Everyone Wants Pharmaceutical Breakthroughs. What Drives Drug Companies to Pursue Them?
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Innovation Healthcare Sep 6, 2018

Every­one Wants Phar­ma­ceu­ti­cal Break­throughs. What Dri­ves Drug Com­pa­nies to Pur­sue Them?

A new study sug­gests that firms are at their most inno­v­a­tive after a finan­cial windfall.

Drug innovation at a pharmaceutical company

Michael Meier

Based on the research of

Joshua Krieger

Danielle Li

Dimitris Papanikolaou

When choos­ing which new prod­ucts to devel­op, com­pa­nies must decide how much they want to inno­vate. Should they make an incre­men­tal improve­ment on an exist­ing prod­uct? Or should they cre­ate some­thing entire­ly new?

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Dim­itris Papaniko­laou, a pro­fes­sor of finance at Kel­logg, explored how this choice plays out in the phar­ma­ceu­ti­cal industry. 

Some researchers argue that phar­ma­ceu­ti­cal firms these days are often mak­ing minor changes to exist­ing med­ica­tions instead of deliv­er­ing inno­v­a­tive drugs. And, giv­en the poten­tial life-sav­ing and life-improv­ing pow­er of new drugs, such a trend would have clear con­se­quences for society. 

Break­throughs are becom­ing less fre­quent,” Papaniko­laou says. 

To mea­sure what is hap­pen­ing in the indus­try, he and coau­thors devel­oped a method to quan­ti­fy a medication’s lev­el of nov­el­ty and applied it to a data­base of more than 64,000 drugs. They found that more inno­v­a­tive ther­a­pies had a low­er chance of being approved by the U.S. Food and Drug Admin­is­tra­tion (FDA). On the oth­er hand, those that did pass this hur­dle tend­ed to be more effec­tive and lucra­tive than so-called me too” drugs, which are vari­a­tions on exist­ing medications. 

Yet the researchers found that firms were eager to work on nov­el drugs — under the right finan­cial cir­cum­stances. When phar­ma­ceu­ti­cal com­pa­nies got a wind­fall, such as a sud­den increase in prof­its, they were more like­ly to spend it on devel­op­ing nov­el drugs than on incre­men­tal improve­ments. The reverse, of course, is also like­ly true, Papaniko­laou says. Firms may be held back from pur­su­ing inno­v­a­tive ther­a­pies because they lack the cash to turn their finan­cial­ly riski­er ideas into reality. 

These finan­cial fric­tions may be lim­it­ing inno­va­tion,” says Papaniko­laou, who col­lab­o­rat­ed with Joshua Krieger of Har­vard Busi­ness School and Danielle Li of MIT Sloan School of Man­age­ment on the research. If soci­ety wants to encour­age more nov­el drugs, he says, one solu­tion would be to increase the sup­ply of cap­i­tal to these firms. 

A Yard­stick for Drug Inno­va­tion

Papaniko­laou and his coau­thors tack­led the issue by first con­sid­er­ing how to define inno­va­tion. In the past, researchers often mea­sured nov­el­ty by count­ing, say, the num­ber of new drugs or patents a firm pro­duced. But these meth­ods didn’t cap­ture whether the ther­a­pies were inno­v­a­tive or me too” drugs. 

Instead, Papaniko­laou and col­leagues exam­ined the chem­i­cal struc­tures of indi­vid­ual drugs that were being devel­oped. In gen­er­al, mol­e­cules that are chem­i­cal­ly sim­i­lar tend to have sim­i­lar func­tions. So to mea­sure nov­el­ty, the researchers used recent advances in bioin­for­mat­ics to com­pare each med­ica­tion in a large drug data­base to every drug devel­oped before it. The algo­rithm, which was devel­oped by researchers at the Uni­ver­si­ty of Cal­i­for­nia, River­side, returned a score that cap­tured the chem­i­cal sim­i­lar­i­ty between each pair of drugs. The team then iden­ti­fied the max­i­mum sim­i­lar­i­ty score for that med­ica­tion — that is, how sim­i­lar it was to its clos­est neigh­bor.” The low­er the score, the more inno­v­a­tive the drug.

Good ideas may not always be able to be financed.” 

The team found that from 1999 to 2014, the aver­age nov­el­ty of drugs declined. This trend was part­ly due to the fact that the num­ber of exist­ing med­ica­tions grew. But even when the researchers com­pared each drug only to those devel­oped dur­ing the pre­vi­ous five years, the pat­tern persisted. 

Papaniko­laou cau­tions that this doesn’t nec­es­sar­i­ly mean all areas of inno­va­tion are declin­ing in the phar­ma­ceu­ti­cal indus­try. The researchers’ method of mea­sur­ing nov­el­ty worked only on small-mol­e­cule drugs; more com­plex bio­log­ic” drugs — con­sist­ing of mol­e­cules such as pro­teins or sug­ars — were exclud­ed from the analy­sis. While these bio­log­ic med­ica­tions occu­py a small frac­tion of the mar­ket­place, they are a major source of inno­va­tion, he says. 

A Fail­ure or a Blockbuster?

Next, the researchers inves­ti­gat­ed the risks and rewards of devel­op­ing nov­el drugs. 

They found that, on aver­age, an inno­v­a­tive drug was less like­ly to pass reg­u­la­to­ry hur­dles. A drug with a nov­el­ty score that was one stan­dard devi­a­tion high­er than anoth­er med­ica­tion for the same dis­ease pro­duced around the same time had a 29 per­cent low­er chance of FDA approval. 

If you’re try­ing some­thing that hasn’t been tried before, you’re more like­ly to fail,” Papaniko­laou says. 

But inno­v­a­tive drugs that did get approved per­formed bet­ter on sev­er­al measures. 

A one stan­dard devi­a­tion increase in nov­el­ty was linked to a 33 per­cent rise in the like­li­hood of being cat­e­go­rized as high­ly impor­tant by Haute Autorité de San­té, a French health­care orga­ni­za­tion that eval­u­ates med­ical prod­ucts and issues treat­ment guide­lines. It was also asso­ci­at­ed with 10 – 33 per­cent more cita­tions for patents relat­ed to the drug. Rev­enue gen­er­at­ed from the med­ica­tion was approx­i­mate­ly 15 – 35 per­cent high­er. And the firm’s stock val­ue increased by 2 – 8 per­cent more upon announce­ment of FDA approval. 

The results sug­gest that while nov­el drugs may be less like­ly to get through the approval process, they have more upside poten­tial for the com­pa­ny and for patients. 

If you want to have a block­buster drug, that’s the way,” Papaniko­laou says. 

An Influx of Cash

Still, ques­tions about firms’ atti­tudes toward nov­el drugs remained. Giv­en the risk of fail­ure, did com­pa­nies view inno­v­a­tive prod­ucts as a worth­while investment? 

Ide­al­ly, the researchers would have per­formed a con­trolled exper­i­ment to find out whether firms respond­ed to an influx of mon­ey by devel­op­ing nov­el ver­sus me-too drugs. 

We would ran­dom­ly drop heli­copters of cash on firms,” Papaniko­laou says. Unfor­tu­nate­ly, that can­not be done.” 

Instead, the team took advan­tage of a nat­ur­al exper­i­ment. In 2006, the U.S. gov­ern­ment rolled out Medicare Part D, which increased insur­ance cov­er­age of pre­scrip­tion drugs for old­er patients. So phar­ma­ceu­ti­cal com­pa­nies that already man­u­fac­tured med­ica­tions for this age group were like­ly to become more prof­itable. That’s almost the same as me giv­ing out mon­ey,” Papaniko­laou says. 

This nat­ur­al exper­i­ment wasn’t per­fect, how­ev­er. Ide­al­ly, all oth­er fac­tors in the firms’ envi­ron­ment would remain the same. But Medicare Part D had anoth­er side effect. It increased the incen­tive for com­pa­nies to devel­op more drugs for the elder­ly so that they could cash in on the ben­e­fits of the new reg­u­la­tions. If the researchers sim­ply com­pared drug-devel­op­ment trends between firms whose drugs were most­ly used by the elder­ly to oth­er firms dur­ing this time, it would be unclear whether changes were due to the increase in prof­its or the new incentives. 

Papaniko­laou and his col­leagues devised a way to get around this con­found­ing fac­tor. At some firms, the patents on drugs were about to expire, so any addi­tion­al prof­it from Medicare Part D would be short-lived. At oth­er firms, the patents still had a lot of life left in them, so those firms would like­ly ben­e­fit finan­cial­ly from the reg­u­la­tions for a long time. By com­par­ing com­pa­nies with dif­fer­ing patent expi­ra­tion dates — among the firms with pre­scrip­tion drugs for old­er patients — the researchers could iso­late the effects of prof­its on drug development. 

Financ­ing Poten­tial Block­buster Drugs

The team found that firms that reaped more prof­its tend­ed to devel­op more drugs — and those med­ica­tions were more like­ly to be nov­el. Addi­tion­al­ly, many were tar­get­ed at younger patients, not the elder­ly. This con­firmed that the increase in inno­v­a­tive drugs was not caused just by the greater incen­tives for drugs for old­er customers. 

This can only be due to cash-flow shock,” Papaniko­laou says. 

The typ­i­cal finan­cial advice for a com­pa­ny with a good idea but not enough cash on hand is that it should raise mon­ey — say, by tak­ing out a loan or issu­ing shares. But the study sug­gests that even large phar­ma­ceu­ti­cal firms may have trou­ble doing this. 

Good ideas may not always be able to be financed,” he says. 

Papaniko­laou notes a cou­ple impor­tant caveats. One is that the study assumes that firm man­agers make drug-devel­op­ment deci­sions to fur­ther best inter­ests of share­hold­ers — rather than pri­or­i­tiz­ing their own pet projects or careers. The oth­er is that nov­el drugs may not nec­es­sar­i­ly be bet­ter for soci­ety. It is pos­si­ble that me-too drugs ben­e­fit patients more because they low­er prices and increase competition. 

But regard­less of how inno­v­a­tive drugs affect soci­ety, it appears that phar­ma­ceu­ti­cal com­pa­nies con­sid­er them worth­while invest­ments — when they have extra cash on hand. 

Firms seem to per­ceive them as more valu­able,” Papaniko­laou says.

About the Writer

Roberta Kwok is a freelance science writer based near Seattle.

About the Research

Krieger, Joshua, Danielle Li, and Dimitris Papanikolaou. 2018. “Developing Novel Drugs.” Working paper.

Read the original

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