose by 5% to $27.6 billion. The average projected peak sales of new drugs grew by almost 60% over the five-year period, from nearly $700 million to $1.1 billion (see Figure 3).3
Given the increased sales potential of each compound, we believe a more complete measure of pharma lab productivity is the return on investment generated by R&D company-wide over a period of time. Focusing on overall R&D return rather than the rate of individual drug launches paints a very different and, in our view, far more illuminating picture of recent trends in R&D performance.
We looked at returns during the six years ending in 2003 – a period in which the number of new drugs fell from its peak in the late 1990s (see methodology on page 34). Our research revealed that returns from new drugs exceeded the costs of bringing them to market until 1998, but fell in 1999-2000 to below the costs of innovation, possibly for the first time in the industry’s history (see Figure 4).4 Despite fewer compounds in the pipeline, returns started to rise again in 2001 and are now near the levels achieved in 1998, when the industry was the darling of investors.
In 2003, Big Pharma earned a positive return on its R&D investment for the fourth year in the six-year period, during which stories about its "R&D crisis" continued to grab headlines. The real crisis in R&D productivity actually occurred in 1999-2000, three years before the drop in the number of drug launches hit company valuations (see Figure 5).5
Does R&D Need to Run Faster?
If returns on pharma R&D investment are holding up relatively well, why are the valuations of pharma companies falling?
In measuring ROI, we have assumed constant profit margins from sales of drugs to make our productivity figures comparable over time. The market has not been so equitable: Over the past few years, margins have come under considerable pressure from adverse trends in both costs and prices.
On the cost side, companies are spending much more on marketing. For example, the number of primary care sales reps soared by 50% between 1998 and 2003 and, in addition to the traditional expense of sales reps "detailing" drugs to doctors, a costly new marketing front has opened up in the form of direct-to-consumer advertising of drugs in the U.S. market.3
At the same time, pricing pressures are compounding the margin squeeze from increased marketing. Easier movement of drugs across borders, closer government scrutiny of drug prices, greater consumer price sensitivity through increased use of co-pay in the U.S. and the continuing penetration of generics are all restraining price levels. In the U.K. and the U.S., pharmaceutical price inflation has fallen by 2-3% relative to other goods over the past two years.4
As a result, Big Pharma’s challenge is not a collapse in R&D productivity per se, but a failure to increase productivity sufficiently to compensate for a reduction in operating margins.
