In 280 BC, the king of a minor Greek state called Epirus led his forces on a campaign in Roman territory. The son of the state’s former ruler, he rose to power and was convinced to come to the aid of Teranta, a Greek colony and part of Magna Graecia. The colony was engaged in a war against the Empire on the Italian peninsula. The king was a skilled commander and strategist and his armies were victorious more often than not. His name was Pyrrhus.
Pyrrhus’s forces met the Roman Legion for their first battle in Heraclea in 280 B.C.. They met again soon after in the Battle of Asculum a year later. According to Dionysius of Halicarnassus, Pyrrhus had 70,000 infantry (16,000 were Greeks) and the Romans had more than 70,000 infantry (20,000 were Romans and the rest being troops from allies). The two armies fought to a stalemate, though Pyrrhus had a trump card – nineteen heavily armored elephants.
While the main battle raged, mercenaries on the Roman side attacked the minimally fortified Greek camps in the rear, forcing Pyrrhus to divert some of his forces to defending their camps, which they succeeded in doing. According to Hieronymus of Cardia the Romans lost 6,000 men and that, according to Pyrrhus’ own commentaries, he lost 3,505 men. For the latter, a long way from home, the casualties were significant. According to Plutarch, when Pyrrhus was congratulated for his victory, he surveyed his men and commented, “If we are victorious in one more battle with the Romans, we shall be utterly ruined.”
Turned out, not all victories are created equal. Sometimes, even when you win, you lose.
Though separated by two thousand years, antibiotic company CEOs can’t be blamed for empathizing with Pyrrhus’ victorious resignation.
In Part 1 of Treading Water, we heard the story of Melinta and its Chapter 11 filing. Far from being an outlier, the company’s travails represents a cautionary tale for other antibiotic companies. On one very basic level, Melinta did what it’s supposed to do. It succeeded in bringing a new drug to market. Nobody would blame them for feeling as if they’d delivered the goods for their investors.
Three in fact.
Baxdela the showpiece, Orbactive the backup, and Vabomere the other backup. Not only that, right before filing for Chapter 11 protection, Baxdela had won approval from the FDA to treat more conditions. And if that wasn’t enough — because let’s be honest, when is enough ever enough for people — Melinta had more potential antibiotics in the pipeline, any one of which could have been a game changer.
By all counts, positive signs flashed for the world to see if anyone bothered looking (this being the antibiotic resistance crisis, chances are very few people outside the industry paid attention).
And yet, it still wasn’t enough.
In truth, it wasn’t completely Melinta’s fault. The same way it wasn’t Achaogen or Aradigm’s when they filed for bankruptcy at the beginning of 2019. If anything, the blame fell squarely on the predominant business model used in the pharmaceutical industry that placed them into a precarious position from the start.
Meet the Small- Medium-Sized Enterprise
When it comes to business, risk is seldom a good thing and, when possible, should be avoided. Still, it’s there. Just about everywhere. In daily life, we constantly weigh then decide what constitutes acceptable levels of risk we’re willing to take. Crossing the street. Driving a car. Going out on a first or second date. Buying new clothes. Deciding whether to have that last drink at the end of the night. Risk assessment is at the heart of many seemingly banal decisions.
When it comes to pharmaceutical and biotechnology companies, assessing and then mitigating risk effectively can be the difference between success and failure. Yet somehow, the larger the operation grows, the more risk-averse they become, particularly on the R&D side. While discovering new antibiotics should be considered long-term investments on the part of the pharmaceutical company, the C-suite view can be much less sanguine. What they see is risk and red numbers on their financial statements and balance sheets. Still worse, investors see very little upside to the endeavor.
According to Jennifer Robinson, Communications Lead at CARB-X, a global non-profit partnership dedicated to accelerating antibacterial research, “Drug companies are hesitant to invest in antibiotics research, since any resulting new treatment would be used only in limited, emergency cases, and it has proven to be impossible to recoup the costs of developing a new antibiotic, much less of earning a profit. There are also economic disincentives built into some health care systems.”
During the 1990s, a new R&D paradigm evolved among pharmaceutical companies. It shifted as much risk as possible away from large companies while still allowing them to reap the bounties of successful drugs. Rather than appropriating funds to develop potential compounds that may or may not pan out (and in the process lose millions of dollars), companies essentially outsourced R&D to smaller companies, referred to as small and medium-sized enterprises (SME). These smaller entities assumed all the risk of failure. What’s more, the new model shifted the financial burden of developing novel drugs and winning FDA approval to the SME. Once the final regulatory hurdle was cleared and the risk of failure minimized, large pharmaceutical firms could buy the company outright, in the process acquiring not only the novel drug, but also the proprietary platform used during the R&D process, all for a fraction of the price they would have paid to develop the drug in-house.
During the R&D process, the responsibility for patching together funding falls on the SME. By far, most are pre-revenue entities. As a result, the bulk of the money at their disposal comes from private investors during various funding rounds. While, contract work and partnerships with larger companies are other sources of income for SMEs, its really very little in the bigger picture, sort of like trying to pay your rent with money from an Uber gig.
The process works out well for the SME if it gets acquired by one of the big pharmaceutical companies. Unfortunately, nothing is guaranteed even with an approved antibiotic in hand.
One of the model‘s major drawbacks is that it places significant strain on the tenuous and limited funds SMEs possess, so much so that many of them are close to collapse by the time their products win FDA approval. From day one they’re almost automatically behind the 8 ball. (The dynamic is strikingly similar to saddling college students with so much debt that by the time they graduate their choices have dwindled because of the pressure to begin paying back what they owe. What is empowering for one party is disenfranchising for the other.) From the moment the company forms, they must navigate constant uncertainty in the form of endless fundraising rounds.
A study of the SME landscape by Joseph DiMasi, et al. investigated the overall costs of bringing a completely novel drug to the market. According to the authors, the precarious financial position most SMEs find themselves manifests itself in the specifics of how they raise funds.
Research intensive industries, including the pharmaceutical industry, generally finance most of their investments through equity, rather than through debt. This is the case even when the cost of debt is significantly below the cost of equity. One of the primary reasons is that servicing debt requires a stable source of cash flows, while the returns to R&D activities are skewed and highly variable.
As the antibiotic giants of the Golden Era stepped away from R&D, the few that remained adopted the SME model while doing limited R&D in-house. Much of this had to do with shifts in the industry landscape that favored M&A vs organic growth. According to a paper on pharmaceutical mergers and acquisitions by James Mittral,
In the 1960s, ‘conglomerate mergers’ predominated as efficient acquirers built up diversified groups and added capital and management to the target firms. In the 1980s, ‘bust-up takeovers’ allowed raiders to acquire and dismantle the conglomerates assembled during the 1960s, although the pharmaceutical industry avoided this bust-up phase until the early 1990s, when companies split their agro-chemical and health divisions. The 1990s witnessed industry consolidations redolent of mergers in the 1920s.
Of today’s top pharmaceutical companies, only Merck & Co. and Eli Lilly have retained their position through organic growth, rather than through large-scale M&A. Acquiring SMEs simply made more business sense.
According to one former executive, “With smaller companies it’s different because you don’t have the same tax operation [potential to write off expenses]. There you are looking at pipelines … dealing with the smaller company is much more directed and there it’s potentially a technology match, a product match, or a pipeline.”
In other words, in the cases of acquiring start-ups, the goal is primarily meant to either bolster internal R&D efforts or as a quick way to even out a company’s portfolio.
SMEs don’t have the same luxury of choice.
Visualizing Victory: Surveying the damage
Considering Melinta’s fate discussed in Treading Water Part 1, comparing similar companies can be instructive. Rather than focusing on their drug development platforms and products, there’s more to be learned from dollars and cents. That’s not to say that their specific products don’t play a role in the company’s success. They do. An antibiotic that can be taken orally and therefore outside of a hospital setting potentially has greater upside than one that can only be administered intravenously. But even the best drug’s fate is at the mercy of its parent company’s financial viability.
So let’s take a look under the hood of a few antibiotics SMEs to get an idea of what they. I chose companies that had similar profiles to Melinta/Cempra, namely Tetraphase, Scynexis, Entasis, and Paratek.
The company had the largest pipeline among top antibiotic SMEs with 11 projects targeting priority pathogens, including eight in clinical development. It also reported access plans in place for its late-stage projects, but not stewardship plans.
LOSS FROM OPS
Scynexis has five antifungal projects in its pipeline, including one novel clinical-stage antifungal medicine ibrexafungerp which treats various fungal infections, including acute vulvovaginal candidiasis.
LOSS FROM OPS
Tetraphase has a smaller pipeline many of its peers. The company has access and stewardship plans in place to support its approved product, eravacycline. This includes a licensing agreement and plans to develop a surveillance network. Tetraphase has three antibacterial projects in its pipeline that target priority pathogens, including one candidate for the treatment of serious and life-threatening multidrug-resistant (MDR) bacterial infections caused by pathogens including Carbapenem-resistant Enterobacteriaceae (CRE) and Carbapenem-resistant A. baumannii (CRAB).
LOSS FROM OPS
Paratek’s primary product is an antibiotic called Nuzyra (omadacycline). The oral and intravenous drug is used to treat community-acquired bacterial pneumonia and acute bacterial skin infections. Recently, Paratek reached a research agreement with the U.S. Department of Defense wherein Nuzyra is being studied against pathogens that are significant in terms of public health and biological weapon defense.
LOSS FROM OPS
Entasis’ pipeline targets bacteria in the highest threat category defined by the World Health Organization and the U.S. Centers for Disease Control. For example, its most advanced project targets A. baumannii, which can cause severe drug-resistant infections including pneumonia and urinary tract infections (UTIs). This includes zoliflodacin, a novel Phase II candidate targeting gonorrhoea.
LOSS FROM OPS
How to Win a Battle but Lose the War
There’s so much wrong with the way the antibiotics industry is structured that it’s hard to know where to begin. According to people directly involved in the antibiotics industry, the primary issue is with the reimbursement model used to pay for antibiotics. And while that’s true, it only scratches the surface. There are many other things that make discovering, developing, and marketing novel antibiotics challenging.
There’s a fair amount of risk involved in so-called small molecule R&D. The likelihood of approval (LOA) for novel antibiotics clearing Phase I clinical trials is a paltry 19.1%. Those are long odds, except for Vegas gamblers, but not multimillion dollar companies. The overall process, with its multiple steps is like walking through a minefield.
“The antibiotics sector has been under a lot of pressure during the past 15 years where the regulatory science has shifted and there’s been uncertainty in the development pathways,” explains Evan Loh, Paratek’s CEO. This uncertainty keeps investors on the sidelines when it comes to taking a stake in the company.
One of the first problems faced by antibiotic SMEs stems from the nature of the drug discovery business and is by no means exclusive to the antibiotics business. Isolating chemically active molecules is a time consuming process and even when the process runs smoothly, the costs incurred can be significant. A study by Christine Ardal, et al. surveyed antibiotic SMEs in Europe. They found that, on average, costs accumulated during lead compound identification ranged from €250,000 to €1,000,000. On top of that, costs incurred optimizing lead compounds often averaged €5,000,000.
For startups just embarking on their quests, the costs can be managed. But as time passes and investor fundraising rounds come and go, the pressure begins to build. On top of that, many antibiotic candidates never actually pan out. This means all the money budgeted to those pipeline projects becomes a permanent loss on the company ledger. This, in turn, influences the price of any drug that makes it onto the market.
“The cost of a drug is actually the cost of failures,” says Manos Perros, the CEO of Entasis Therapeutics, an antibiotic SME. In essence, the price of a drug that makes it through to the market is essentially the price of the various risks assumed. In other words, there’s no way to silo the damage done when a candidate falls short. Instead, it is spread out between successful products.
To a person unfamiliar with the drug discovery process, it would seem as if discovering a new drug out from nowhere was the hard part. And by extension, the most difficult steps must be the most costly. That couldn’t be further from the truth.
The painful part is yet to come and, fortunately and unfortunately, there’s no way around it.
There was a time when the drug discovery process was much quicker than it was today. Products flew from test tubes to pharmacy shelves in almost miraculous speed. The only problem was that the drugs were approved before anyone knew whether they were safe or not.
For a long time, pharmaceutical firms and their customers were unbelievably lucky. Nobody really got sick from the medicine they were taking. Then, in 1937, the Fates released a shot across the bow of the drug world. A liquid form of sulfanilamide, essentially an early version of antibiotics, was being prescribed by unsuspecting physicians whose patients were dying one by one. The American Medical Association tested a sample of Elixir Sulfanilimide received from S.E. Massengill Co. and determined that the solution used to dissolve the antibiotic was diethylene glycol, a chemical used as antifreeze. As it turned out, the company tested their product for flavor, appearance, and fragrance — all of which were deemed satisfactory — but they never tested for safety. Part of the reasoning at the time was that killing customers was bad for business so it was in a company’s best interests to test their products.
One doctor, A.S. Calhoun, recounted at the time, “But to realize that six human beings, all of them my patients, one of them my best friend, are dead because they took medicine that I prescribed for them innocently, and to realize that that medicine which I had used for years in such cases suddenly became a deadly poison in its newest and most modern form, as recommended by a great and reputable pharmaceutical firm in Tennessee: well, that realization has given me such days and nights of mental and spiritual agony that I did not believe a human being could undergo and survive. I have known hours when death for me would be a welcome relief from this agony.”
Over a hundred people died due to poisoning from Elixir Sulfanilimide. Unfortunately, it wasn’t the last, nor the worst, example of a drug’s safety being inadequately established. The thalidomide tragedy during the late 1950s killed thousands of children while deforming the estimated 10,000 who survived. Most of the victims were in West Germany.
The rigorous multi-phased clinical trials used today are partly designed to ensure potentially deadly drugs do not make it into the market. They take years to complete and involves thousands of subjects. The downside is that funding the trials are obscenely costly and the financial pain is inevitably passed down to the customer.
Turning back to DiMasi, et al., they estimated the total capitalized cost per approved drug. The total is staggering. “Our base case total out-of-pocket cost per approved new drug is $1395 million, while our fully capitalized total cost estimate is $2558 million.”
Faced with the unenviable task of somehow pulling themselves back from the edges of insolvency, antibiotic SMEs have limited options at their disposal. Their choices dwindle further when the prevalent volume-based sales model is factored into the equation. The company can either pray for a “blockbuster drug” that sells like a Taylor Swift album or they can increase the price to astronomical levels like a one-of-a-kind Wu-Tang Clan album. The way things are set up, those are the two primary options to recoup the money they put out to develop a novel antibiotic. Flat out discounting of the drug — as beautiful as that would be — simply punishes the company for its scientific success.
The dependency of pharmaceutical companies on sales volume has significantly hampered the viability of antibiotic companies. In fact, it ends up harming the company’s chances even more. The only way to recoup their investments is by sending legions of sales representatives into communities.
Consider the company’s predicament. After fifteen long years of discovering new compounds and weeding out the ones that actually show promise, after three expensive rounds of clinical trials, after clearing administrative hurdles, you’ve achieved your goal and developed a drug that can potentially change the antibiotics landscape. Now, you are faced with the fact that someone needs to know about your product and learn about the advantages your new drug offers. The most obvious and proven method for that to work is by employing sales people. But it costs money. Lots of it. What are you going to do give up and just let everything go to waste? Or give it your best shot, pay for a sales force, and have a fighting chance? That’s right. You’d pay up. In Melinta’s chart below, the ballooning orange bar between 2017-2018 reflects the increase in expenditures needed to sell their products. For most antibiotic operations, this is what a fighting chance looks like.
And just to prove that the financial burden imposed by sales operating costs aren’t exclusive to Melinta, here’s another look at Paratek’s chart. If anything, they’ve carried on much longer than Melinta and, by no small feat, managed to stay afloat. It’s far from ideal though. CEOs are almost handcuffed by the their operating costs.
“You have a non-overlapping paradox,” say Evan Loh. “On the R&D side for companies like Paratek, we’d like to bring another product on board. The problem is we don’t have the cash to do that until we achieve profitability. Until then, the company’s R&D budget goes to zero, except for any post-marketing requirements as requested by the FDA.”
In other words, they’re stuck.
Not only that, the dependency on volume can influence the type of antibiotics being developed. Bringing a narrow-spectrum drug to the market that only targets a limited range of bacteria makes no sense. Not enough will sell. The most logical thing to do would be to develop broad-spectrum that has the flexibility to treat a greater number of conditions. Unfortunately, that strategy has played a major role in the development of antibiotic resistance.
“The industry has been looking for the new broad-spectrum antibiotic that would work for all patients but what physicians need is something they can prescribe to far fewer patients whose infections are resistant and that’s a much smaller number,” explains Manos Perros, whose company has moved forward with a pathogen-specific antibiotic. “You’re moving from a place where you had large volume/low margin commercial model to one where you now have patients with a high medical need but there are far fewer of them. The large volume low margin model no longer works.”
Believe it or not, it gets worse
Even with legions of pharmaceutical representatives on the road, the antibiotics market is challenging, if not impenetrable. The healthcare system holds much of the blame, specifically the way hospitals eke out profits in the face of dwindling revenue.
Diagnostic related grouping (DRG) is the way Medicare and some insurance companies like Empire or Emblem Health determine how much money to pay a hospital for a patient’s stay. Rather than taking a piecemeal approach and paying for each specific service a patient receives (and leaving the wide open for over-billing), insurance companies estimate how much treating a given condition costs by using past pricing as guide. The metrics employed by the companies takes into consideration the resources needed for diagnosis, prognosis, and all phases of treatment.
Since its inception in the 1980s, DRGs have worked efficiently enough, especially for the insurance companies. That’s by design. They were created, presumably, with good intentions. For hospitals, things have proven a bit more complicated. Even in the best of times, they are low-margin businesses. In the face of DRGs, administrators are in the position of carving out money wherever they can find it. One area ripe for cost cutting is with medications.
“What’s happened is that these products being developed are being introduced into a hospital system that has very sharp cost containment pressures,” explains Loh. “Even before COVID, running a hospital was akin to running a grocery store with very low margins. What they would do is look for places to cut costs.”
Generic drugs provide hospitals with some wiggle room when it comes to controlling costs. Rather than paying the full price for prescription drugs, using the cheaper version allows the hospital to keep the difference. This works well for older drugs whose patents have run out. Antibiotics, the vast majority of which were discovered over fifty years ago, are particularly common.
For a company trying to sell new, more effective antibiotics, this presents an almost unsurmountable problem. Newer drugs are bound to be more expensive because the expenses incurred during the R&D process. It’s hard to convince hospitals to prescribe expensive antibiotics when a similar, but potentially less effective, drug is readily available. Hospitals prefer to roll the dice because DRGs have incentivised doctors, nurses, and administrators into choosing the cheapest possible drug that does the bare minimum to get the immediate job done.
“The bundled DRG model takes away the prescriber’s ability to choose the drug,” says Perros. “Instead, through a DRG carve-out, let prescribers decide how much the product is worth.”
The trade for short term gain means a long term loss down the line. And we are now at the point where the long term loss is beginning to catch up with hospitals. For a long time, doctors have made deals with the devil in order to keep costs down. Now the devil wants his due. It takes the form of antibiotic resistance.
Relying on generic drugs risks the development of antibiotic resistant bacteria since they have been around for so long. This is of particular concern in hospital settings where infections by multidrug resistant Acinetobacter baumanii represents a particular concern. Ironically, hospitals can keep resistance at bay by using more modern antibiotics. They often choose not to in order to keep costs down.
“Antibiotics are part of the bundled costs and DRG doesn’t recognize the value of innovation,” says Loh.
And, it gets worse still.
Even if a hospital purchases a novel antibiotic, that doesn’t mean problem-solved for the SME. Whereas antibiotic resistance has provided companies with the positive impetus to develop new molecules in order to address the problem, it has discouraged the use of those same drugs in healthcare settings. An antibiotic’s novelty and effectiveness, i.e. its primary selling-points, makes doctors save it for desperate situations where other drugs have stopped working. If history has taught them anything, it’s that the more you use an antibiotic the greater the chances of bacteria figuring out how to neutralize it.
While keeping the powder dry is understandable, it’s terrible for antibiotic sales. As you can imagine, if a drug is only being used as a last resort, it isn’t being used much. If nobody is using the latest wonder drug, you can bet nobody is buying it. And if nobody is buying that wonder drug, you better bet the pharmaceutical company that developed it is hurting.
Which brings us back to Pyrrhus and his costly triumph.
Sometimes, it’s possible for a company to achieve its goal at such a steep price that it’s viability down the line is hampered so much that surviving to the next day is a challenge in itself. The cycle of financial distress eventually stops spinning and the companies succumb to the damage that accumulated while doing things the right way.
A Pyrrhic victory to be sure.
Jennifer Robinson offers a bleak assessment of the situation. “The economic model for antibacterials needs to be fixed. It cannot be fixed without government intervention. The longer we wait for a sustainable solution, the more companies will go bankrupt, the more the pipeline will degrade, and the more patients will die as resistance grows.”
IMAGE SOURCE: Creative Commons
Sign up for Scientific Inquirer’s Steady State Newsletter for the week’s top stories, exclusive interviews, and weekly giveaways. Plenty of value added but without the tax. http://bit.ly/2VEF06u