policy - ct 6

Working Paper No. 2013/11

Advancing Pharmaceutical R&D on Neglected Diseases: Valuing Push and Pull Economic Incentive Mechanisms Rutger Daems, PhD¹, Edith Maes, DBA², Guy Nuyts, PhD³

26 April 2013

© The authors, 2013

¹ Planet Strategy Group, Brussels, Belgium. ² Maastricht School of Management, The Netherlands. 3 Janssen, Pharmaceutical Companies of Johnson & Johnson.

Corresponding Author: Dr. Edith Maes; E-mail address: [email protected]

The Maastricht School of Management is a leading provider of management

education with worldwide presence. Our mission is to enhance the management

capacity of professionals and organizations in and for emerging economies and

developing countries with the objective to substantially contribute to the

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The views expressed in this publication are those of the author(s). Publication does not imply

endorsement by the School or its sponsors, of any of the views expressed.

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ACKNOWLEDGMENTS

This study has been supported by Janssen, a Johnson & Johnson company. The authors were free in study design, collection, analysis, and interpretation of data, as well as writing and submitting the article for publication. The views expressed in this publication are those of the authors. Publication does not imply endorsement by the publisher or the study sponsors, of any of the views expressed.

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TABLE OF CONTENT

ABSTRACT

INTRODUCTION

NEGLECTED DISEASES AND INNOVATION

Addressing ‘Neglected Diseases’

Fostering Product Development

PUSH AND PULL INCENTIVE MECHANISMS

‘Push’ Incentive Mechanisms

‘Pull’ Incentive Mechanisms

AN ‘INVESTMENT-RISK-INCENTIVE’ MODEL

Corporate Strategy Options

Risk-Adjusted Present Value

SIZE AND SCOPE OF INCENTIVES REQUIRED

Poverty-Related Diseases

Other Neglected Diseases

CONCLUSION

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ABSTRACT

This paper describes an innovation framework that fosters public-private partnership as a

means to overcoming the barriers of developing medicines to combat neglected diseases.

We define neglected diseases as those therapeutic areas for which a great unmet need

exists but for which market demand is lacking so that innovation-driven companies cannot

recoup their investments in product research, development and large-scale manufacturing.

Tropical infectious diseases like malaria represent an enormous burden of illness but are

poverty related because the majority of people affected by them live in poor resource

settings making affordability the main issue. On the other hand, rare diseases in advanced

economies like cystic fibrosis affect few people so the volume-related demand is low despite

the fixed cost of R&D. In addition, problems with access to medicines against widespread

diseases persist due to a lack of awareness and financial constraints within the health care

system resulting in under diagnosis which in turn leads to slow adoption and drug utilization.

The common thread running through this disease category is that pharmaceutical companies

cannot on their own address the specific challenges posed by neglected diseases. This paper

provides insight into how a number of push and pull incentive systems that foster innovation

may overcome the problem, and how the related corporate strategy and public policy can be

aligned.

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INTRODUCTION

Pharmaceutical R&D is known as a long-term, risky and expensive business venture and this

despite all of the modern tools that nowadays are available and the progress made in

biological, chemical and physical sciences and technology. It usually takes between 7 and 20

years to develop and produce a novel therapeutic or preventive medicine, and this endeavor

may cost over $1 billion in capital outlay. Fundamental research in biomedical sciences

leading to the discovery of new mechanisms at the cellular and molecular level require the

use of increasingly more sophisticated and expensive tools like genetic mapping, molecular

biology and engineering, nanotechnology and proteomics. Developing a chemical or

biological pharmaceutical ‘lead’ compound to the point of scientific ‘proof of concept’ – that

is, proving that the compound under investigation has the intrinsic ability to cure, or if it is a

vaccine to stimulate protection from a target disease or condition – remains a high risk

proposition.

Beyond the discovery phase, clinical testing in humans frequently by means of multi-country

and multi-population clinical trials, represents the single largest incremental cost in bringing

new medicines to markets in the industrialized and developing world. The clinical testing

programs constitute a high risk because their ‘sunk costs’ are not flexible or recoupable. Not

surprisingly, these clinical trial phases in humans (Phases I, II, III) are often ‘go/no go’

decision points for research-based companies, and is often a pivotal hurdle in a firm’s

resource allocation and multi-pronged decision-making with regard to capital budgeting.

Building up manufacturing capacity takes time, and occurs only when manufacturers

perceive relatively low risk. Due to the complexity and size of the enterprise, pharmaceutical

and biological manufacturing facilities require investment early in the process.

Consequently, manufactures must allocate funds years before a new compound is projected

to enter the market, and before data are available that demonstrate the effectiveness of the

new product. In other words, producers often must make investment decisions before major

considerations like for instance a new product’s potential market are assured, or even

before its clinical efficacy and safety has been established to a level sufficiently high for

marketing licensure. Besides, once a pharmaceutical or biological manufacturing facility is

built, its capacity becomes relatively fixed. It is difficult to quickly scale-up and expand

production of an existing medicine, and even more difficult to totally change the focus of a

facility, as changes to the process must be validated and are subject to rigorous approval

from regulatory authorities.

Against this backdrop, decisions to invest in pharmaceutical R&D and the scaling-up of the

production are relatively complex and monitored through a variety of managerial

considerations. Besides the scientific risk inherent to the development of a new medicine,

market considerations play an important part in each phase of the ‘stage-and-gate’ process

during which candidate products move from discovery over testing, licensing, production,

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distribution to delivery. Private-sector firms, whether they are multinational corporations

(MNCs) or small and medium-sized biotechnology companies, are likely to invest substantial

funds only when they are confident that a market will exist for a future product. Acemoglu

and Lin (2004) found innovation indeed to be responsive to expected market size. In the case

of neglected diseases, however, this criterion is not satisfactorily resolved.

This paper proposes a conceptual framework that is based on collaboration between a

number of key stakeholders, i.e. enterprises, governments and non-governmental

organizations (NGOs) in order to advance pharmaceutical R&D in the field of neglected

diseases. We will endeavor to gain insight into the ‘risk-investment-incentive’ relationship

and will specifically focus on the association between a number of risk factors (i.e. technical,

market and financial), and the managerial decision to investment (or not) in the discovery,

development and production of medicines that hold great social potential. The goal is to

integrate in the investment-risk equation the influence that some external incentive systems

are likely to have on a pharmaceutical firm’s decision to invest in such neglected disease

category.

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NEGLECTED DISEASES AND INNOVATION

Addressing ‘Neglected Diseases’

Faced with increasing research and development costs exacerbated by pressures on pricing

and reimbursement in every country in the world, pharmaceutical and biotech companies

must make difficult choices regarding which products in their pipeline to pursue with the

limited resources they are able to mobilize. Given the high risk of failure and long

development timelines companies feel compelled to focus on products that are likely to

generate substantial market demand and generate a relatively high return on capital

invested which increases the ability to attract venture capital. While the patent system

enables innovation-driven companies to recoup their investment by granting a limited

period of exclusive marketing rights, intellectual property protection by itself does not

trigger investment.

The net present value method (NPV) is considered to be the standard tool in capital

budgeting appraisals. A project is defined as having a positive NPV if the present value of

cash inflows (by means of future sales) exceeds the present value of the cash outflows

(product development costs). The NPV decision rule commends investment if the expected

net present value of the project is substantially greater than zero. The result of this valuation

process turns out positive for the majority of pharmaceuticals that can demonstrate their

added value from a clinical and socio-economic viewpoint. In contrast, profit-maximizing

firms that cannot fully appropriate these returns from R&D will invest less than the social

optimum (Arrow, 1963). This is why some therapeutic areas have been termed ‘neglected

diseases’. Although the social return in this disease category is likely to exceed the business

return, they are not actively pursued to the extent they should and this despite their added

value profile. This warrants government intervention and a number of conceivable solutions

have been proposed.

There is consensus among the majority of key stakeholders affirming that if the availability of

medicines for neglected diseases ought to be expanded, a number of ‘push-pull’ incentive

mechanisms that are able to engage pharmaceutical firms in the development of these

medicines must be identified and implemented. Nevertheless, controversy exists over

whether a ‘push’ or ‘pull’ system should be used, and what their likely impact would be as

standalone measure or acting in combination on the private sector decision to investment in

these projects. The objective of these incentive mechanisms is to lower the overall cost of

innovation by either directly subsidizing research activities (‘push’), or by creating an

economically viable market (‘pull’). This will positively influence the expected NPV outcome

of the project. We will examine the advantages and drawbacks of each method and besides

a qualitative assessment of the merits, the quantitative impact of these mechanisms on the

investment equation will be investigated leading to recommendations for what system best

to focus on.

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Fostering Product Development

To design and implement the right incentives both in terms of quality and quantity we

believe it is important to assess their impact against the backdrop of the pharmaceutical

R&D process. A detailed description of this research, development and launch process is

beyond the scope of this paper but can be found elsewhere (Paul et al., 2010). For our

purpose, it is important to acknowledge that the following three stages and clusters of

activity are essential in the design: Scientific Discovery, Product Development and Market

Access (figure 1).

Figure 1: Targeted Incentives to Accelerate Pharmaceutical Product Development

Scientific Discovery

The innovation process underpinning the development of medicines can be described as

follows. At the start, governments of industrialized countries invest in ‘pure’ or ‘basic’

research in life sciences and other relevant areas, producing data which can be considered a

public good and (in many cases) made accessible to other parties anywhere in the world.

There is a benefit to having a significant proportion of public research being carried out by

universities, independent research institutions and publicly-funded organizations. In this

essentially open innovation paradigm, research is not explicitly focused on new product

discovery. What these scientists produce is not a new medicine, nor necessarily a substance

that might become a drug. Rather, from their observations of biology, they generate ideas

and hypotheses about the biochemistry of disease states, which may offer inspiration for

drug discovery. A good example is the U.S. National Institute of Health (NIH) that

collaborates with research-based pharmaceutical companies to ‘push forward’ the discovery

of new medicines.

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Product Development

This represents the bulk of industrial activity and investment. The private sector comprised

of national and transnational companies is also undertaking basic biomedical research while

being able to access the pool of public research in search of new ideas and biomedical

pathways from which to make proprietary goods. In this market-driven framework,

companies are primarily responsible for the process of developing, testing, producing and

launching new products on the market. This process is the most expensive, time-consuming

and requires highly-educated labor. By virtue of the critical resources, know-how, skills and

capacity needed, R&D-based private sector companies are major contributors and few if any

other organization is able to effectively support and manage the pharmaceutical value chain

from early development, manufacturing, testing and market approval, up to distribution and

delivery.

Market Access

The private sector’s business model is market-driven and performance-based as it rewards

results only after they have been obtained. The industry’s R&D efforts are financed from

sales across many markets. As a result, it does not make sense to develop products if the

likelihood is high that they will not be bought or utilized. In the face of rising health care

costs, payers (including insurers, pharmacy benefits managers and government agencies)

exert great influence over pharmaceutical markets and demand insight into a drug’s cost

effectiveness compared with alternative drugs and generics. In other words, for

pharmaceutical companies it is no longer sufficient to just make and sell innovative drugs.

They also have to convince government and third party payers how well their drugs work,

for whom and at an acceptable cost. In the case of neglected diseases the latter part of this

paradigm is challenged despite the fact that treatment or prevention of neglected diseases

represents an important social value. The investment amounts to $1.8 Billion on average

(Paul et al, 2007). Can this cost be recouped? If market demand is small or moderate the

return is low unless prices are set high, possibly beyond reach of populations that are meant

to be the beneficiaries.

Poverty Related Diseases

Neglected tropical diseases (NTDs) like malaria 1 , tuberculosis

2 and dengue, chagas disease

and leishmaniasis constitute a large fraction of the world’s disease burden, yet they receive

only a small fraction of global R&D spending. This occurs because private and public

purchasers in the developing world have limited ability to pay for treatments, and

government and donor financial support for neglected diseases is limited. While the amount

1 Malaria infects 300-500 million people per year the majority of which reside in poor countries; mainly sub-

Saharan Africa. The mortality is highest among newborns and children. However, there is no malaria vaccine available. 2 Two billion people are infected with the tuberculosis pathogen. A worrisome phenomenon is the

development of drug-resistant strains of the bacterium (MDR-TB). About 500 000 MDR-TB cases emerge every year and this is due to doctors giving inappropriate treatment, or patients missing doses or failing to complete their treatment.

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spent on NTD R&D has increased over the past decade and has involved new actors, existing

funding mechanisms and other government and public policies aimed at stimulating private-

sector involvement do not provide sufficient incentive to overcome the scientific and

commercial risks that companies face in considering whether to invest in R&D for a drug or

vaccine aimed primarily at resolving problems in low-income countries. It is difficult for

companies to forecast demand or project prices in these markets because of uncertainty

about subsidies from donor organizations in support of purchase by the poorest countries.

‘Orphan’ Rare Diseases

Orphan drugs for rare diseases affect small numbers of patients, the majority residing in

high-income countries (e.g. cystic fibrosis patients). As a result - due to the low volume of

doses sold - the cost per dose would be prohibitively high and if lowered would not be high

enough to recoup the R&D investment. In an attempt to remedy this situation, the United

States Orphan Drug Act (ODA) of 1983 and subsequent Japanese (1993) and European

(2003) orphan drug policies have addressed the problem through a combination of

government-sponsored push and pull mechanisms. This includes push systems like tax

credits for up to half of the clinical testing expenses in combination with an attractive pull

scheme, i.e. seven years of market exclusivity on Food and Drug Administration (FDA)

approval.

Under Diagnosed Diseases

There are diseases that affect people in industrialized countries but that are underdiagnosed

and underreported, such as hepatitis C. Two decades of basic and applied science led to the

licensing of novel drugs against viral hepatitis c infection (HCV) 3 . Those are expected to offer

significant advantages over current therapy. With a higher level of cure rates and

convenience, it is probable that nearly all identified patients will be offered therapy and that

acceptance among those affected will be higher. Estimates suggest that currently only 10%

to 20% of patients known to be infected with HCV accept therapy and complete a full

therapeutic course. Despite this improvement in therapy, the most burning question will

not be whether to treat these individuals but rather how to identify the many chronic HCV

‘carriers’ who are often unaware of their infection and are at risk of cirrhosis, end-stage liver

disease, or hepatocellular carcinoma (Perz et al., 2006). This access issue could be resolved

by sponsoring programs that enhance the detection rate. This would advance the social and

business return. However, these programs are not yet functional and health care budgets

need to be allocated. This may necessitate finding alternative ways of social funding as we

will discuss.

3 According to the World Health Organization (WHO) about 170 million people are infected with hepatitis C.

The disease is prevalent in high, middle, and low--income countries.

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PUSH AND PULL INCENTIVE MECHANISMS

‘Push’ Incentive Mechanisms

In this section, we review the effectiveness of a number of ‘push’ or supply-side mechanisms

to encourage innovation in the area of neglected diseases and the issues to overcome if

implemented.

Push incentive programs consist of public subsidies in support of pharmaceutical R&D on

neglected diseases. The rationale for such subsidies is to provide financing to cover the large

upfront cost that any developer of these types of new products would face, so that prices

can be set much nearer to the marginal cost of pharmaceutical production without

discouraging commitments of funds to R&D. In other words, the ‘static’ urge for immediate,

widespread access to medicines goes hand in hand with the dynamics of innovation.

Historically, the public sector has invested substantially in push mechanisms, particularly

basic biomedical research and some early product development. An important benefit of

push mechanisms is the familiarity and proven track record of this type of publicly-funded

intervention. The down side is that push mechanisms necessitate picking early on one

prototype, or candidate product, over another. This entails sponsoring R&D of a particular

innovator or company. Moreover, recipients of the subsidy may have an inadequate

incentive to use these funds efficiently. The reward is granted before results have been

obtained.

Tax Credits and Direct Funding

Studies in the literature have estimated the effects of public policies aimed at reducing the

costs of R&D. Most of these studies found that pharmaceutical firms significantly increase

R&D expenditures and innovation in response to such policies. McCutchen (1993) studied

the impact of R&D tax credits on pharmaceutical expenditures. The evidence indicates that a

positive and statistically significant change occurred in R&D spending in the pharmaceutical

industry after the tax credit went into effect. Unfortunately, in the case of neglected

diseases that are poverty-related, any tax credit on sales has little impact because of the low

commercial value.

Direct funding as a push option entails providing money to directly finance or help

implement activities related to a well-defined product or a variety of projects in a neglected

therapeutic area. Despite the fact that this can be a powerful mechanism, direct sponsoring

risks alternating the incentive mechanism in a way that may work against the objectives of

timeliness and efficiency. If the recipient company or innovator knows that all of the costs

associated with product development are funded a priori, the incentive to work quickly and

in the most cost-efficient manner is reduced. Moreover, the fact that sponsors elect to fund

one or two specific products or companies changes the competitive landscape in a way that

discourages competition. Due to asymmetric information where the innovator knows far

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more about the chances of success than the sponsor, this increases the risk of ‘picking the

wrong horse.’

Orphan Drug Legislation Extension

As cited, the orphan drug act (ODA) has been designed to predominantly stimulate

innovation in rare disease drugs. To that end, ODA uses a combination of push-pull

incentives: an income tax credit equal to 50% of clinical trial expenses, and a 7-year market

exclusivity provision. The tax credit aims to lower the cost of conducting human clinical trials

which account for approximately two-thirds of total expenditures in pharmaceutical product

development. Because of its success, the ODA has often been discussed as a model for how

public policy can be designed to stimulate R&D in other health markets where technologies

generate small private returns and where the related investment is upfront, high, and

uncertain.

Extension of the ODA concept to include poverty-related neglected diseases would not be

sufficient though. Reportedly, the FDA has characterized the ‘pull’ part of the ODA incentive

mechanism as the most sought-after incentive (Lakdawalla et al., 2012). Unfortunately,

however, the ‘market exclusivity clause’ which constitutes the pull part of the ODA incentive

system is not viable in the case of neglected diseases that intrinsically have little commercial

value.

Product Development Partnerships

A number of public-private partnerships (PPP) have been set up aimed at reducing the risk

and alleviate the cost of pharmaceutical R&D. Different forms of PPP are being tested either

with a focus on fundamental research or the development of compounds across all stages of

the process.

A good example of non-rivalry collaboration where knowledge is treated as a public good

but does not impede the development of propriety goods at a later stage is the recently

established ‘European Lead Factory’ under the auspices of the EU Innovative Medicines

Initiative (IMI) 4 . The pharmaceutical companies involved in this new project have committed

to putting at least 300,000 chemical compounds from their corporate libraries into the Joint

European Compound Collection. The teams of universities and small and medium-sized

enterprises taking part are expected to add another 200,000 compounds to the Collection.

The proposed European Screening Centre will build on industry’s existing expertise in high-

throughput screening, whereby robots test hundreds of thousands of unique chemicals for

biological activity. Overall, the European Lead Factory will “provide to public partners an

‘industry-like’ discovery platform to translate cutting-edge academic research into high-

quality candidate drug molecules on a scale and speed that was not possible previously”

(IMI, 2013).

4 http://www.imi.europa.eu/content/european-lead-factory

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Public-private development partnerships (PDP) have also been set up specifically designed to

support work on poverty-related neglected diseases. They are funded by grants from the

public-sector and philanthropic sources. Examples of such PDPs include the Medicines for

Malaria Venture (MMV), the Global Alliance for TB Drug Development, the International

AIDS Vaccine Initiative (IAVI), the Aeras Global TB Vaccine Foundation, and the Institute for

One World Health (iOWH). Typically, these PDPs collaborate with MNCs and smaller biotech

companies, subsidizing the R&D costs in return for commitments to make the resulting drugs

or vaccines affordable in developing countries. It is unclear whether the benefits of this type

of organizational structure and funding mechanism exceed those aimed at incentivizing

R&D-based corporations directly based on performance. The latter would leave the initiative

with the innovator who can decide to go it alone or in partnership. This approach will be

further discussed in the section on pull systems.

In general, the drawback of so-called push funding is that external funders (governments and

foundations) pay for inputs (research projects, clinical trials, etc.), rather than outputs (i.e.

tangible drugs and vaccines). Therefore, they may ultimately fund R&D activities that will not

be successful. Faced with the challenge of picking ‘winners’ upfront, donors rely on expert

peer-review panels (which have been criticized for review bias as well) and specialized

intermediaries such as PDPs to guide their investment decisions. But the inherent handicap

of asymmetric information is only partially taken away by the PDP organization. There is a

tendency for these organizations to concentrate on lobbying for the next funding round. In

our opinion, this bias does not exist with pull incentive mechanisms, and are therefore

preferred.

‘Pull’ Incentive Mechanisms

While ‘push’ mechanisms subsidize research inputs, ‘pull’ mechanisms reward research and

development outputs. In contrast to push mechanisms which pay for R&D up front, pull

mechanisms offer the prospect of a financial reward once the product has been developed

and thus encourage private investment in R&D. In short, pull funding is contingent on

success while push funding reduces the cost or risk to the product developer but is not

contingent on success.

Pull mechanisms include prizes, purchase commitments, market exclusivity rights, patent

exclusively rights transferrable to other products, and priority review vouchers to speed up

marketing approval. The latter is issued by regulatory authorities to reward companies for

their efforts on poverty-related neglected diseases by alternatively granting them a priority

marketing authorization review for another more profitable product of their choosing

(Towse et al., 2012).

Whereas revenue-side policies such as prizes and purchase commitments have several key

benefits (for instance, they directly impact the firm’s revenue margins), they suffer from

time-inconsistency. Dominant purchasers of drugs or vaccines such as governments or aid

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agencies may renege on prize or purchase price commitments once the product has been

developed.

The following analysis critically reviews the origins and effects of four important ways to

stimulate pharmaceutical R&D of neglected diseases by using a number of pull incentive

mechanisms.

Advance Market/Purchase Commitment

An example of a successful ‘pull’ mechanism is the existence of specialized development aid

organizations like The GAVI Alliance (vaccines), The Global Fund to Fight AIDS, Tuberculosis

and Malaria, and the TB Alliances Green Light Committee that use public tender processes

and also effectively support the delivery of medicines in developing countries. However, the

associated pull effect is not always strong enough to stimulate the development of new and

innovative products. Due to dealing with markets with limited or no buying power, a

supplementary incentive system must be mobilized. The Advance Market Commitment

(AMC) is a special purpose finance system designed to stimulate pharmaceutical R&D that

primarily benefits developing countries.

Advance purchase commitments like the AMC represent ex ante commitments by national

governments, international organizations or private foundations to purchase, on behalf of

developing countries, a certain quantity of a drug or vaccine that has yet to be invented at a

predetermined price (Berndt et al., 2007). Under an AMC contract, public and private

sponsors of high-income countries make a legally binding commitment to pay a ‘premium’

price for up to a specified number of doses of the newly developed medicine, provided that

the developing countries commit to using the product and gradually increase their co-pay

over the years. If the disease is exclusively or predominantly prevalent in the developing

world, the subsidy should aim to cover the risk-adjusted costs of the entire project. And so,

the size of the subsidy should vary depending on the disease prevalence.

From a pharmaceutical company’s perspective, the most important feature of the AMC

system is the creation of a market. In contrast to push mechanisms, AMC rewards successful

research output rather than research input and it safeguards a level playing field among

candidate innovators. Sponsors only pay for results and the technical risks remain with the

contenders. The AMC is consequently less vulnerable to moral hazard problems than push

programs. Nonetheless, innovators remain in a position of economic dependence because

they will have made large investments during a protracted period of more than a decade.

Meanwhile, the political environment may have changed. Sponsors have incentives to

renege on their promise ex post when the R&D investment is sunk, to obtain the product at

the lowest possible price. To prevent such a hold-up situation, an explicit long-term

commitment with clear, judicially enforceable rules is of crucial importance. One way to

address this is the establishment of an adjudication committee independent from the

sponsor or buyer. At the moment the AMC subsidy expires companies are required to

continue supplying at vastly reduced prices. A ‘tail price’ can be agreed when the AMC is

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signed. Alternatively, it can be left to competitive forces when eventually generics come to

market.

Priority Review Voucher

With a PRV system the holder is entitled to an expedited regulatory review of another

product with possibly major market potential, allowing the holder to bring this lucrative

product to market considerably earlier than under normal marketing authorization

procedures.

There has been much debate about the precise value of the Priority Review Voucher (PRV)

after the concept was published (Ridley, Grabowski, Moe, 2006). Having a drug approved

about 6 months earlier by the US FDA regulatory authority initially has been estimated to

represent on average US$300 million. Subsequent publications (Ridley, Sánchez, 2010;

Dimitri, 2010; Noor, 2009) weakened that position and eventually an estimate was agreed

upon in the range of US$50-300 million. The PRV value has been determined by three

factors: i) Shifting sales earlier by accelerating the approval process (of a lucrative product in

the company’s portfolio); ii) Having a longer effective patent life due to earlier entry (and

hence extra time gained over competitors); iii) Competitive benefits from earlier entry vis-à-

vis rivals (leading to increased market share and offering the opportunity to establish brand

loyalty).

However, the resulting value remains hard to predict and may be equivocal. Much depends

on the other products that a firm contemplating developing products for the developing

world has in its portfolio and that would have ‘blockbuster’ potential in affluent countries.

Consequently, the value of the priority review voucher as a reward for R&D work done in

poverty-related disease areas not only depends on the ability of the regulatory authority to

successfully carry out an expedited review that significantly shortens market approval; it also

varies with the breadth, composition and level of diversification of the company’s R&D

pipeline (although a start-up biotech company can always sell its voucher to a third party e.g.

a MNC).

Medical Prizes and Innovation Fund

Prizes for major innovations that are paid as a lump sum to innovators are notorious for

being undervalued (far more than being overvalued) by those who raise the funds and have

to justify to the public payment of these sums because they represents taxpayers’ money.

Historically, awards granted were miserly; they certainly were not what Schumpeter had in

mind in describing “spectacular prizes…thrown to a small minority of winners” (Schumpeter,

1942). However, one could argue that a modest voluntary prize may be useful as an

incentive to solve well-defined issues at certain stages of the pharmaceutical research and

development process. In other words, resolving technological issues that are common and of

interest to all researchers (e.g. biomarkers that function as surrogate endpoints in efficacy

trials). On the whole, the prize model would not be an effective replacement for the current

pharmaceutical R&D process. The fact that the innovator is being separated from the

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ultimate user of the product puts prize systems in a category diametrically opposed to open

innovation systems where internal and external stakeholders play a pivotal role in the design

of innovations.

Nonetheless, Love and Hubbard (2007) have proposed a “radical rethinking” in the field of

pharmaceutical innovation policy, suggesting a mandatory prize mechanism as an alternative

to the ‘marketing monopolies’ constituted by patents. The idea of this ‘Medical Innovation

Prize Fund’ is to ‘divorce the incentive for innovation from the product’s price to consumers’

so that ‘knowledge goods, including the R&D for a new medicine, can be placed in the public

domain immediately’. Underlying this proposal is the idea that the cost of R&D can be ‘de-

linked’ from the price of the product (Müller-Langer, 2009). The company would receive the

prize in a single payment, reimbursing it for any costs incurred; leaving generic companies

free to manufacture from the day the product is approved. In the same way, Banerjee, Hollis

and Pogge (2010) promote a voluntary prize fund named the ‘Health Impact Fund’, which is

designed as a supplement to the existing system of patent protection. The prize fund would

again be used as the ‘draw’ for innovation.

Health System and Demand Security

Given the unique complexities of pharmaceutical development, manufacturing and

regulatory oversight, supplying products takes significant time and investment to come on

stream. Manufacturers therefore hugely benefit from predictable demand scenarios and

mitigating demand risk through adequate forecasting. However, in many of the developing

countries and a number of the emerging economies, health care systems are weak and

underdeveloped. There is a need for strengthening the health care infrastructure and

building capacity in management and policy making through professional training and

education. Evidence-based policies need to be developed and the public better informed.

The industry is called upon to expand its thinking beyond product-focused, pharmaceutical

development and get actively involved in addressing the need for an integrated approach to

patient care. This would include the use of tools, software and services to help monitor a

patient's progress (Narayan, 2013). Treatment plans that leverage combined benefits of a

pharmaceutical product with devices and programs that support medication adherence and

access to treatment and services may indeed be the shift needed to keep pace with today’s

disease management challenges. This may become an important future pathway at times

where most illnesses require chronic treatment.

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AN INVESTMENT-RISK-INCENTIVE MODEL

Corporate Strategy Options

Since pull mechanisms pay for outputs rather than inputs, they do avoid the difficulty of

picking winners. However, they introduce another problem: how to set the financial reward

at the right level? For rare diseases that are prevalent in high-income countries the reward

provided by the ODA incentive seems to have attracted a sufficiently high number of product

developers. On the other hand, attaining the right balance is of great concern in developing

products for poverty-related diseases. At a minimum, the reward must be sufficient to cover

the R&D costs incurred by product developers; at the most expansive, it would also provide

a rate of return comparable to what the developer would earn from alternative uses of its

investment capital (Hecht et al., 2009; Daems, 2008). If the reward is too small, product

developers will not be motivated to invest in this type of R&D; if it is too large, however,

funders will have ‘overpaid’, losing taxpayer or foundation money that could have been used

for other purposes.

The majority of multinational corporations have publicly stated that they do not per se seek

financial gains by developing medicines in disease areas that predominantly affect

developing countries, but they do not want to lose money either given the high costs and

risks involved in pharmaceutical R&D. We therefore assume that of the three strategic

options in figure 2, the zero-based return-on-investment (ROI) can be taken as one of the

benchmarks for calculating the ROI. However, this represents the lower limit especially if the

objective is to attract small and mid-size biotech companies with limited means to invest in

such ventures.

April 2013 Page 17

Figure 2: Poverty-related Neglected Diseases and Corporate Investment Options

Risk-Adjusted Present Value

To compute the amount of external push or pull R&D funding that is needed in the pursuit of

poverty-related neglected diseases; the lower threshold can be found based on the ‘not-for-

profit’ approach cited earlier. As a result, the pivotal point in investment decision-making

(‘go/no-go’) hinges on the outcome of the zero-based ROI equation, that is, the risk-adjusted

return on cash flows. As a rule of thumb, the expected net present value (NPV) should be

well above zero for a go ahead to be given although intangible factors may play an important

role as well.

We have used simulation modeling that enables executives and public policymakers to

compare a number of strategies at a world-wide scale with their respective risk factors and

investment outcomes under uncertainty. The analytical instrument estimates the likely

revenues and costs. To gain further insight into the dynamics of the interaction between the

variables underpinning the model, we have examined the dimensions of the risk factors

separately (i.e. technical, market and financial risk variables). Although these variables are

considered to be independent, in combination they have the capability to predict a firm’s

decision to invest (or alternatively not to invest) in a particular project. The dependent and

independent variables with their respective risk factors are summarized in figure 3.

April 2013 Page 18

Figure 3: Project Expected Net Present Value and Risk Factors

The model is based on modern capital budgeting techniques for technology-driven project

investment. In principle, a number of analytical methods are available in the literature of

which the Internal Rate of Return (IRR), net present value (NPV) and Real Options valuation

method are well known. All methods are valid but some require more expertise (Smart,

2004). The NPV, and in particular the risk-adjusted NPV, is most frequently used and

software programs based on decision tree analysis are available. Projects are defined as

having a positive net present value (NPV) if the present value of future cash inflows (i.e.

expected income) exceeds the present value of the cash outflows (i.e. the investment). This

rule generally leads to good investment decisions. The hurdle rate - sometimes called

discount rate - to calculate the net present values in the NPV equation represents the

opportunity cost, or the highest rate of return that investors can obtain in the marketplace

on an investment with risk equal to the risk of the specific project. For the pharmaceutical

industry this has been set at 11% although individual firms may differ (Myers et al., 1995).

Sensitivity analysis is recommended to see whether the decision to invest or not holds under

different scenarios.

The probability distribution of the parameters in the NPV can be determined by means of

internal and/or external expert estimates for each cost and technical probability of success

(followed by Delphi consensus). With regard to building the sales forecast, there is no

evidence that leads to the suggestion that the market penetration of a new product follows

the Normal or Gaussian, or any other statistical distribution. Hence, it is suggested to apply

triangular distribution analysis which means that three scenarios of market uptake (i.e.

optimistic, pessimistic, and most likely) must be defined for each forecast year. These yearly

April 2013 Page 19

estimates are then written as triangular distributions and entered into a spreadsheet by

means of advanced software programs (e.g. Risk TM and Crystal Ball TM). This stochastic

simulation process, called the ‘Monte Carlo’ process is acknowledged as being a valid

quantitative method for risk analysis. The result of the above process is a distribution of

NPVs. The range of future returns for a particular project is plotted on a graph. This

distribution of NPVs is an indicator of investment risk. The wider the spread, the higher the

risk.

SIZE AND SCOPE OF INCENTIVES REQUIRED

Poverty-Related Diseases

A model has been developed that allows determining the minimum required return on

investment (ROI) to engage in R&D on poverty-related neglected diseases. Failing to achieve

the minimum threshold level using a risk-adjusted ‘zero-sum’ calculation applied to a specific

compound is likely to lead to a decision not to invest. Through the application of value-based

pricing in private market segments, and through external donor funding in public markets of

primarily poor countries, total revenues can be lifted above the required minimum threshold

level. The tipping point in favor of investing is positively influenced by the social

responsibility/ goodwill factor. The model can be used to measure the impact of push as well

as pull systems which can be seen as communicating vessels. If one incentive goes up, the

other could be reduced so that together they fulfill the threshold condition. This may not

always be true as push funding lends itself to support the early-stages while pull is aimed at

later stages.

We argue that in particular the Advance Market Commitment (AMC) and the Priority Review

Voucher (PRV) schemes constitute market-driven incentives and because of their advantages

to the various stakeholders are to be preferred to reward private-sector developers of new

medicines for neglected diseases. These pull incentive schemes can also be used to

incentivize other organizations that are committed to the development of these products.

The size of the AMC fund required depends on the global disease burden. If prevalent in rich

and poor countries, a system of tiered pricing can be applied where the joint costs of

research and development are largely paid for by the industrialized countries. In the case of

a characteristic tropical disease like malaria, the investment will have to be regained by

means of developing country markets, and consequently a larger fund would need to be

created.

The first AMC pilot has been launched in 2010 to accelerate the development and access to

vaccines against pneumococcal disease. The governments of Italy, the United Kingdom,

Canada, Russia, and Norway and the Gates Foundation decided to commit US$ 1.5 billion to

this initiative. The developing countries are providing a small co-payment to contribute to

the product’s production cost. While the World Bank provided fiduciary support, the WHO

established the minimum technical criteria for a suitable pneumococcal vaccine, and the

April 2013 Page 20

UNICEF procurement services are responsible for purchase and distribution. It is estimated

that this AMC pilot project can prevent more than seven million childhood deaths by 2030

(GAVI, 2013).

We advocate for using the AMC as a template for incentivizing the development of a series

of next generation drugs and vaccines against neglected diseases. A number of neglected

disease areas could be identified by an independent committee. Yet, the prerequisite for

success lies in the expectation whether or not the individual, voluntarily participating

governments (in the absence of one world government) are willing to make such binding

long-term funding commitments in global health. In the wake of the global financial crisis,

governments are especially concerned to spend their scarce funds efficiently. In the case of

AMC, however, the benefits generated in terms of social return exceed the investment costs.

After this pilot, new AMCs should be launched. Given the remaining unmet needs in various

poverty-related therapeutic areas, we advocate launching simultaneously commitments

across various therapeutic areas. After all, funds are only awarded after results have been

obtained.

Other Neglected Diseases

The problem of neglected diseases is not confined to poverty-related diseases only. The

spread of human immunodeficiency virus (HIV), hepatitis B and C, evolving influenza strains

and antibiotic-resistant organisms have put healthcare agencies on guard to avert pending

pandemics from these diseases. While these diseases affect people across the world, the

situation is exacerbated by the fact that there is a lack of coordinated programs aimed at

controlling these diseases. And, despite efforts made in the past there is a growing gap in

funding.

Although these diseases are highly prevalent they are not adequately addressed for a variety

of reasons. Neglected diseases like hepatitis c were until recently not fully reported in

statistics. This is due to under-reporting but also due under-diagnosis because of a lack of

detection methods or awareness. As a result, the policy measures to foster innovation in this

area of ‘non-poverty-related’ neglected diseases (i.e. under-reported and under-diagnosed

diseases) are different in nature. However, the public health goal should be the same, and

that is to improve access to medicines to underserved populations regardless of the country

they live in (high, middle or low-income), and the financial means that they have at their

disposal.

There is a need for strengthening the infrastructure, enhancing disease surveillance systems,

and building capacity in management and policy making through training and education.

Hence to succeed in the case of neglected diseases, it will be necessary to identify gaps in

the organization and performance of health care systems. A case could be made for

strengthening both the vertical and horizontal functioning. The advantages and

disadvantages of vertical versus horizontal delivery modes is beyond the scope of this paper

and been described by Ooms and Oliveira-Cruz (Ooms et al., 2008; Oliveira-Cruz et al., 2003).

April 2013 Page 21

It revolves around the question whether interventions to reduce disease burden in specific

‘at-risk groups’ should be delivered through an integrated, horizontal approach or through

separate vertical programs. There is a tension between the temptation of seeking to reach

the targets quickly, using a vertical approach, and the ideal of strengthening the overall

health system, which should over time deliver the interventions needed. Global health

initiatives for instance such as Roll-Back Malaria and Stop TB pose new challenges in the

context of expanding access to priority health interventions. Experts advocate that vertical

and horizontal approaches do not necessarily have to be seen as mutually exclusive but as

complementary strategies. We assume this rationale could also apply to non-poverty-related

diseases like hepatitis c that are underdiagnosed. This means that efforts must be made to

connect the elements of disease management programs comprising prevention, diagnosis

and treatment.

Because of the extra efforts to be made, special purpose ‘pull’ funding systems must be

created in order to kick start new programs or sustain the efforts that have been made so

far. This approach has been successfully applied to accelerate access to vaccines through a

special purpose finance system, called the International Finance Facility for Immunization

(IFFIm). IFFIm issues government-backed bonds in international capital markets to fund

immunization programs and in support of building capacity which includes strengthening

health system through training, and improvement of infrastructure especially in lower

income countries. By borrowing on capital markets, IFFIm generates immediate revenue to

accelerate access to vaccinations in countries, and donors make payments over a longer

period of time.

A similar approach might be taken by the European Union to help poorer member states like

Romania, for example, deal with the extraordinary public health burden caused by specific

diseases. In February 2013, the European Commission published a proposal for a financial

transaction tax – also called a Tobin tax – in the EU. One aim of the proposed tax is to

improve the efficiency of financial markets by reducing speculation. Another is to generate

tax revenues. Much work remains to be done at the EU and global level on the shape and

timing of such a tax. Critics argue that such a transaction tax is likely to lead to distortions in

the form of short-term and long-term transactions migrating to other countries. In the event

of such tax to be implemented, we call on authorities to consider spending part of the

proceeds on addressing important health issues. To close the funding gap, future financing

systems may also have to rely on social entrepreneurship fostering convergence toward

higher standards of health across nations. It should be explored whether socially-responsible

investment bankers are able and willing to invest shareholders money in these social

enterprises.

April 2013 Page 22

CONCLUSION United Nations agencies like the World Bank and the World Health Organization, as well as

several governments of industrialized and developing countries and foundations like the

Gates Foundation, have recognized - together with many industry CEOs individually and by

way of the pharmaceutical industry associations - the dearth of private-sector incentives to

conduct or scale up projects on neglected diseases; especially those that affect developing

countries.

We have argued that intellectual property rights conferring patent protection remains an

important incentive for private-sector investment in research and development. However,

this measure will not be enough in itself when dealing with poverty-related diseases. As a

consequence, new ideas around novel economic incentive schemes must be conceived and

thoroughly evaluated. Together, these “push” and “pull” mechanisms create more attractive

markets, lower uncertainty, and support return on investment, thereby stimulating

increased investment in R&D.

In the early stages of scientific research, push funding is likely needed to support

translational research and academic-industry initiatives. As soon as the ‘proof-of-concept’

has been established, however, performance-based mechanism should be activated like the

Advanced Market Commitment (AMC) and Priority Review Voucher (PRV). The ‘risk-

investment-incentive’ model that we have developed allows calculating the size of funds

needed to sufficiently reward the original innovator, or group of innovators that must be

rewarded.

The problem of neglected diseases is not confined to poverty-related diseases only. The

spread of human immunodeficiency virus (HIV), hepatitis B and C, evolving influenza strains

and antibiotic-resistant organisms have put healthcare agencies on guard to avert pending

pandemics from these diseases. While these diseases affect people across the world, the

situation is exacerbated by the fact that there is a lack of coordinated programs aimed at

controlling these diseases. And, despite efforts made in the past there is a growing gap in

funding.

We call on national governments and international agencies to reinforce the disease

surveillance systems necessary for pandemic-related decision making and for monitoring of

programs. National authorities should also support greater coordination among the health

care systems at country level – by providing greater clarity regarding national disease-

specific priorities, and optimizing resource allocation among control and eradication

campaigns.

April 2013 Page 23

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