Last month, Evotec, a major provider of drug development services, implemented restructuring initiatives, including layoffs, due to slowing early-stage R&D spending. Similarly, Charles River Laboratories, a key player in drug discovery and development, cut its 2024 forecasts, citing reduced demand from both biotech and larger pharmaceutical clients. The company pointed to increased regulatory pressures, including the U.S. Inflation Reduction Act, and worsening economic conditions.
The Inflation Reduction Act introduces price negotiation provisions for Medicare. While aimed at lowering patient costs, this legislation is expected to significantly reduce future revenues for certain high-cost drugs. As a result, many biotech and pharma companies are becoming more hesitant to invest in high-risk, high-reward drug development projects. Coupled with broader economic factors, such as rising interest rates and inflation, these pressures are reshaping research and development (R&D) priorities across the industry.
In this article, we take a look at what this could mean for biotech.
Impact of the Inflation Reduction Act on R&D spending
The Inflation Reduction Act, passed in August 2022, introduced several measures aimed at reducing healthcare costs in the U.S., with a key provision allowing Medicare to negotiate prices for certain high-cost drugs. This regulation is designed to lower the financial burden on patients but on the other side of the coin, it has significant implications for the pharmaceutical industry, particularly on long-term revenue and investment in drug development.
Under the Inflation Reduction Act, Medicare can negotiate prices for a select number of drugs, primarily focusing on treatments for chronic and high-cost conditions. The law targets drugs that have been on the market for a certain number of years and have no generic competitors. According to L.E.K. Consulting, these provisions, while benefiting patients, are expected to reduce revenue for pharmaceutical companies by limiting the potential market exclusivity period before generics or biosimilars enter the scene. This could lead to more conservative investment strategies in the future. The potential reduction in revenue from Medicare price negotiations could be as much as 50% for certain drug categories.
Dave Latshaw, chief executive officer (CEO) of BioPhy, confirms the Inflation Reduction Act’s drug price negotiation provisions are likely to have a significant impact on R&D spending in the biotech and pharma sectors. “By allowing Medicare to negotiate prices for certain high-cost drugs, these provisions could substantially reduce the potential future revenue of successful drugs, thereby discouraging companies from investing in high-risk, high-cost R&D projects.”
“Certain areas are likely to be disproportionately affected. Small molecules, which often have high development costs and face quicker generic competition, may see reduced investment. Precision medicine and rare disease therapies, which target smaller patient populations, could become less economically viable under the new pricing regime. Complex biologics, despite their longer market exclusivity, might also become less attractive investments due to high development costs and potential biosimilar competition. While these areas might be more heavily impacted, the effects will likely be felt across the entire industry, potentially shifting focus towards lower-risk, more predictable R&D investments,” added Latshaw.
Venu Mallarapu, vice president of Global Strategy at eClinical Solutions, agrees that small molecules are at risk under the Inflation Reduction Act and identifies other areas that could suffer from the change.
“Drugs for common chronic conditions like diabetes or heart disease, due to their nature of high-volume, may be prime targets for negotiation. Hence, we could see reduced R&D investment due to lower profit potential. Incremental innovations will be impacted due to reduced incentives for developing multiple drugs in the same class. Hence, may discourage refinements to existing therapies. Also, drugs nearing market entry may be reevaluated based on new revenue projections.”
While Mallarapu agreed on the vulnerability of small molecules to this regulation, she thinks rare diseases and precision medicine might be less affected by the Inflation Reduction Act. “Rare disease treatments are often exempt from negotiations due to their small patient populations and may see increased R&D focus as a result. Similarly, precision medicine and targeted treatments impact smaller patient populations and may help avoid negotiation triggers. Hence, they have the potential for premium pricing, if significant clinical benefits are demonstrated. Breakthrough innovations and drugs with substantial clinical improvements may still command premium prices and could see increased R&D focus to justify higher prices. Basic research and early-stage drug discovery may be less directly impacted. However, it could face indirect pressure if overall R&D budgets are reduced.”
In addition to the Inflation Reduction Act, broader economic factors are putting a strain on biotech’s R&D.
Economic headwinds: Rising interest rates and their effect on R&D
“Broader economic factors, particularly rising interest rates, are significantly influencing R&D budgets and investment decisions in the biotech industry. Higher interest rates increase the cost of borrowing, making it more expensive for biotech companies to finance their R&D activities through debt. This can lead to reduced R&D budgets and more conservative investment strategies,” said Latshaw.
“Additionally, higher interest rates typically lead to lower valuations for growth stocks, including many biotech companies, making it more challenging to raise capital through equity offerings. The increased opportunity cost of investing in high-risk biotech ventures may also cause investors to choose safer options, reducing the overall capital available to the industry,” added BioPhy’s CEO.
This shift is leading to more conservative investment strategies across the industry. Companies are being forced to scale back their R&D budgets or focus on projects that promise faster returns and lower financial risk. “Economic uncertainty, including inflation and recession fears, can further contribute to more conservative investment strategies, with companies prioritizing cash conservation over aggressive R&D spending,” explained Latshaw.
Mallarapu pointed out that emerging biotech firms are particularly vulnerable to these economic headwinds. “With reduced cash flow projections and increased labor costs, many firms are shifting focus toward late-stage products that offer lower financial risk.”
Mallarapu identifies this context has created an increasing emphasis on mergers and acquisitions (M&A) in the life sciences sector, as leading companies seek growth and aim to safeguard their pipelines against the impact of shorter patent life cycles, driven by evolving regulations, drug pricing negotiations, and looming patent cliffs. To maximize resources, many are prioritizing late-stage products that are closer to commercialization.
“Companies are also considering geographic strategies, such as relocating R&D operations to more favorable markets with government tax incentives and lower costs, as well as diversifying their portfolios across different regions. Financial strategies include tranched investments tied to specific R&D milestones, allowing for more controlled and milestone-driven funding,” said Mallarapu.
Historically, there have been several instances of regulatory and economic shifts that led to slowdowns in R&D spending, each with its own long-term effects on drug development and innovation. Latshaw gives the example of the Hatch-Waxman Act. “The Hatch-Waxman Act of 1984 initially raised concerns about reduced innovation due to increased generic competition. However, it ultimately led to a more balanced approach to drug development, with companies focusing on both innovative drugs and improved formulations.”
Will the Inflation Reduction Act and the broader economic conditions set the stage for a new approach to drug development or will it just represent a downturn for certain companies like Evotec and Charles River Laboratories? This question needs a bit more time to take a step back but as Mallarapu puts it, biotech is a resilient industry. “Driven by the long life cycle of drug discovery and clinical trials, which can sometimes be 10 years or more, the industry has shown resilience, as these core components demand sizable investments in innovation and science. Although the beginning of the year was marked by cautious optimism, investors have been exercising more targeted and selective approaches in their investments.”
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