Working with Risk in Pharma R&D

© Kelvin Stott 2013

Working with Risk in Pharma R&DHow to define, measure, manage, and embrace it

Kelvin Stott PhDPharma R&D Portfolio Strategy, Risk & Decision Consultant

BPE Pharma SummitLondon, 27 February 2013

© Kelvin Stott 2013Source: BCG / Bernstein Research, 2010

R&D productivity has fallen by 99% over the past 60 years: Cost is now $4 billion per NME!

New technologies have done nothing to slow the steady decline in R&D productivity

Note thelog scale!


Biggest cost is failure as attrition rates have risen dramatically, especially in late development

Source: PhRMA


Decreasing quality of new

drug leadsTechnical

Increasing standards

of care

Commercial& regulatory

Pharma R&D output has been hit by technical, commercial, regulatory & operational factors

Decreasing productivity

Increasing costs/project

Increasing timelines

Decreasing success rates

Decreasing organizational effectiveness

Operational

Poor decisions due to misunderstanding of risk


What is risk?

How to define risk?

How to measure it?

How to manage it?


Risk defined by ISO 31000

“Effect of uncertainty

on objectives”


What is the main objective?

Get new products to market?Meet customer needs?Maximize sales/profit/value/ROI/… ?Minimize/manage risk?Maximize probability of success?Optimize time, cost, quality?Do the right projects, do them right?Support the strategy?Manage resources effectively?


Objective depends on stakeholder perspective

Business & ShareholdersMaximize Actual Net Value Added (NPV or ROI)

Customers (Patients, Physicians, Regulators, Payers & Providers)

Maximize Actual Net Health Benefit vs Cost

1. Business objective absolutely depends on customer objective as key value driver (win-win)

2. Actual outcome ≠ Expected outcome3. Potential difference is based on risk


Expected value depends on many value drivers: All of them are assumptions!

Expected Value/ROI

OperationalTechnical & regulatory Commercial BD&L

Sales, P&L, cash flow forecasts

Financial

Product claimsPoS by phaseProb. approval

R&D costs R&D timelinesLaunch dateCapexCOGSS&M costsG&A costs

Target patientsMarket shareAdoption rateDose & compl.Net priceNew entrantsGeneric entryOther factors

Licensing feesDev. m’stonesSales m’stonesRoyalty rates

Discount rateDSI, DSO, DPOExchange ratesInflation ratesTax rates


Risk is uncertainty in value, based on uncertainty in all value drivers (quality of assumptions)

Value/ROI± RISK

OperationalTechnical & regulatory Commercial BD&L

Sales, P&L, cash flow forecasts ± RISK

Financial


R&D costs R&D timelinesLaunch dateCapexCOGSS&M costsG&A costs

Target patientsMarket shareAdoption rateDose & compl.Net priceNew entrantsGeneric entryOther factors




Corporate Value ± RISK

Comm. portfolioValue ± RISK

TA portfolio Value ± RISK




Project Value± RISK




Product Value± RISK




R&D portfolioValue ± RISK

Portfolio risk is based on uncertainty in the value of all projects (and individual value drivers)


Business goal is to optimize risk-return profile of asset value/ROI in line with risk appetite

Risk

Expected Value/ROI

Risk appetite

Available options

Target

profile


Similarly, customer goal is to optimize risk-return profile in terms of Net Health Benefit vs Cost

Risk

Expected Net Health Benefit vs Cost

Risk appetite

Available options

Target

profile


Each point on risk-return landscape represents uncertainty in expected outcome

Expected Outcome

Risk


Risk & uncertainty: Basic concepts

Both risk and uncertainty are:Based on the current lack of certainty in a potential fact, event, outcome, or scenario, etc.Defined by probabilities or probability distributions Include upside and downside potentialSubjective: depend on who knows what

Key differencesRisk involves exposure to impact: consequences that matter to a subjectHence, risk is even more subjective, depends on how much the consequences matter, to whom


3 basic sources of risk & uncertainty

Known unknownsPotential facts, outcomes, scenarios that we are aware of, but don’t yet know with any certaintyBased on stochastic processes and known probability laws

Unknown knownsCertain facts that others know but we don’tBased on information asymmetry or poor communication

Unknown unknownsPotential facts, outcomes or scenarios that we are not yet aware of, have not considered or encountered beforeRare and extreme events or outliers (“black swans”) in the tails of a probability distributionOften over-looked due to lack of experience/imagination


Risk and uncertainty are often complex, based on discrete & continuous probability distributions

Discrete

Continuous

Complex


Volatility risk is expected deviation from expected value (mean absolute deviation vs eNPV)

Scenario Value

Probability

Expected value

(eNPV)

Downside volatility

risk

Upside volatility

risk


Downside tail risk is average value (expected loss) over worst X% of all potential scenarios (CVaR)

Scenario Value

Probability

Expected value

(eNPV)

Downside tail

risk


Volatility Risk ≠ Tail Risk ≠ Probability of Failure≠ Maximum Loss ≠ Risk-Adjusted Value

Scenario Value

Downside volatility

risk

Upside volatility

risk

ProbabilityProbabili

ty of failure

Expected value

(eNPV)

Maximumloss

Downside tail

risk


PoS is a key value driver, but a poor & misleading indicator of risk (uncertainty in value)

PoS

ValueExpected Value= PoS x Upside

Value + (1-PoS) x Downside Value

Volatility Risk= 2 x PoS x (1-PoS)x (Upside Value -Downside Value)


Even the experts misjudge risk in the most clear and simple cases

4 simple options have the same expected value of $100: Which is the “MOST RISKY” option?1. Gain $100 (100% probability)2. Gain $300 (75%) or lose $500 (25%)3. Gain $500 (50%) or lose $300 (50%)4. Gain $700 (25%) or lose $100 (75%)

13% of experts1 chose Option 1 as “most risky”26% chose Option 2 based on potential loss only26% chose Option 4 based on probability onlyOnly 35% chose correct Option 3 based on potential loss and probability combined2

1. LinkedIn survey of over 800 professional risk managers, financial analysts and investors2. Greatest risk according to all key risk metrics: expected loss ($150); downside risk vs EV ($200);

standard deviation ($400); mean absolute deviation vs EV ($400)


Where are your projects now on the risk-return landscape? Where is your overall portfolio?

Risk

Phase 1projects

Phase 2projects

Phase 3projects

Currentproducts

BD&L options

Expected Value/ROI


Risk appetite

Target

profile

Where do you want them to be? How will you get them there?

Risk

Available options

Expected Value/ROI


Risk-return profiles are evaluated, managed and optimized by a continuous iterative process

EVALUATE PROGRESS

DEVELOP & EVALUATE OPTIONS

MAKE DECISIONSEXECUTE

DECISIONS

RISK-RETURNOPTIMIZATION


Expected value & ROI are calculated based on all potential value drivers (assumptions)

Value& ROI

Operational value drivers

Technical & regulatory

Commercial value drivers

BD&Lvalue drivers


Financial value drivers


R&D costs R&D timelinesLaunch delayCapexCOGSS&M costsG&A costs

Target patientsMarket shareAdoption rateDose & compl.Net priceNew entrantsGeneric impactOther factors




Uncertainty in each value driver is modeled by a 4-parameter distribution fit to all available data

Bottom-up analysis

Top-down analysis

Internal experts

External advisors

Skew ShapeMean Spread


The Science and Art of evaluating risk

Left and right brain must work

together


The probability distribution of each value driver is fed into the valuation model

Value& ROI




BD&Lvalue drivers









The expected value distribution is calculated by Monte Carlo simulation to evaluate risk

Scenario Value

Probability

Expected value

(eNPV)

Downside volatility

risk

Upside volatility

risk


Target

profile

The risk-return profile is plotted on the risk-return landscape to represent uncertainty in value/ROI

Risk

Expected Value/ROI

Risk appetite


Options are developed by creativity and intuition, based on sensitivity of key value/risk drivers

Project value/ROI ± riskValue driver

Phase 3 PoS

R&D timelines

Phase 2 PoS

Market share

R&D costs

Generic impact

COGS

Uncertainty


Options are quickly evaluated by modifying only the relevant value/risk drivers (assumptions)

Value& ROI




BD&Lvalue drivers









Risk appetite

Target

profile

Risk-return profiles of options are calculated and plotted on the risk-return landscape

Risk

Expected Value/ROI


Risk appetite

Target

profile

Options are selected based on risk-return profile vs risk appetite

Risk

Expected Value/ROI


Target

profile

Changes in the risk-return profile are monitored as new data & information become available

Risk

Negative data

Positive data

Expected Value/ROI


The process is applied iteratively throughout the entire project/product lifecycle

EVALUATE PROGRESS

EVALUATE OPTIONS

MAKE DECISIONSEXECUTE

DECISIONS

Research& discovery

Preclinical developmt.

Approval& Launch

Lifecycle managemt.

Clinical developmt.


The process can be applied to any business asset, at any level, at any stage of development

Individual R&D projects (early or late-stage)Marketed products (branded or generic)BD&L opportunities (in & out-licensing deals)Entire portfolios (R&D or commercial)


Change and innovation require taking significant risks to step into the unknown


Risk-averse herd thinking can be very unsafe

© Kelvin Stott 2013Source: Bernstein Research, 2010

Especially when the industry is facing the biggest challenge in its history


Bobcat climbs cactus to escape hungry lion

Sometimes taking more risk is the safest, or only option to adapt and survive


Risk-averse corporate cultures are reinforced by a vicious cycle

Risk-averseleadership

Risk-aversedecisions

Risk-aversebehaviour

Risk-aversehiring &

promotion

RISK-AVERSECULTURE,

RESISTANT TO CHANGE


Generics and biosimilars:

exact copies of existing drugs competing on

price only

Pharma companies face a strategic dilemma to take on more technical or commercial risk

Incremental improvements

of existingdrugs based on

established target/MoA

Revolutionary first-in-class treatments

based on newand unproven target/MoA

Combination therapies and

improved formulations of existing drugs

Increasing technical risk (innovation)

Increasing commercial risk (competition)

Regardless of strategy, overall risk is increasing with time


Key message

Pharma companies will need to take more risk in the short term – but

manage it better, smarter –in order to innovate, adapt and

survive in the long term


Summary

Risk is expected deviation from expected value, based on uncertainty in all value driversGoal is to optimize risk-return profile of assets according to stakeholder risk appetiteContinuous process of developing & evaluating options to navigate risk-return landscapeApplies to all assets, at every level, every stageRisk is critical for change & innovation, requires great courage by individuals (i.e., you)R&D is risk management: Manage the risks, the objectives will take care of themselves


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Thank you!

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