The humanistic and economic consequences of the 2020 COVID-19 pandemic will not be completely understood for years. The humanistic toll has been well documented; as of early May 2020, the global death toll attributable to COVID-19 is more than 280,000, with more than 4 million confirmed cases.[1] Both numbers are believed to be substantial undercounts of the actual number of cases and deaths. In addition to the humanistic burden, it seems highly likely that in the near term there will be some type of economic downturn triggered by the slowing of the global economy on a massive, unprecedented scale. Most likely the downturn will take the form of a recession, the severity and duration of which are difficult to predict at this time.
In the life sciences field, where it can take between 5 to 15 years to bring a product to market (generally shorter for uncomplicated medical devices, and longer for complex devices and pharmaceuticals), recessions pose a particularly vexing business problem: ignore the recession, and assume it will be over by the time the product reaches the market, or put the brakes on research and development (R&D) until it is more clear what’s going on. Which strategy typically wins? How did life sciences companies approach this problem in 2009, the most recent global recession?
In this blog entry we explore some of these issues and offer some advice to life sciences companies facing these types of decisions in 2020 and until things return to normal. Most of the sources are literature and reports (some from the time of the 2009 recession) combined with some recent reports assessing the likely macroeconomic effects of the pandemic on the global economy. We also rely somewhat on informal conversations with pharmaceutical and medical device leaders, whom we do not identify but who have provided a “front lines” view of the crisis we are currently facing.
Macroeconomic Impact
In order to inhibit the rapidly spreading virus, public health leaders of most countries reached the conclusion that economic activity would essentially have to come to stop, especially those activities associated with congregating in close proximity (shopping malls, conferences, sporting events, restaurants, retail outlets, salons, etc.), as well as a large swath of other large industries that also bring people close together, such as airlines, hospitality, cruise ships, tourism, manufacturing, etc. For many businesses and some entire industries, consumer demand as fallen to zero. After two months of “lockdown,” filings for unemployment in the U.S. topped 30 million.[2] The United Nations estimates that as many as 200 million jobs could be lost globally.[3]
Economists estimate that in 2020 the European Union gross domestic product (GDP) will fall by 7.4% (it shrank only 4.5% in the 2009 financial crisis).[4] Similarly the U.S. GDP is projected to fall by 6%.[5] Globally, these effects (measured a number of different ways) are expected to dislodge the economy from its normal trajectory for the next 3 years before it is able to stabilize at normal levels.[6-8] Thus, many experts seem to agree that the fundamentals of the global economy were strong enough prior to COVID-19 that, as economies begin to re-start, the “gravitational pull” will eventually bring economic growth back to the levels seen in the decade preceding the pandemic. Several elements are likely to fuel the pull, including positive economic activity attributable to the pandemic; for example, a substantial increase medical R&D activity associated with testing, treatment, and vaccines aimed at COVID-19 (but in some cases redeployable to other uses), a large boost to online retail, increased use of business communication tools, and increased demand to other apps that facilitate home entertainment, home fitness, etc. While all of this may seem like an overly optimistic outlook, it is important to not underestimate the impact of what could be a 3-year downturn.
Health Industry Impact
Before we can assess how these macroeconomic factors are likely to impact the life sciences product development cycle, we start with looking at how the health industry itself is expected to be affected. In the news we see busy hospitals, and in one of our April blog entries we discussed the costs that hospitals will likely incur caring for COVID-19 patients—costs that will likely to be reimbursed by a mix of public and private payers. The pandemic “bailout” package in the U.S. (the CARES Act) also includes a 20% add-on to inpatient prospective payment amounts for COVID-19 patients.[9] Additional federal government subsidies to hospitals and integrated delivery systems will likely come in the next few months, and additional funding from foundations and donations is expected to remain stable.
In addition, as soon as quarantines are loosened, hospitals will resume normal non-urgent services, diagnostics, and elective surgeries, most of which are associated with higher operating margins. These factors are not likely to compensate hospitals and integrated delivery systems fully for the scale of disruption many of them have had to manage, but it will help to some degree to stabilize that part of the industry.
As for the remainder of the health industry, the main issue will be demand-side factors. Outside the U.S., most countries maintain health systems that provide comprehensive health care coverage to every citizen. It is unlikely that the fallout from COVID-19 will cause overall demand for health care to fall in such countries. In the U.S., on the other hand, even after the passage of the Affordable Care Act (ACA) years ago, the ranks of the uninsured will likely rise as the economic downturn results in higher rates of unemployment. These effects were observed after the 2009 recession in the U.S.[10, 11] According to one study, the percentage of the nonelderly population with employment-based coverage was 61.3% in May 2007 (prior to the recession), and by July 2009 the rate fell to 58.2% as the unemployment rate rose to nearly 10%.[10] This gives us some sense of what might happen in the COVID-19 scenario, which at least temporarily is likely to result in unemployment rates in excess of the 10% levels seen a decade ago (early May reports had it at nearly 15%). However, it is also important to note that the ACA was not in place during the 2009 recession, and we would expect the ACA to have at least a partial mitigating effect.[12]
Product Development Impact
So, what does all of this mean for product development? In our business we deal with innovation; our clients have novel products and services in development, and our job is to help them build the “value story” around those products and services so that developers and manufacturers can help consumers and payers make informed decisions. But with the economic uncertainty of the foreseeable future, it is reasonable for drug and device makers to pause and consider the likely economic conditions they might face when entering the market. There is a natural tendency to “pump the brakes” when hazardous conditions lay ahead; should R&D expenditures be trimmed or re-purposed? Should some early-stage initiatives be shelved? As counterintuitive as it may sound at first, excess caution may not be as warranted as the current overall economic outlook might imply. There are five main drivers of this conjecture, and we review them here.
- Time to Market. It is important to consider the length of product development lifecycles in the life sciences, which are considerably longer than development lifecycles in other industries. This is mainly due to having to conduct rigorous clinical studies in advance of regulatory approval, but earlier-stage scientific experiments and securing intellectual property also add considerable time to the development clock.[13] For pharmaceutical drugs, this process can take as long as 10 to 15 years.[14] In the development of medical devices and diagnostics, the process is generally more condensed, but still typically takes 3 to 7 years to complete.[15] Moreover, the R&D process in the life sciences requires ongoing investment on the part of the manufacturer, with costs typically rising with each success stage of development.[16] Shelving projects that have already incurred substantial sunk, unrecoverable costs may in many cases be a poor choice relative to entering a market with some demand-side uncertainty in the short run.[17] In addition, as we reported above, the current global recession economic outlook forecasts a 3-year downturn. Given the average length of the product development lifecycle, there is a good chance that products in development now will miss at least part of the downturn and be well-positioned in the market for the recovery.
- R&D Efficiency. Another reason to approach the 2020 recession differently is that R&D has become more agile, efficient, and profitable over the past decade, making it a more productive investment relative to other investments. R&D efficiency gains have been driven by the application of more innovative drug discovery processes (i.e., greater reliance on external biotechnology developers in earlier stages) and more automated clinical trial management, relying on emerging tools relying on artificial intelligence, biomarkers for patient selection, and electronic medical records.[18-24] Although there have been periods of sluggish returns to R&D in the past,[25, 26] the new “agile” R&D has resulted in much stronger returns on investment in recent years. For example, even during a time interval encompassing the 2009 recession, R&D and sales data from 1989 to 2017 show that cumulative returns on oncology drugs were about $15 for every $1 spent on R&D.[27] While such returns are expected to vary substantially by therapeutic area,[16] and between pharmaceuticals and devices, the implication is that more efficient, targeted R&D is likely to remain a sensible investment for life sciences firms. Moreover, to the extent that returns to R&D are believed to drive overall company, stakeholders and investors will be generally more supportive of R&D. One potential mitigating factor is that some degree of new product development takes place in universities and research centers, both of which are expected to face considerable financial stress in the event of a prolonged recession. But again, the new more agile approach to R&D is likely to perform better than traditional models under these economic circumstances.
- Role of Government. As we mentioned above, public-sector financing aimed at the health industry has already increased substantially in response to the pandemic. This is expected to continue. Because the economic disruption was caused by a massive health-related crisis, public payers will be reluctant to scale back coverage. This will have a substantial mitigating effect on what might otherwise be a significant drop in demand for health care products and services, but there will also be costs shifted to individuals as governments face rapidly mounting expenditures.[28, 29] There is little information at this time as to the amount of financial assistance that will flow from governments into the health care sector, but we expect it to be somewhat higher over a short period of time before returning to normal. In addition, as we mentioned above, foundation and philanthropic support will likely remain stable and may increase somewhat given the high rates of civic involvement observed thus far.[30]
- Value-Driven Care. With larger public payers globally playing a crucial whole in protecting and improving access to health care, the pressure on manufacturers to clearly demonstrate value to payers will intensify. This was certainly the case following the 2009 recession. Although the concepts of cost-effectiveness analysis, “value-based pricing” and “value-based purchasing” were of course around long before 2009, the recession fueled greater experimentation with value-based approaches, including ideas like bundled payments and risk-based contracting.[31-37] We would expect that these incentives will continue, perhaps even with a resurgence in interest. Thus, drug and device developers will need to intensify their efforts to build clinical and economic evidentiary foundations.
- Health Industry & Recessions. The health care sector of the economy has historically weathered recessions better than other more vulnerable sectors, mainly because a substantial proportion of services are associated with relatively inelastic demand. Regardless of GDP, cancer patients will need surgery and chemotherapy; heart attack patients will need angioplasty and drugs. While the health industry clearly is not “recession proof,” globally the industry fared quite well in the aftermath of the 2009 recession. In fact, some argue that the layoffs and consolidation that occurred in pharmaceuticals and other life sciences companies a decade ago were more a function of lackluster R&D performance in the 1990s than they were a direct consequence of the recession.[38] We expect the sturdiness of demand in the health sector to help position the industry as one of the better performing ones in the next 3-5 years. In addition, as we discussed above, the industry as a whole will benefit from the increased attention on its societal importance, including the critical role of medical R&D (there are now more than 100 COVID-19 treatments and vaccines under development),[39] public health preparedness, and maintaining a well-equipped and technologically advanced health care infrastructure and workforce.
In sum, when the pieces are put together the message to life sciences companies is perhaps not as dire as one might initially think. Although the macroeconomic outlook is somewhat grim, at least for the short run, the balance of these five factors suggests that life sciences companies should continue with their product development plans, albeit with an extra layer of circumspection.
(By John Schneider, PhD and Mirela Sima, MD, MBA) (May 11, 2020)
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