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Dr. Manuel Hermosilla shares his thoughts on how the pharmaceutical industry reacts to challenges that arise during trials, specifically during the search for an effective COVID-19 vaccine.
The development of a COVID-19 vaccine is at the forefront of everyone’s minds. Recent news suggests that a solution may be available in 2021, though the hope is sooner. The race for a vaccine adds to a body of evidence that suggests when under pressure the pharmaceutical industry reacts quickly.
During these times, I have been constantly reminded of the work of David Dranove and David Meltzer, which supports that more therapeutically important drugs reach the market sooner. That is, the development process, from beginning to end, is shorter for drugs targeting more pressing medical needs. But therein lies the question: Is pressure to succeed a good thing for the industry?
Beyond sponsoring firms, regulators, providers, payers, and patient advocacy groups may all support the speedy development of drugs targeting the more pressing medical needs. This kind of broad societal alignment, which is manifesting in extreme form during the current crisis, may give strong tail wind and reduce the amount of non-scientific challenges encountered in the process. In other words, pressure could be a sign of good things to come if it also means broad societal alignment.
Most times, however, the industry must respond to various forms of pressure that do not imply societal alignment. They include paragraph-IV challenges, tornados that destroy manufacturing facilities, adverse clinical trial results, among others. In recent research published in the INFORMS journal Management Science, I investigate the innovation response to these adverse events. Evidence suggests that, when in these circumstances, pharmaceutical companies’ responses may be bogged down by their own internal issues.
Let me unpack the idea by considering a leading source of pressure for firms in the industry: Phase III failures. Phase III clinical trials are the final set of trials required before an application for commercialization is submitted to the regulator. They are the largest, longest, and most expensive set of trials in the process, and are often seen as the last big hurdle to overcome to reach the market. But unfortunately, Phase III success is far from ensured: About 40% of Phase III trials imply failure of the tested drug’s development (the percentage is significantly higher in oncology). Partly because these failures also tend to bring along sharp declines of stock market valuation, they are big blows to developers.
A source who lived through a few of these events while working for a large pharmaceutical company recounted to me that Phase III failures invariably raised anxiety levels within the organization. For those working in sales, there was a chance that their positions would be no longer needed. The added tension also reached R&D leaders as Phase III failures introduced sizable pipeline gaps.
If the failed technology relates to others in the pipeline (e.g., they all rely on the same mechanism of action), these gaps may signify that entire programs become unviable, drying up pipelines. Replenishing pipelines with new internal candidates may not be possible in the short term, while re-activating “shelved” candidates may not be attractive. Thus, Phase III failures may, at least in the short run, significantly reduce the size of the R&D portfolios that need management.
In my research, I was specifically interested in the question of whether pharmaceutical companies help themselves in the aftermath of these events. My analysis focused on licensing frequencies and post-licensing development outcomes of 20 of the largest firms worldwide over a 15-year period. A first piece of evidence suggested that these firms react to Phase III failures by in-licensing candidates from other firms to try to fill the gap.
At face value, this should be good news—firms help themselves by replenishing their pipelines through outsourced innovation. But a flag was raised by the timing of the effect. These reactive licensing events take place within the year after the triggering Phase III failure. This is potentially problematic given that licensing deals have highly involved transactions—many complex ideas to agree upon, due diligence to perform, incentives to align, etc.—all of it via a carefully negotiated deal. Is the celerity of reactive deals an expression of relaxed licensing standards?
This suspicion was not unfounded: I discovered that candidates licensed within a year of a Phase III failure were about 10% less likely to reach the market compared with others licensed under normal circumstances (no recent failure). That is, candidates licensed “in a rush” failed post-licensing development more often. Why?
Some evidence suggested that rushed contracting could be playing a role. Rushed agreements may not have been as iron clad as one could have wanted—remember, these are very complex and detailed agreements. Contractual “lose ends” could have in turn created inter-organizational frictions and, with it, the derailment of collaborations. Insufficient due diligence or weakened due diligence standards also may be playing a role.
Perhaps you have heard of the Bob Marley rule in economics. I will adapt it to make it fit our context: Someone can be fooled sometimes, but everyone won’t be fooled all the time. Why would pharmaceutical companies allow themselves to react to Phase III failures in this way, knowing the relatively higher chances of subsequent failure?
It is important to point out that, despite the higher risk, these deals may still have positive net present values (NPV). After all, most of licensing compensation is contingent upon outcomes, so quick failure also means smaller costs. But the relevant question is: Do rushed in-licensing strategies have the highest NPV of all possible strategies? In other words, did reactive deals need to happen so quickly after the Phase III failure?
One could argue that financial markets value these quick licensing reactions. But I found no evidence to support this. Also, let’s not forget that the organization is not only committing financial resources to the licensing deal, but also its business development personnel and later on, potentially, the clinical trial and regulatory liaison machineries. That is, there are non-trivial opportunity costs. Development attrition rates being so dramatically large in the industry, you have to wonder if there really can exist a hidden source of rush-based economic value that is large enough to rationalize this behavior.
Jean-Pierre Garnier, the former CEO of GlaxoSmithKline, suggested that the loss of personal accountability is one of the factors behind the slide in pharmaceutical productivity in the last few decades. The results of my analysis reflect Garnier’s concern: Could this “hidden” source of value indeed not exist? Could rushed licensing be just one more expression of the well-known problem of misaligned incentives within the organization?
As provocative as this hypothesis may sound, problems like these are common. There is evidence, for example, for the idea that CEOs may use the their companies’ investment strategy to their own benefit and, more generally, that CEOs with less oversight from shareholders deliver worse performance. Additional flags should be raised in our context given the common incentive structure that R&D leaders face. Because success is so elusive, incentives tend to prize activity (e.g., how big the pipeline is) rather than exclusively relying on accomplishment (e.g., how efficiently portfolio management is).
This somber assessment should not be taken as a suggestion that pharmaceutical companies should avoid outsourcing innovation to replenish their pipelines in times of need. About 15 years ago, Matthew Higgins and Daniel Rodriguez showed that M&As can indeed help to solve the problem of pipeline gaps for desperate pharmaceutical companies (e.g., firms with weakening pipelines or impending patent expirations). Why do M&As work but licensing deals backfire?
One reason may stem from the relative size of the two types of deals. M&As are much larger transactions than licensing deals, which means they also command much greater scrutiny from stakeholders. The smaller size of licensing deals may make them more discretional and thus more vulnerable to managerial reactions.
While the broad societal alignment behind the development of a COVID vaccine provides a good omen, experts have already started to raise concerns that rush may be compromising the chances for success. Particularly at times like this, it is crucial that these unnecessary sources of added risk be kept in check.
Manuel Hermosilla is an assistant professor of marketing at the Carey Business School at Johns Hopkins University. He has studied diverse aspects of new product innovation within the biopharmaceutical industry. His ongoing research focuses on the interplay between patenting and drug development, as well as on different aspects of pharmaceutical drug consumption in emerging markets. He is also a member of the Institute for Operations Research and the Management Sciences (INFORMS).