From 2012 early stage companies in biotech/pharma have changed business models into a virtual or a semi virtual form. The need for an in-house laboratory, animal testing facility or a mass-spec has gone thereby reducing the need for expensive capital investment on top of the high research and labour costs.
The revolution in the business model has come about with the cost-cutting of the big Pharma companies which has directly led to improvements in the capabilities of Clinical Research Organisations (CRO’s) – be they small or large.
The virtual model means biotechs can contract out every piece of their operations from the earliest stages onwards leading to small nimble companies that can be highly efficient with all their costs. This often leads to early stage companies only having 2-4 employees with the rest being contracted out to CRO’s, Clinical Manufacturing Organisations, Universities and other service providers.
The virtual model is all about efficiency of resources; to maximise the use of the resources of the company and the importance of using them efficiently.
How the biotech business model works
As it costs a considerable amount of time and money to get a new therapy to market, at least 10 years (DiMasi 2016) and according to (DiMasi 2016) it costs close to USD 2.6bn on average to get a therapy to market – that includes both successful and failed therapies. Those costs are much lower when you look at early stage biotech companies which usually are only working with 1-2 specific therapy candidates, asset centric companies.
That still means an early stage pharma company has to spend at least 10 years with no revenues from product sales and has to pay for that journey. The funding to pay for this usually comes from grants, tax incentives, funding from investors (VC, angels, pharma companies, patient organisations, etc), partnerships with pharma companies and lastly acquisitions.
The chance of success is another factor in the development of a new therapy – at the early stages the chance of success is fairly low – about 10.4% (Hay 2014) to 11.83% (DiMasi 2016) chance that a therapy that enters Phase 1 trials will be approved. The type of therapy, type of disease, prevalence of the disease, where in the development cycle the project is as well as other factors all materially affect the chance of success.
As investing in early stage biotech companies is risky and time consuming, there is a need for a high return on investment. This ties into how you value the assets/companies. A common way to do that is with risk-weighted Net Present Value(rNPV), another is to find comparable companies in a similar field and try to find and compare valuations and yet another is to avoid the valuation until there is more progress or certainty in what is being valued by using Convertible bonds or Advanced Subscription Agreements. rNPV is an interesting approach to look at which can give context to the development costs and requirement of return. Hundred dollar spent today is worth 25 dollars in 10 years time at a 15% interest rate/required return. Then the 11% chance of success it takes it down to 2.75 dollars. To rephrase, every 2.75 dollars spent today require 100 dollars of revenue 10 years from now if the required return is 15%.
To get to a possible revenue model for a therapy there are three major factors, disease prevalence, market share and price of therapy. The prevalence has to do with the number of patients you can treat at a given time, how big is your market of patients. As for market share you have to be able to roughly assess how many of the potential patients you can serve, there are different assumptions based on whether your a first entrant to a market, second or third and so on and what your expected market share will be. The price is the average annual price – it will vary from country to country, area by area but for simplicity assume one price.
It is best to look at the costs to get to market in three stages. Preclinical is the earliest development and happens before a therapy is allowed to be tested on humans – it ends with safety trials in animals before an IND (Investigational New Drug) application is made to the relevant authorities. Clinical Trial costs are the costs surrounding testing the therapy in humans. That can take a number of years and is very costly. Then there are expenses surrounding registration of a therapy, a New Drug Application, the important paper pushing.
Assuming all the trials are a success there are a number of costs that fall on a company post approval, sales, marketing, patient outreach, Phase IV trials, manufacturing and so on.
In the semi-virtual model, usually where a company is working towards becoming a larger and established player with its own pipeline of therapies there is a case for adding internal capabilities but with a very strategic approach to which capabilities are internal, which are external and at what stage new internal capabilities need to be added and bolstered.
Each project & each company is of course different and there is no one approach to setting up a new company that fits all situations, but this should be a helpful tool to understand the basic points to think about.