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NEW YORK (Reuters Breakingviews) - Valeant Pharmaceuticals International's failed strategy has a grain of truth at its center. Drugmakers spend over $50 billion a year on research and development, but the payoff keeps declining. Valeant attempted to address the problem by acquiring companies, slashing R&D outlays and jacking up prices to keep the top line growing. But its aggressive approach backfired.
The projected return for the dozen biggest-spending companies - a group that includes Merck, Sanofi and GlaxoSmithKline - has declined to less than 4 percent last year from 10 percent in 2010, according to a report this month by Deloitte. The consultancy compared estimated future cashflows from new drugs with total expenditure on developing and licensing late-stage medicines.
Both numbers are going the wrong way for the industry. The projected peak annual revenue for a typical new drug has declined to under $400 million - less than half what it was in 2010. And the associated development cost has risen by about 30 percent over the same period to $1.5 billion, according to Deloitte.
Rich veins like treatments for cardiovascular and respiratory diseases have largely been worked over. Remaining goldmines are harder to tap, perhaps because many involve less well understood science in areas such as neurology. Eli Lilly's recent failure with an Alzheimer's treatment it spent about $1 billion developing shows the risk. Niche diseases offer easier pickings, but these markets are smaller. Big pharma's growth in earnings per share has slipped to less than 3 percent per annum over the past five years, according to Thomson Reuters Eikon.
Valeant's solution made a certain sense, but it carried the idea to excess. It ended up paying too much for companies with mediocre drugs and its merger conveyor ground to a halt, leaving it teetering under a massive debt load - that's why it's offloading assets, including two roughly $1 billion sales this week.
The company's steep price increases also fueled a backlash. That led to political scrutiny of practices elsewhere, for example Mylan's pricing of its anti-allergic shock EpiPen. The biggest U.S. drug distributer, McKesson, said in October that fewer companies were raising prices and by smaller-than-expected amounts.
That means big drugmakers are losing control of a lever that, used more judiciously, could keep their sales growing. Maybe they need to accept their own shortcomings discovering new drugs and either shrink or build partnerships with smaller firms with more productive labs.