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Innovation sourcing in biopharma: Four practices to maximize success

May 31, 2022
Mckinsey & Company
By Roerich Bansal, Geetika Bhalla, Jens Bongard, Patrick Flagmeier, Regina Israel Atance, Alberto Loche, and Ozge Ozbek

Biopharmaceutical companies are no strangers to looking outside their own walls for the innovations that will improve future patient healthcare. In 2020, no less than 45 percent of the drugs in the pipelines of the 20 biopharmaceutical companies with the biggest R&D budgets were sourced externally, and in 2021, 66 percent of the entire industry’s pipeline revenues were generated from such drugs.

Externally sourced drugs often have a greater chance of clinical success than those developed internally. Between 2016 and 2020, assets sourced through partnerships at Phase 1 were more than twice as likely to be launched than those developed internally (Exhibit 1). And all five of the biggest recent blockbusters were sourced externally by the companies that launched them.

Exhibit 1

The rate of Americans diagnosed with diabetes isn’t slowing down, and the Covid-19 pandemic only exacerbated the risks and concerns for this debilitating chronic disease.

According to the American Diabetes Association, 1.5 million people will be diagnosed with diabetes this year. So why aren’t more people talking about it? The pandemic may have shifted the collective focus. After all, a nation in health crisis mode can only focus on so many problems at once. Yet hospitalizations and deaths due to diabetes or related complications were right behind the elderly and nursing home residents.

Aside from the pandemic pileup, the disease was not getting the attention it warranted, partly because of how the stigma attached to diabetes impacts our concern, even as it affects more people each year.

Between 1980 and 2014, the number of people with diabetes rose from 108 million to 422 million. “Prevalence has been rising more rapidly in low and middle income countries,” reports the World Health Organization. Diabetes can lead to blindness, kidney failure, heart attacks, stroke, and lower limb amputation.

Why Aren’t More People Talking About This?

“Diabetes is always swept under the rug because, in so many people’s minds, they just associate it with bad health habits and being overweight,” says Deena Fink of New York City. The Long Island native bartends in the West Village in addition to running a small online knitting business.

Most days, her Type 1 Diabetes doesn’t slow her down. It’s a disease she has been living with for sixteen years. “What really has to change is the stigma of diabetes,” Deena explains in an interview with Wealth of Geeks.

She is grateful for her health care plan, despite the roadblocks she often faces to receive her medication. “They have to start actually treating it as a chronic illness.”

Like many others during the first months of the pandemic, Deena was afraid to leave her house. “I didn’t even want to leave the house to go grocery shopping,” she says. The risks are different for someone with a chronic illness. “Just getting a cold, I am knocked out for several days.” She also could not get to a doctor’s office.

“You’re supposed to get your A1C done every quarter,” she explains, but she couldn’t see her doctor for a year and a half. So instead, Deena had to estimate what those numbers would be. The A1C test provides a three-month average of what blood sugar levels should be. It’s how a person with diabetes keeps themselves in range.

Deena faces a monthly battle with the insurance company just to receive her regular dosage of three insulin vials. Without insurance, she would have to pay $175 per vial.

The Global Factor

While lifestyle changes such as maintaining a healthy weight and diet, engaging in physical activity, and not smoking may decrease the health risks associated with diabetes, it does not guarantee that the disease won’t have harmful symptoms over time. Additionally, Covid-19 increases these risks across the globe.

Diabetes was responsible for 6.7 million deaths in 2021, according to the International Diabetes Federation. In addition to the 537 million adults living with diabetes today, an additional 541 million have Impaired Glucose Tolerance, a condition that places them at high risk of Type 2 Diabetes.

And what about the financial side? WHO reports that “diabetes caused at least 966 billion dollars in health expenditure – a 316% increase over the last fifteen years.”

As more people are diagnosed, the opportunity for visibility and change grows. Those with diabetes often become advocates for change.

“Stigma can result when you take an ‘invisible’ condition like diabetes out into the open,” says diabetes advocate Michael Donohoe of Ohio. When he was diagnosed with Type 2 Diabetes, he was also diagnosed with a heart condition. “I try to improve awareness and understanding by being as open about my diabetes as possible. I also advocate loudly for people who are newly diagnosed or severely impacted,” he says.

Covid Collision

Although the elderly and nursing home residents were hit hardest by the virus, people with diabetes were right behind them. This news comes to light as the total number of deaths in the United States nears one million.

“People with poorly controlled diabetes are especially vulnerable to severe illness from Covid, partly because diabetes impairs the immune system but also because those with the disease often struggle with high blood pressure, obesity, and other underlying medical conditions,” reports the New York Times.

Those with diabetes have to keep up with their disease constantly. “It’s a disease that’s a pain,” says Deena, “because you never stop taking care of yourself. Every decision you make for every day of your life will affect your diabetes.”

“It’s so much work,” she says, “but it keeps you alive.”

With diabetes diagnoses soaring across the globe, it is only a matter of time before the world stops hiding from this health crisis and confronts it head-on.

Not surprisingly, then, demand for new assets is fierce. There were 4,650 biopharmaceutical deals in 2021, up some 25 percent before the COVID-19 pandemic in 2019. And the industry attracted a record $47.2 billion of venture capital (VC) in 2021, up more than 80 percent from 2019, while capital raised from IPOs reached $35 billion, roughly triple the 2019 sum.

Against this backdrop, we examined deal activity to identify investment trends. Our research shows that competition is increasingly fierce for assets in four areas: oncology, infectious diseases, platform technologies, and data and analytics. Sixty-five percent of the value of all partnership deals in 2020 were in oncology, for example (for more detail, see sidebar, “Investment hot spots”). And the research reveals shifts in the types of deals struck: more deals are being made for early-stage assets and there are more partnerships—especially R&D partnerships.

We also reviewed the strategies pursued by some of the industry’s best deal makers regarding asset productivity to understand how others might hone their investment strategies and skills. This, combined with our own industry experience, suggests four practices that will help ensure that assets acquired in such a heated deal environment flourish and support the next wave of medical innovation.

Investment trends

Intense investment interest has triggered shifts in the market for pharmaceutical assets.

First and not surprisingly, M&A premiums have risen. The median deal price offered in 2020 by nonfinancial acquirers in the industry was 86 percent above the target’s stock price a month earlier—a record high.

This probably helps explain why there has been a sharp increase in the proportion of funds invested in partnerships at the expense of M&A. In 2010, M&A accounted for 73 percent of total deal value. By 2020 that figure had fallen to 47 percent. At the same time, as the proportion of partnership deals rose, so too did the proportion of partnerships deals made for early-stage assets. In 2020, 58 percent of all partnerships were for assets that had not yet entered the clinic, compared with 45 percent in 2010. Finally, while partnerships have always been a means of sharing the risks associated with unproven assets, today we see evidence of companies seeking to manage those risks still further by lowering up-front payments and linking the remainder to development milestones and royalties. The median up-front payment as a percentage of total deal value ranged between 3.8 and 16.0 percent between 2016 and 2020, depending on the asset stage. That is between 0.5 and 2.3 percentage points lower than between 2010 and 2015 (Exhibit 2).

Exhibit 2

Beating the odds

Ever-increasing competition for innovation assets among biopharmaceutical companies and other players makes it harder to strike successful deals. There is no single right formula, but some companies have a better track record than others.

We reviewed the financial performance of 21 of the world’s biggest biopharmaceutical companies by revenue over the past 15 years and discovered that those with the best financial performance also had the best deal record on certain measures. Of the 21, six companies—two European and four from the United States—enjoyed above-median revenue growth between 2003 and 2017 and then economic profit between 2013 and 2017. On average, those same six companies made deals that were three times more productive than others in the group, measured as average revenues per externally sourced asset over a five-year period. Their deals were 6.5 times more productive when measured as average revenues over a five-year period in relation to the reported deal spend (Exhibit 3).

Exhibit 3

We therefore took a closer look at the investment strategies of these six outperformers to learn what they might be doing to beat the industry odds. This, along with our own experience working alongside companies in the industry, suggests four practices than can help maximize the performance of a biopharmaceutical company’s external innovation portfolio.

Sharpen the focus

Sharp therapeutic focus was a common trait of the outperformers in our analysis. First, they concentrated their on-market assets in fewer therapeutic areas (TAs) (an average of 4.7 compared with 10.7 for others in the group). This could be key to their superior deal record: it is likely that companies can add more value to assets in TAs or platform technologies where they have a track record of expertise and are likely to be more attractive to sellers in the same space as a result.

Another trend pronounced among our outperforming group of companies is a focus toward deals for early-stage assets. A considerably higher proportion of the assets they sourced externally between 2003 and 2007 were in the early research and preclinical phases of development (61 percent compared with 49 percent for others in the group), and they sourced fewer assets that were filed, approved, or marketed (12 percent compared with 29 percent). More recently, the outperformers doubled down on early innovation, sourcing 74 percent of their assets here between 2018 and the beginning of December 2021, compared with 61 percent for others in the group (Exhibit 4).

Exhibit 4

Use data and analytics to spot the next wave of innovation

In the VC and private-equity (PE) industries, value lies in spotting a future innovation hot spot ahead of the pack—a principle that outperformers in the biopharmaceutical industry appear to have applied by investing more in early-stage assets. Scientific expertise, business acumen, and relationships with others in the innovation ecosystem have long been used to identify potential opportunities. Today, however, advanced analytics can deliver additional valuable insights, identifying biochemical pathways, targets, and technologies that are attracting scientific and investor attention before preclinical evidence is generated and, hence, often before they are on the radar of pharmaceutical companies’ networks of academics and innovation partners. Artificial intelligence (AI) deployed on publications and patents data, for example, could steer biopharmaceutical companies toward promising disease targets and modalities and toward those working in the relevant areas, with the aim of staking a position. Companies that use AI to screen and rank investment options in various industries are already emerging, and some forecasters predict AI will soon shape the majority of investment decisions.

Scouting in this manner does not replace traditional ways of nurturing external innovation through academic collaboration and incubators, however. Rather, it augments those approaches by widening the net geographically and beyond traditional biopharmaceutical clusters.

Build expert capability to enable fast but sound decisions

The trend toward sourcing more assets at an early stage of the innovation funnel entails more risk, which is why biopharmaceutical companies well-practiced at sourcing innovation externally build dedicated teams with the right set of capabilities. These include strong scientific due diligence capabilities to rapidly assess the technical validity of the potential target or partner’s pipeline, a regulatory and intellectual property (IP) capability to form a view on these risks, and an early commercial capability to pressure-test future revenues. Critically, given the competition for assets and the need to assess potential deals fast, a team with the right profiles (including scientific subject matter experts) is assembled to work alongside the deal team, with governance structures in place to make sure investment decisions can be made quickly. Working in this way, some companies can make an offer just two to three weeks after identifying a partner or target. And some are working to cut the time gap still further to ensure they do not miss out on a valuable asset.

Take an activist approach to maximizing the value of external partnerships and assets

PE and VC firms put mechanisms in place to support the success of their portfolio companies—an approach we see some biopharmaceutical companies now emulating. These include:

Review rigor and tracking. Portfolio-review meetings should track both internally sourced and externally sourced assets with the same rigor, using the same evaluation processes and metrics—value to patients, level of evidence, the timely completion of trials, and enrollment rates, for example. This ensures a level playing field when making investment decisions and deciding which assets to progress, and also optimizes the productivity of a company’s assets.
Functional and operational support. Some biopharmaceutical companies have replaced the traditional alliance management approach of biannual progress check-ins with a more hands-on approach, providing access to their functional capabilities in medicine development, regulatory affairs, and IP, for example, and deploying operational talent to troubleshoot emerging challenges.
Cross-fertilization. The partnerships biopharmaceutical companies enter into often give them access to enhanced capabilities or technology—genomic/omic or clinical data, for example. Like PE and VC firms, they should consider using this to maximize the value of other assets or companies in the portfolio, though this requires full portfolio transparency and incentives that ensure those managing alliances work to identify such opportunities.

The bar for outperformance in biopharmaceutical deal making is rising. Competition for assets is heating up, and deals are increasingly struck for early-stage assets. Against this backdrop, biopharmaceutical companies may find they need to sharpen their strategies and invest in building the skills and capabilities that will help ensure their investments deliver important new innovations in healthcare. Some of the industry’s best performers show the way.

Read more on Mckinsey & Company

Stay Informed

Innovation sourcing in biopharma: Four practices to maximize success

Why Aren’t More People Talking About This?

The Global Factor

Covid Collision

Investment trends

Beating the odds

Sharpen the focus

Use data and analytics to spot the next wave of innovation

Build expert capability to enable fast but sound decisions

Take an activist approach to maximizing the value of external partnerships and assets

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