Stephen Foley: Big Pharma ignores R&D at its peril

US Outlook: It might be a little early to declare, but 2010 looks like being a year of profound change for Big Pharma.

Almost as if a management consulting-led fad has swept through the industry, the world's biggest drug makers are, one by one, declaring a shift away from research and development spending.

Where previously these companies have thought of themselves as laboratories for world-changing drugs, there seems to be an emerging view that their core competence is, in fact, their aggressive – and always controversial – ability to market their drugs to doctors and (in the US) patients.

Announcements by Pfizer and GlaxoSmithKline, the two industry goliaths, this week, and AstraZeneca earlier, have put concerns about return on investment in R&D front and centre. AstraZeneca responded with 8,000 job cuts, Pfizer promised to lop 25 per cent from its research budget, and Sanofi-Aventis is next week expected to propose moving in a similar direction.

Sensing the wind in their favour, revolutionaries on Wall Street and in consulting argue that shareholders will be best served by Big Pharma ending all early-stage drug research entirely. Cheaper, they say, to license in new compounds from smaller biotech-style companies, or from academia, after they have already shown promise.

Drug research is a game of trial and error. Analysts at Morgan Stanley, who have been pushing a Pharma 2.0 model based on in-licensing, reckon the return on investment on licensed products is three times higher than on in-house research, at least in the current economic conditions. Yes, the big drug companies will have to pay out more in royalties to the drugs' inventors, but the cost savings more than make up for that.

Here's where we should start to worry about unintended consequences, and about whether we are creating a drug research industry that is, overall, more costly for the economy – just at the point we should be getting healthcare costs down.

For an individual firm, shutting research labs and picking likely winners from outside may be a no-brainer, but trial and error is still a fact of life. Who absorbs the cost of the failures? This will fall to biotech investors – venture capitalists or small company investors in the public markets – and it seems possible that the cost of the failures will rise.

Time and again, small biotechs waste money on projects that would have been cut at Big Pharma because admitting defeat leads to a share price collapse and may even be the end of the company. And a constellation of small firms will have duplicated and higher overheads than research concentrated in Big Pharma.

Meanwhile, a major complaint of biotech chief executives is that they have to spend too much time scrabbling for funding for the work they need to do, and often don't have enough to do it properly.

As for Big Pharma, those calculations about the benefits of in-licensing over in-house could change rapidly if the competition for licensing deals, which has been getting more ferocious for several years, increases dramatically. It could be that they will regret swingeing cuts to their R&D budgets sooner rather than later.

And there is another reason for executives to pause. There are very great political benefits from drug companies being able to trumpet the life-changing discoveries that have emerged from their research labs and their scientific trials. Yes, these are companies that have manipulated the publication of scientific data, made over-reaching claims for their drugs, and practiced price gouging of government health and insurance services, but they are also companies that lower our cholesterol, shrink tumours, keep diabetes in check and lift the burdens of depression. In the UK, there is an explicit compact with the government on this score: drug prices charged to the National Health Service are set to allow for investment in research. In the US, the good works of drug research help keep in check the demands for reimportation of drugs from lower-priced Canada, and other cost-cutting measures.

Are the Big Pharma execs who jump on the R&D cost-cutting bandwagon sure where it leads?