The road to positive R&D returns

McKinsey have published an interesting article, the road to positive R&D returns (PDF), which analyzes ways that biopharma companies can increase the efficiencies of their R&D activities.

As productivity in the pharmaceutical industry has fallen, calls for a new paradigm that would radically change pharmaceutical R&D have increased.  The trend has been to view diminishing returns as a science problem.  But while scientific innovation is certainly part of the solution, management should not overlook other, more familiar ways to create value.  Increased attention to costs, speed of development, and decision making could increase the internal rate of return (IRR) of an average small molecule from around 7.5 percent—less than the industry’s cost of capital—to 13 percent.

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Previous industry experience suggests that such goals are attainable: from 1997 to 2001, the return on the portfolio described above would also have been 14 to 15 percent, driven by a higher probability of success and shorter development times.  Although the current environment is tougher, managers are not yet fully exploiting the value creation levers described here, and moderate improvements could substantially increase returns.  An IRR of 14 to 15 percent on R&D might not sound like a jackpot, but over a large portfolio it would create considerable value.

In the current economic climate biopharma companies have increasingly outsourced R&D; finding ways to make it more efficient internally could reverse that trend.