Below Zero and Falling Fast: R&D Productivity as an Enterprise-Wide Crisis

Richard
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We estimate current returns on R&D spending of -7% – before costs of capital – for a typical R&D portfolio (typical in terms of # of projects, mix of projects by phase of development, and mix of projects by large v. small molecule)

Critically, we find that the industry’s rapid pace of real pricing growth – in particular for small molecule products sold in the US – accounts for half of total returns on R&D spending
Because we anticipate an erosion of US real pricing power, we now also anticipate that returns to R&D spending will deteriorate further, in all likelihood at an accelerating pace

Managements have viable options for rescuing R&D returns, but these are not being adequately pursued for two apparent reasons: the problem (poor R&D productivity) is defined too narrowly, and targeted productivity gains are far too modest

R&D productivity is an enterprise-wide measure – the COGS and SG&A costs of commercializing a discovery are just as impactful to R&D returns as the time and costs associated with bringing the product to approval. Framing poor R&D productivity as a problem that exists narrowly within the borders of R&D operations appears common, and severely limits options

Recent cost-focused restructurings are benchmarked to income-statement measures (e.g. margins, EPS), but current-period (or even 5+ year forecast period) income statements cannot ‘see’, and accordingly cannot reflect the scope and scale of the R&D productivity problem. Current-period profits are the result of R&D long since spent, and the bulk of returns to current-period R&D spending are perhaps a decade in the future

By comparing the present value of future profits for the typical project to the cumulative development costs (projected to the point of approval) for the typical project – as we do in this research note – the firm can produce a meaningful estimate of current R&D productivity

We conclude that R&D productivity is deteriorating at a potentially accelerating pace, and that firms are capable of rescuing their R&D productivity, but we can think of none who are yet on track to do so

We continue to recommend therapeutics portfolios built solely around companies with pending or recent product approvals (i.e. positive idiosyncratic risks), in large part for the reason of avoiding deteriorating systematic (e.g. R&D productivity) risks

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