During the U.S. “State of the Union” address this past week, President Obama devoted some time to emphasizing the importance of “personalized medicine,” referring to the rapid pace of innovation and the high expectations for the role molecular diagnostics in the U.S. health care system: “”I want the country that eliminated polio and mapped the human genome to lead a new era of medicine – one that delivers the right treatment at the right time…Tonight, I’m launching a new precision medicine initiative to bring us closer to curing diseases like cancer and diabetes – and to give all of us access to the personalized information we need to keep ourselves and our families healthier.”
An important question, however, is where will all of the molecular diagnostic tests come from? The development of genomic diagnostics is complicated by several factors. First, the most fundamental challenge in the development of diagnostics is financial risk and return on investment (ROI). The unit costs of diagnostic tests tend to be considerably lower than the costs of treatment within a therapeutic area, yet the total costs of developing and testing a diagnostic test can be high, as regulatory approval and caregiver acceptance hinges on the ability of the diagnostic to disrupt and improve the status quo—both of which demand a high level of test accuracy in the form of sensitivity, specificity, and clinical utility. Sensitivity and specificity are measures of the error in testing (e.g., “percent correctly classified”), and clinical utility refers to the value of the test to physicians and patients in terms of improving treatment outcomes. Thus, a very important challenge to developing new genomic diagnostics is to find ways of breaking out of the “undervaluation cycle” where low downstream reimbursement deters upstream investment, which in turn limits the availability of resources to conduct the necessary research to establish clinical utility.
Innovation and development in molecular diagnostics is primarily carried out by small and innovative biotechnology companies, larger clinical laboratories and a small number of larger diagnostics companies, some of which are spinoffs of larger pharmaceutical companies. Similar to pharmaceutical markets, it is common for larger companies to license novel tests developed by smaller diagnostics companies. Venture capital markets are the main source of financing for the smaller firms, whereas the larger companies generally are publicly owned and have access to equity financing.
In the case of tests designed primarily for risk assessment and screening, the incentives faced by test developers are tied to some extent to the underlying population prevalence of targeted diseases and conditions, because low-cost tests can generate substantial revenues when utilized by large numbers of individuals. However, as we discuss later, the same potential for widespread utilization has become a major concern of payers, and consequently there has been considerable pushback on the medical necessity of high-utilization tests.
Companion diagnostics pose a different set of development challenges. Large pharmaceutical companies with diversified portfolios have the ability to spread risk, but their incentives to develop tests may be limited to the therapeutic areas in which they have treatments on the market or firmly in the pipeline. Moreover, not all companion diagnostics have a clear business case; in some therapeutic areas, there may be concern on the part of pharmaceutical developers that improved diagnostic accuracy could result in decreased sales revenue insofar as tests are able to identify appropriate and inappropriate candidates for treatment. However, in cases where clinical trials of larger populations show less than promising efficacy effects, companion diagnostics offer the opportunity to “rescue” the drug by identifying the sub-population wherein the drug has its greatest clinical value. In this case, even as treatment indications become smaller, the prices of companion diagnostics are likely to rise along with the price of the drug therapy to maintain ROI. Thus, for some companion diagnostics, this could also help “rescue” the price of the diagnostic.
Smaller independent diagnostics developers face a different set of challenges and are generally more susceptible to the undervaluation cycle. In the case of companion diagnostics, small developers assume two kinds of risk and uncertainty. First, there is the usual risk and uncertainty associated with whether the diagnostic test under development will prove to be accurate and reliable and offer clinical value following initial rounds of testing. Second, the future of the companion diagnostic under development is closely linked to the clinical efficacy and utility of the companion treatment. One way for smaller firms to minimize this risk is to target therapeutic areas in which there exist established treatments but where there is mounting evidence of heterogeneity in treatment response.
Finally, the regulatory and reimbursement environment for genomic diagnostics plays a critical role in upstream innovation and development. Test developers often point to the lack of clarity on FDA regulations regarding genomic testing as a deterrent to development, though the FDA has enacted new rules and guidance for industry in recent years that will likely reduce regulatory uncertainty. Venture capitalists also opine about regulatory uncertainty, but are generally more concerned about the undervaluation cycle and the challenges associated with demonstrating to payers the overall value of genomic diagnostics.
-John E. Schneider, PhD
 IOM, Genome-Based Diagnostics: Clarifying Pathways to Clinical Use: Workshop Summary.
 A. Agarwal, “Do Companion Diagnostics Make Economic Sense for Drug Developers?,” N Biotechnol 29, no. 6 (2012).
 Trusheim, Berndt, and Douglas, “Stratified Medicine: Strategic and Economic Implications of Combining Drugs and Clinical Biomarkers.”
 S Naylor and T Cole, “Companion Diagnostics in the Pharmaceutical Industry: Part Ii: Business Models,” Drug Discovery World, no. Summer (2010).
 FDA, “In Vitro Companion Diagnostics: Guidance for Industry and Food and Drug Administration Staff,” in Guidance for Industry (Washington, DC: U.S. Department of Health and Human Services, Food and Drug Administration, Center for Devices and Radiological Health, Center for Biologics Evaluation and Research, Center for Drug Evaluation and Research 2014).
 E.D. Blair, E.K. Stratton, and M. Kaufmann, “Aligning the Economic Value of Companion Diagnostics and Stratified Medicine,” Journal of Personalized Medicine 2(2012); IOM, Genome-Based Diagnostics: Clarifying Pathways to Clinical Use: Workshop Summary; Kulkarni and Ma, “Personalized Medicine: The Path Forward.”