Senior life science commerical strategy consultant and Managing Partner at Red Team Associates
There’s a famous quote often attributed to F. Scott Fitzgerald that says, “The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.”
Investors in biotech need to be optimistic realists. They need to consider and balance two views of every investment: the optimism of the new and exciting science with the realism that there’s a low probability the science will translate into successful products.
I’ve observed that biotech investors are largely optimists. Scientific advances bring the promise of new and better products that will enable us to live longer and better lives. Indeed, even without the added impact of Covid-19, the combination of an aging population, insatiable demand and new drug technologies that continue to mature has caused investors to pour money into biotech, and many investors have been richly rewarded for doing so.
According to the Pharma, Biotech & Medtech 2020 in Review (registration required) from Evaluate, 2020 saw the highest level of biotech deal activity ever, with approximately $20 billion in total biopharma investments. For IPOs, 2020 was also a massive year, with biotechs driving significant activity. Seventy-six biotechs went public in 2020, the most since 2015 and a 72% increase from 2019.
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But there are realities associated with this sector investors should also consider:
1. Few drugs in clinical development get approved by the FDA.
The road from science to salable products is a long and expensive journey. According to PhRMA, the pharmaceutical research organization, while scientific advances allow for a better understanding of diseases at a molecular level, this also means researching and creating new medicines is more complex and difficult. The report states that, on average, it takes about 10 years to get a drug to the marketplace with a cost of about $2.6 billion. And the probability of product success is less than 12%.
2. Less than half of approved drugs hit their forecasted revenues.
According to life science consulting firm L.E.K., approximately half of all the drugs commercialized since 2004 didn’t live up to sales forecasts. In fact, only 20% of new drugs reached $1 billion in U.S. sales, and more than half failed to hit even $250 million.
3. Insurers rule because he who has the gold makes the rules.
Approval by the FDA doesn’t mean a drug will be used or commercially successful. Insurers like Aetna, United Health, Anthem and others play a key role in determining whether a product will be commercially successful. Insurers actually pay for the drugs, so they decide which drugs will be included in their formulary, their continually updated list of prescription drugs approved for reimbursement by the insurer.
It stands to reason that those drugs not included in the formulary are more difficult for physicians to prescribe. Even if a drug is on the insurer’s formulary, unless the product’s benefits are unique, there might be a requirement that another, often cheaper drug, be tried first. This is referred to as a step edit. For example, when you see a commercial for Humira, you might hear something like, “For patients who didn’t respond to Methotrexate, Humira …” Of course, companies may choose to lower their price or give rebates to avoid step edits, but that can hurt a product’s rate of adoption, revenues, profitability and the return on investment.
4. “First in class” or “best in class” are increasingly outmoded mantras.
The industry mantra for product development has always been to get to market first or develop a better product than what is already on the market. Both of these strategies now face new challenges that impact a new product’s future commercial potential.
Being first to market brings with it the challenge of needing to educate prospective customers. That takes time, can be expensive and is most valuable if there’s sufficient time before a competitor enters the market. But, given enough time between the first and later entrants, it can be very effective, especially if the new product has a compelling advantage.
Being best in class can have definite advantages. As I heard one client say, “It’s a lot easier to tell people I have a better toothpaste than it is to teach people about the need to brush their teeth.” It’s tough to argue that logic. The reality is that unless your differentiation is compelling versus the products currently being used, it’s hard to change ingrained behavior. Physicians get comfortable using a particular product. The later entrant might not capture a preferred position on an insurer’s formulary unless they’re willing to pay significant rebates or spend extensively on direct-to-consumer advertising and hope to generate demand that way. All of these strategies are expensive and dampen a product’s revenues and profitability.
An Optimistic Realist
It’s only natural to be optimistic about investing in biotech. Indeed, new drugs and treatments arising out of biotech have increased life expectancy and will likely continue to do so in the future. But investors need to be optimistic realists. How well a new product is likely to perform commercially should be factored into the assessment of the company’s attractiveness as an investment.
Don’t be lulled into thinking that others have already performed the requisite due diligence. That only works if the other investors have similar financial objectives, time horizons and amount of money to invest. Each investor should make their own determination as to whether an individual biotech investment makes sense.
It is difficult to find a more exciting and rewarding market than biotech in which to invest, or a more exciting time in which to do so. But be an optimistic realist. Wishing you good luck and good fortune.
The information provided here is not investment or financial advice. You should consult with a licensed professional for advice concerning your specific situation.