Why externalizing pharma innovation is a winning strategy

To be successful, biopharma companies need to accelerate the transformation to increase reliance on external innovation. 

External innovation is intrinsic to the biopharma business model. Not only do large companies highlight their partnering accomplishments, but many have started experimenting with various external innovation models. These models include the formation of corporate venture capital funds, incubators and “innovation centers” in biotech hubs.

This openness means that companies are spending significant dollars on M&A and alliances. Indeed, from 2014 to 2018, biopharmas spent an average of roughly US$100 billion on M&A annually. In 2019, the value for M&A was even higher, well north of US$250 billion. Where possible, some biopharmas have even expanded beyond traditional deal structures to create option-based alliances and flexible co-development and co-commercialization arrangements with eager partners.

As we noted in the 2020 EY M&A Firepower report, this increased dealmaking activity is at least partly due to biopharma companies’ desire to deepen their therapy area focus and simplify the operational complexity of their business models. Given the current pace of technological and scientific change, one way to create the needed therapeutic depth while also investing in new science (e.g., cell and gene therapy) and digital tools is via the strategic use of deals.

If such capital allocation decisions signal the growing importance of externalization, other data suggests that there is still room for improvement. Based on data from Evaluate Pharma, the industry’s top 20 biopharmas by revenue continue to spend roughly US$100 billion on R&D annually.

Yet our analysis suggests that these same companies are less efficient at delivering new drugs to the market than their smaller counterparts, spending more per approved product. What’s more, since 2014, a larger percentage of these biopharma companies’ revenue has come from therapies that were acquired. These efficiency and value trends are even more pronounced for newer modalities, such as cell and gene therapies, where many big pharma companies missed the initial opportunity to invest organically.

It’s time for large biopharma companies to be honest about how they deliver value to patients and shareholders. They should significantly decrease internal spending on innovation and focus at most on two or three therapeutic areas.

Such prioritization will allow them to do three things:

1. Invest more time and money in strategically aligned external innovation
2. Boost their R&D efficiencies
3. More intelligently tap novel platforms that are the key to future growth

Buying innovation

We aren’t saying companies should eliminate their R&D efforts as part of this externalization strategy. But, companies should make a deliberate, structured review of their internal scientific strengths and limit internal innovation investment to areas where they demonstrate clear market superiority. Future innovation in all other therapy areas should be sourced externally.

In areas where a company lacks that clear market superiority, all existing internal development activities should be spun out, outsourced to partners or even abandoned. In these areas, companies only need to retain the minimum scientific capabilities required to adequately evaluate external assets.

To be successful with this approach, companies must invest more in their business development capabilities. Critical skills include:

• Effective valuation mechanisms
• Leading-class scouting abilities
• Redoubled focus on alliance management and partnering
• A nose for risk analysis
• Smart incentives for scientists so external and internal assets are on equal footing

What’s more, the business development function should be represented at the board level. Such board representation helps ensure that key decisions are made with alacrity. Moreover, it reflects not only business development’s importance to the overall organization and its performance but also the company’s mandate to source innovation wherever it resides.

Innovation in the biopharma industry as measured by new molecular entity approvals increasingly resides within smaller organizations. This is where large biopharma company resources need to be focused: outside the walls of their own labs. The value contribution of acquired pipeline drugs has risen and will continue to rise. We argue that the successful large biopharma companies of the future will be those that accelerate the transformation to increased reliance on external innovation and significantly curtail internal innovation activities.