Aug 10, 2005

Historically, the big pharmaceutical companies (Big Pharma) have sought to feed their marketing machines by manufacturing blockbuster drugs—chemical-based, one-type-fits-all products that treat chronic conditions such as heart disease or arthritis. This approach has yielded recurring revenue streams from large patient populations. In contrast, biotechnology companies typically have created protein-based drugs,or biologics, to treat acute or niche conditions and diseases. With few exceptions (such as the biotech giant Amgen), biotech companies have foregone doing the marketing and sales of their drugs themselves, and have, instead, relied on others to perform their marketing and sales functions.

Sometimes Big Pharma's blockbuster drugs have been accompanied by blockbuster risks. A one-type-fits-all approach may be hazardous, in that a single drug taken by many users may inevitably result in harmful side effects in some patients. These side effects can adversely affect not only the physical health of the patients but the economic health of the manufacturer, as well. For example, although Merck's drug Vioxx brought great relief to many, some patients experienced heart attacks and strokes. As a result, Merck must now contend with 600 lawsuits and settlements that some speculate could reach $20 billion — a figure equal to nearly one year's revenue for the company.1 If that figure seems unimaginable, consider that as of December 31, 2004, Wyeth had paid and reserved a total of $21.1 billion to settle litigation over the FenPhen diet drug it introduced in the 1990s, a drug which also caused heart problems in some patients.2

In the future, Big Pharma may migrate from one-type-fits-all drugs to more personalized medications. As a result of the personalized nature of these therapeutics, side effects may be reduced and efficacy may be increased. Biotech companies, because they are accustomed to providing personalized niche therapeutics, will become increasingly important as alliance partners for the big pharmaceutical firms. A move from blockbuster drugs to more personalized medicines and niche therapeutics will require reexamination of the Big Pharma business model, as well as a reexamination of the business arrangements between Big Pharma and biotech companies.

Potential Drawbacks of Licensing and Development Deals

Today most business arrangements between Big Pharma and biotech companies are royalty and milestone-based licensing and development deals. There are, however, some potential drawbacks to that configuration for both Big Pharma and the biotech companies.

Drawbacks for Big Pharma

For Big Pharma, as the demand for new drugs increases, there is a substantial risk of overpayment for these drugs. The end value of a developed and commercialized drug may, in hindsight, be less valuable to a Big Pharma firm than aggregate milestone payments made to a biotech company and the continuing overhang of future royalty payments against future revenues. In addition, if a large pharmaceutical company shoulders development costs on its own, the risks of product efficacy, safety, and regulatory approval are borne inordinately by that company. Finally, after a new drug is launched, it may not perform in the marketplace as projected, or its manufacturing or marketing costs may be higher than anticipated.

Drawbacks for Biotech Companies

For a biotech company involved in a royalty and milestone-based licensing and development arrangement with a large pharmaceutical manufacturer, an important portion of the economic value chain is substantially absent. The biotech company can be relegated to its historical role of being a research and development company, receiving only royalties or sales milestone payments, while the pharmaceutical firm reaps large and ongoing revenues from the commercialization of the developed product. The biotech company in such an arrangement remains essentially an intellectual property (IP) platform company. In addition, venture capital and public markets place a higher valuation on companies that also participate in profits from commercialization. For these reasons, a biotech company would do well to pursue an arrangement in which it receives profits and not just royalties or sales milestone payments. An example of such a biotech company is Amgen, which has a large, active sales force to sell its products.

A Prototypical Deal

To better understand royalty and milestone-based licensing and development deals for drug development and commercialization, let's examine a prototypical example to illustrate a template commonly used today between biotech and Big Pharma companies.

lorem ipsum