Business Models & Portfolio Management in The Pharmaceutical Industry

Business Models & Portfolio Management in the
Pharmaceutical Industry
Catherine Godrecka-Bareau, CFA
Summer 2016
To give you a quick background about myself

Objective of the lecture
Gain a helicopter view of the money flow in the pharmaceutical industry
• 1st Part : Understand the Top 3 business models in the pharmaceutical industry
• 2nd Part : Understand the 3 key strategies to refuel the pipeline
• 3rd Part : Understand how to prioritize compounds within the portfolio

Agenda
1 The pharma business models
2 How to refuel the pipeline
3 Prioritize the best compounds within your ideal portfolio

Overview of the 3 major business models :
Innovator, Generic, and OTC
Innovator Generic OTC
 New Chemical Entities (NCEs)  After innovator’s patents have  Based on generic drugs with a
expired, the generic company very safe product profile
 New Biological Entities (NBEs) can make the copy
 Patient can obtain the drug
 High R&D investment  The generic is cheaper without prescription
 Revenue from compound only because clinical data from the
innovator can be re-used  Branded generics (e.g. Advil)
guaranteed when patents valid
 Price discount : 10% to 95%  Direct-to-consumer marketing
Before we review in details the above 3 models, what other models exist in the
pharma industry ?

All other business models in the pharma industry
gravitate around the Top 3
Let’s look how external players map along the pharma value chain
Research Development Clinical Trial

Production
Management
• Development • Contract • Clinical Trial • Contract

Stage Companies Research Service Firms Manufacturing
Organizations (e.g. Quintiles) Organizations a.k.a.
• Universities a.k.a. CROs CMOs (e.g. Lonza)
incubators
• Packagers
• Formulators
• API Manufacturers
Hence, it is key to understand the major 3 business models … starting with Innovator model
Source : Innovative Business Models in the Pharmaceutical Industry: A Case on Exploiting Value Networks to Stay Competitive by Francesca Capo,
Federica Brunetta and Paolo Boccardelli

Innovator business model
Innovation based
• The strategy is innovation based
• Sales are function of patent life cycle
Strategy
• Need to constantly refuel pipeline b/c LOE - generic player may take up to 90% of your sales in 6 m
Revenue in $ bn LOE Entry of generics
Positive Cash Flows

+1.0
High return with
peak sales $1bn+
+0.5
High R&D costs ~$1bn
High risk w/ Proba of success ~5%

0 Time
Y1 Y10 Y20
- 0.5
Negative Cash Flows

Investment in $ bn LOE : Loss Of Exclusivity i.e. patents expire
Note : curve here is for illustrative purpose only
Let’s look at a real life example

Lipitor case
14'000 LIPITOR – WW sales in $m
12'000
LOE
10'000
Entry of generics
8'000
• Brand : Lipitor Pfizer lost $8bn in sales
• Company : Pfizer in less than 1 year
• INN : atorvastatin 6'000
• Class : cholesterol-lowering agent
• Launched in 1997
• World's bestselling drug of all time 4'000
• Peak sales : $12bn
2'000
LOE : Loss Of Exclusivity i.e. patents expire

0
Source : Evaluate Pharma, http://www.thelancet.com/journals/lancet/article/PIIS0140-6736(11)61858-8/fulltext
 How do you manage LOE events if you are an innovator ?

Pipeline is key
• To sustain your sales curve , constantly feed the pipeline

Strategy • When you lose exclusivity on a product, ensure you have a new candidate to fill the gap
Revenue in $ bn LOE LOE LOE
+1.0 Positive Cash Flows
+0.5
You constantly need to have
a well stuffed R&D pipeline
0 Time
Product1 Product2 Product3
- 0.5 LOE : Loss Of Exclusivity i.e. patents expire
Negative Cash Flows

 Time to move to 2nd business model : Generic
Investment in $ bn

Generic business model
Based on LOE of innovators
• Based on LOE of innovators
Strategy • Be 1st to market to enjoy 6 months exclusivity in the US (the holy grail of the generic industry)
• Need to constantly refuel pipeline b/c after 6m, sales decrease as a consequence of price competition
Revenue in $ m
6 months exclusivity in the US
Positive Cash Flows
+100
• For 6 months, you can charge 80% of the brand price

Low return with • After the 6 months, others competitors come in
+50 peak sales $100m • Downward spiral on price until price usually drops ~5% of the brand price
Low R&D costs < $5m
Low risk w/ PoS ~90%

0 Time
Year 1 Year 2 Year 3
-5
LOE : Loss Of Exclusivity i.e. patents expire
Negative Cash Flows

Investment in $ m

Lipitor case : and the winner is … Ranbaxy
14'000 LIPITOR – WW sales in $m
• Ranbaxy : #1 Indian pharma company,

12'000
12th-largest WW generics maker
LOE*
• 2010 sales : $1.9bn 10'000
Entry of generics
• Generated ~$600 m sales in 6 months
8'000
$600m in 6 months
6'000
4'000
2'000
*LOE : Loss Of Exclusivity i.e. patents expire

0
Sources : Evaluate Pharma, http://www.thelancet.com/journals/lancet/article/PIIS0140-6736(11)61858-8/fulltext,

http://archive.fortune.com/2011/05/03/news/companies/lipitor_ranbaxy_full_version.fortune/index.htm

Pipeline is key
• Generic business is a mix between low volume/high price and high volume/low price
Strategy • Because you don’t always get the 6m exclusivity, and because even if you do it only lasts 6 months,
you still need to play in 2nd / 3rd tier, where the strategy is to get a maximum compounds
Revenue in $ m
6 m exclusivity
+100 Positive Cash Flows
you arrived with 2nd tier entrants

+50
you arrived in 3rd tier entrants
0 Time
Product1 Product2 Product3
-5 LOE : Loss Of Exclusivity i.e. patents expire

Negative Cash Flows
Investment in $ m

OTC business model
Based on product segmentation
• Business model closer to FMCG (Fast Moving Consumer Goods)
Strategy • Need to reinvent the same product constantly : new formulation, new packaging … new, new, new !
• Hence, pipeline is key
Example : Ibuprofen market
Different brands Segment patients 360 solution for your problem
by indication, age, drug format

Muscle & Joint pain ?
Source pictures : Google

OTC business model
Direct-to-consumer marketing is key
Lamisil case
• Brand : Lamisil
• Company : Novartis
• INN : terbinafine
• Launched in 1990s
• Life Cycle Management
 Started as Rx pill for
onychomycosis
 Then expanded indications to
athlete’s foot & topical forms
 After LOE in 2007, launched
OTC version 2003 : Digger, the toenail-dwelling mascot
• Built great brand equity with Digger as
Rx and then leveraged this brand After LOE,
equity in OTC Digger changed
careers from
onychomycosis
to athlete’s foot
• OTC is based on direct-to-

consumer marketing
 patient education (e.g.
explain onychomycosis)
 provide the solution (here
Lamisil) 2016 : Digger, the athlete’s foot fungus
Source : https://www.youtube.com/watch?v=c4pLm-_YnWs
• Now that you understand the importance of the pipeline,
it is time to look at ways to get more compounds

Agenda
1 The pharma business model

First, the pipeline needs to be balanced between
Short Term and Long Term projects
Late stage projects to ensure Early stage projects to secure long-term

short-term business continuity business sustainability
Now that you know what portfolio you want, the next step is to figure out how you are going to get there

How to expand a portfolio with additional candidates ?
3 ways to replenish the pipeline
 The product is usually still in development
 You buy the rights to commercialize the
 This is the cheapest option product, in exchange you have to pay a
certain price and royalties, as well as finance
 But limited by your resources and discovery yield
the remaining R&D development
 It takes time to do R&D and need luck to find something
In-house
R&D
In-licensing
Company
acquisition
 Outright purchase of a company with an
existing pipeline
 This is the most expensive option, but
available immediately
 80% of big pharma pipeline is sourced externally

In-licensing
Top 3 selling drugs : all sourced externally
Commercialized by
Brand WW Sales2015 Sourced from
US EU Japan
$14.4bn BASF Pharma
$9.0bn Immunex
$8.3bn Centor
Sources : annual reports, Evaluate Pharma
What does an in-licensing deal look like?

In-licensing
Case study : Alfa for skin infections – early stage deal
• Signing fee
o $5m
• Contingent Milestones
o Successful Phase 1 : $5m
o Successful Phase 2 : $10m
o Successful Phase 3 : $ 30m
o EMA approval : $15m
o FDA approval : $ 30m
• Royalties based on Sales Tranches
o 4% on net sales <$100m
o 8% on $100m< net sales <$250m
o 12% on net sales >$250m
How far advanced the drug is in development will influence the price paid and the deal structure

Company acquisition
Case study : Roche / Genentech
 Founded in 1896 – based in Switzerland  Founded in 1973 – based in the USA

 2 divisions : traditional pharma and  Pioneer in genetic engineering
diagnostics
 In the 1980s, like all established pharma houses, Roche  IPO in 1980 to raise additional funds to finance R&D
wanted to participate in the genetic engineering revolution
 However, there was a high market volatility for biotech
 Roche built its own biologics expertise inside the company, equities resulting in money unexpectedly moving out of
but soon realized others were ahead biotech and company valuations coming down
 To avoid being behind, Roche was looking for a  When it was unable to interest investors, it started
partner that would accelerate its presence in genetically looking for a financial partner in the industry
engineered drugs
 Roche entered in an in-licensing/co-promotion agreement with Genentech in 1986
 In 1990, Roche bought 60% of Genentech for $2.1bn
 In 2008, Roche acquired the remaining shares for $ 48bn
 The collaboration resulted in some of the top breakthrough drugs of the 20th century
 e.g. Rituxan (1997), Herceptin (1998), Avastin (2004), Lucentis (2006)
Sources : Roche 10-k and analyst presentations, Roche website, IMD case : Financial Pioneering: The Genentech Acquisition by Roche by Anna Eckardt
Asset swap
Lisinopril : Merck and ICI*
55% market share
 Needed to boost their lethargic sales

 Retail with (1) Smart branding with Zestril - most other Tx for hypertension caused a
Background
loss of energy, patients complained that Tx took the zest out of lives; and (2) Put entire
Pharma division behind Zestril
 Hypertension (ACE inhibitors)  Tender markets - ICI cut their price. With roots in the bulk chemical trade, where price
competition is a way of life, ICI was better at winning tenders - where large buyers were
 Dvped by Merck in the early unwilling to pay for the Merck name
1990s
Better branding, sales force focus and willingness to compete on price
 Structure of Deal
 Merck & ICI both to market
the drug WW @ the same time
 Competing against each other
and using different brand
45% market share
names for same therapy
 In exchange, ICI to give Merck
 Prinivil positionned as follow-on therapy to Vasotech
a compound in diabetes with
high risk / high potential  Merck thought they could beat ICI in marketing Lisinopril – but as Vasotech was booming,
profile marketing teams were less enthusiastic about the 2nd hypertension drug
 Merck was not ready to compete on price
 Merck was very excited about the diabetes compound (which later failed in clinical trials)
Overestimated capabilities in research & marketing !
* : in 1999, ICI (Imperial Chemical Industries Pharma) sold ICI Pharma (Zeneca) to Astra, which then became AstraZeneca
Source : The Moral Corporation: Merck Experiences – by P. Roy Vagelos and Louis Galambos

• Now that you have a full portfolio, you are faced with a new
challenge, budget constraints
• As you will not be able to finance all the projects, you have to
select the ones that are the best

Agenda
1 The pharma business model

Because of limited resources, we have to choose
between projects
How to prioritize the projects ?
2017 Budget
available only
$75m !
To
To reconcile
reconcile
To reconcile
R&D
R&DInterest
R&D View
View
R&D Interest
R&D View Commercial
Commercial
Commercial View
View Interest
Interest
Commercial
Commercial View FinanceFinance
InterestInterest 2017 R&D costs
2017 R&D costs
the
the different
different views
viewsviews
the different
Project
Project
Project
Project PoS PoS
PoS PoS Ranking
Ranking
RankingPeak
Peak Sales
Ranking Sales
Peak
PeakSales Ranking
Ranking
Sales risk
risk adj.
Ranking
Ranking adj. NPV
riskNPV
risk adj.
adj.NPV Ranking
Ranking
NPV RankingPer Project
Ranking Cumulative
Per Project Cumulative
in
in $m
$m inin$m$m in
in $m
$m in $m
in $m in $m in $m in $m in $m
P-1
P-1 P-1
P-1 95%
95% 95%
95% #14
#14 #14#14 80
80 8080 #12
#12 #12#12 196
196 196 196 #1
#1 #1
#1 4 4 4 4
P-2
P-2 P-2
P-2 33%
33% 33%
33% #8
#8 #8
#8 320
320 320
320 #1
#1 #1
#1 115
115 115
115 #2
#2 #2
#2 9 9 14 14
P-3
P-3 P-3
P-3 77%
77% 77%
77% #13
#13 #13#13 134
134 134 134 #10
#10 #10#10 92
92 9292 #3
#3 #3
#3 12 12 26 26
P-4
P-4 P-4
P-4 100%
100% 100%
100% #15
#15 #15#15 55
55 5555 #14
#14 #14#14 39
39 3939 #4
#4 #4
#4 0 0 26 26
P-5
P-5 P-5
P-5 53%
53% 53%
53% #10
#10 #10#10 98
98 9898 #11
#11 #11
#11 33
33 3333 #5
#5 #5
#5 0 0 27 27
P-6
P-6 P-6
P-6 53%
53% 53%
53% #11
#11 #11#11 41
41 4141 #15
#15 #15#15 32
32 3232 #6
#6 #6
#6 4 4 31 31
P-7
P-7 P-7
P-7 62%
62% 62%
62% #12
#12 #12#12 159
159 159 159 #7
#7 #7
#7 31
31 3131 #7
#7 #7
#7 17 17 48 48
P-8
P-8 P-8
P-8 47%
47% 47%
47% #9
#9 #9
#9 215
215 215
215 #4
#4 #4
#4 24
24 2424 #8
#8 #8
#8 8 8 56 56
P-9
P-9 P-9
P-9 9%
9% 9%
9% #1
#1 #1
#1 267
267 267 267 #2
#2 #2
#2 16
16 1616 #9
#9 #9
#9 4 4 60 60
P-10
P-10 P-10
P-10 15%
15% 15%
15% #5
#5 #5
#5 192
192 192 192 #5
#5 #5
#5 16
16 1616 #10
#10 #10#10 11 11 70 70
P-11
P-11 P-11
P-11 19%
19% 19%
19% #7
#7 #7
#7 140
140 140 140 #9
#9 #9
#9 77 77 #11
#11 #11#11 5 5 75 75
P-12
P-12 P-12
P-12 9%
9% 9%
9% #3
#3 #3
#3 220
220 220
220 #3
#3 #3
#3 -1
-1 -1-1 #12
#12 #12
#12 6 6 81 81
P-13
P-13 P-13
P-13 9%
9% 9%
9% #2
#2 #2
#2 180
180 180 180 #6
#6 #6
#6 -2
-2 -2-2 #13
#13 #13#13 9 9 91 91
P-14
P-14 P-14
P-14 19%
19% 19%
19% #6
#6 #6
#6 74
74 7474 #13
#13 #13#13 -2
-2 -2-2 #14
#14 #14#14 5 5 96 96
P-15
P-15 P-15
P-15 9%
9% 9%
9% #4
#4 #4
#4 148
148 148
148 #8
#8 #8
#8 -6
-6 -6-6 #15
#15 #15
#15 6 6 101 101
Drivers
Drivers
Drivers
Drivers NCE over
NCE over
NCE
NCELCM
LCM
over
overLCM
LCM Peak
Peak Sales,
Sales,
Peak Launch
Launch
PeakSales, date
Sales,Launch
Launch dateTiming,
date date Risk,
Risk, Cost,
Timing,Timing,
Timing,Cost,
Risk,
Risk,Sales
Sales
Cost,
Cost,Sales
Sales
Discontinue below the red line
PoS : Probability of Success NPV : Net Present Value
Priority
Note : numbers for illustrative purposes only High Medium Low

The NPV measure is the golden standard to rank
projects, hence it is important to understand how it
works
• Brief overview of NPV
• The concept of NPV and risk-adjusted NPV
NPV : Net Present Value

Overview of the NPV measure
What is the NPV ?
The NPV is the value of the project today
It is calculated as the sum of the Discounted Cash Flows
What are Discounted Cash Flows ?

Discounted Cash Flow = Revenue – Costs – R&D investment – Cost of capital
500
Example Discounted Cash Flows 400

in $m
300
250
Launch product
150
100 100
2016
2017 2018 2019 2020 2021 2022
-10
-100 -50
-100
NPV = -10 -50 -100 +100 + 150 +250 +400 = $740m

-300

Valuation Principles
The NPV Analysis leads therefore to a simple decision rule
NPV
range
+
fund project
stop project
-

What is specific to R&D projects ?
In the case of R&D projects you also need to take risk into account
How ?
By adjusting cash flows using a risk factor
How ?

The decision tree of risk adjusted NPV
Launch
Ph 3 50% x 50% x 50% = 12.5%
Ph 2 50%
Ph 1 50%
Decision Tree
50% Stop
of
Risk Adjusted NPV Stop 50%
Stop 50%
50%
Let’s look at an example

Adjusting for risk through cash flow calculation
Example Product in Phase 1

Ph 3 Proba Launch
Ph 2 50% 12.5%
Ph 1 Risk adjusted NPV is significantly

50% less than the NPV because we have
50% -60 rightly adjusted for the risk in the
Risk Adjusted -35 project
NPV -10
Y0
2016 Y1
2017 Y2
2018 Y3
2019 Y4
2020 Y5
2021 Y6
2022
Ph 1 Ph 2 Ph 3 On the market
Probability of success 50% 50% 50%
Probability of spending
spending 100% 50% 25% 12.5%
Discounted Cash Flows

Discounted Flows -10 -50
-50 -100 100 150 250 400
=> NPV
=> NPV 740
adjusted
Risk adjusted 100% x -$10m
= 100% 50% x -$50m
= 50% -$50m 25% x -$100m
= 25% -$100m == 12.5%
12.5% x $100m
$100m = 12.5%
12.5% x $150m
$150m = 12.5%
12.5% x $250m
$250m == 12.5%
12.5% x $400m
$400m
Discounted Cash Flows
Flows -10 -25 -25 13 19 31 50
=> risk
=> risk adj. NPV 53

Adjusting for risk through cash flow calculation and moving
ahead in time
Same Product – Now in Phase 2
Ph 3 Proba Launch 25%

Ph 2 50% NPV only includes costs going
forward
50%
Risk Adjusted -100 i.e. past costs (a.k.a. sunk costs) are
NPV -50 not included in the valuation
2017 2018 2019 2020 2021 2022

Ph 2 Ph 3
On the market
Probability of success 50% 50%
Probability of spending 100% 50% 25%
Discounted Cash Flows -50 -100 100 150 250 400

=> NPV 750
+10 vs if in Ph 1
Risk adjusted = 100% x -$50m = 50% x -$100m = 25% x $100m = 25% x $150m = 25% x $250m = 25% x $400m
Discounted Cash Flows -50 -50 25 38 63 100
=> risk adj. NPV 125
+72 vs if in Ph 1
Higher valuation of the same project as time advances …

Adjusting for risk through cash flow calculation and moving
further ahead in time
Same Product – Now in Phase 3
Ph 3 Proba Launch 50%

50%
Risk Adjusted
NPV -100
2018 2019 2020 2021 2022

Ph 3
On the market
Probability of success 50%
Probability of spending 100% 50%
Discounted Cash Flows -100 100 150 250 400

=> NPV 800
+60 vs if in Ph 1
Risk adjusted = 100% x -$100m = 50% x $100m = 50% x $150m = 50% x $250m = 50% x $400m
Discounted Cash Flows -100 50 75 125 200
=> risk adj. NPV 350
+297 vs if in Ph 1
Because of its mathematical properties, risk-adjusted NPV gives a higher valuation to late
stage projects due to lower risk and shorter time to market

Is it possible to work with NPV only ?
What is missing in the NPV ?
Need to balance the portfolio Commercial risk Strategic Fit

between early stage and late
stage project
 Risk-adjusted NPV gives a  NPV is based on sales  NPV does not tell you how
higher valuation to late stage forecasts but it does not tell important the project is for the
projects you how easy it would be to company’s strategy
reach or not these forecasts
 Wrongly skewing the decision
towards late-stage projects
 Risk of unbalanced portfolio
Complementary measures exist, but NPV stays the Golden Standard

Portfolio optimization : focused selection
“The essence of strategy is choosing what not to do”,
Michael Porter
NPV
High Value High Value

Early Stage Late Stage
Target availability
for launch
Low Value
Low Value
Early Stage
Late Stage
2025-30 2024 2023 2022 2021 2020 2019 2018 2017 2016
Note : graph here is for illustrative purpose only
Adapted from Effective Porfolio Management, Ewa Krol, 14th Annual Strategic Project & Porfolio Management for Pharma Congress, Barcelona, 2015

Key take-aways
 3 major business models : Innovator, Generic, OTC
 3 ways to refuel a pipeline : In-House, In-Licensing, Company Acquisition
 The Net Present Value (NPV) measure is the golden standard used to prioritize compounds in a portfolio
 A well-balanced portfolio between short term projects and long-term projects is key for a healthy business
 Portfolio selection is a product of cross-functional analysis that results in a decision matrix where risk and reward
are balanced and the final selection of candidates is also function of the budget available

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Business Models & Portfolio Management in the

Catherine Godrecka-Bareau, CFA

Gain a helicopter view of the money flow in the pharmaceutical industry

Catherine Godrecka-Bareau, CFA

1 The pharma business models

2 How to refuel the pipeline

3 Prioritize the best compounds within your ideal portfolio

Catherine Godrecka-Bareau, CFA

Innovator Generic OTC

Catherine Godrecka-Bareau, CFA

Research Development Clinical Trial

• Development • Contract • Clinical Trial • Contract

Catherine Godrecka-Bareau, CFA

Revenue in $ bn LOE Entry of generics

Positive Cash Flows

High risk w/ Proba of success ~5%

Negative Cash Flows

Let’s look at a real life example

Catherine Godrecka-Bareau, CFA

14'000 LIPITOR – WW sales in $m

LOE : Loss Of Exclusivity i.e. patents expire

Source : Evaluate Pharma, http://www.thelancet.com/journals/lancet/article/PIIS0140-6736(11)61858-8/fulltext

 How do you manage LOE events if you are an innovator ?

Catherine Godrecka-Bareau, CFA

• To sustain your sales curve , constantly feed the pipeline

Revenue in $ bn LOE LOE LOE

+1.0 Positive Cash Flows

- 0.5 LOE : Loss Of Exclusivity i.e. patents expire

Negative Cash Flows

Note : curve here is for illustrative purpose only

Catherine Godrecka-Bareau, CFA

• For 6 months, you can charge 80% of the brand price

Low risk w/ PoS ~90%

Negative Cash Flows

Catherine Godrecka-Bareau, CFA

14'000 LIPITOR – WW sales in $m

• Ranbaxy : #1 Indian pharma company,

*LOE : Loss Of Exclusivity i.e. patents expire

Sources : Evaluate Pharma, http://www.thelancet.com/journals/lancet/article/PIIS0140-6736(11)61858-8/fulltext,

Catherine Godrecka-Bareau, CFA

you arrived with 2nd tier entrants

-5 LOE : Loss Of Exclusivity i.e. patents expire

Catherine Godrecka-Bareau, CFA

Example : Ibuprofen market

Different brands Segment patients 360 solution for your problem

by indication, age, drug format

Source pictures : Google

Catherine Godrecka-Bareau, CFA

• OTC is based on direct-to-

Catherine Godrecka-Bareau, CFA

1 The pharma business model

2 How to refuel the pipeline

3 Prioritize the best compounds within your ideal portfolio

Catherine Godrecka-Bareau, CFA

Late stage projects to ensure Early stage projects to secure long-term

Catherine Godrecka-Bareau, CFA

 80% of big pharma pipeline is sourced externally

Catherine Godrecka-Bareau, CFA

Sources : annual reports, Evaluate Pharma