Negative Shocks May Hit Twice in Pharmaceutical Development

Clinical Researcher—December 2020 (Volume 34, Issue 10)


Manuel Hermosilla


One defining aspect of the pharmaceutical industry is its high exposure to negative shocks—product recalls, tornados that shut down production lines, Phase III failures, you name it. As my thinking about some of these shocks has grown over time, I’ve come to realize some shocks may hit twice—the second time being the moment a sub-par decision is made in an attempt to recover from the original hit. With stakes being so high, it seems particularly important for leaders in this industry to remain aware that they are not immune to the perils of reactive decision making.

This point can be underlined using a case study from my recent research published in the INFORMS journal Management Science. The bottom-line message is that, in addition to requiring the self-awareness and reflectiveness of individual decision makers, preventing costly reactive behavior may require organization-level action.

The case study focuses on drug candidate in-licensing, which I’ll address from the perspective of a “buying” large pharmaceutical firm and refer to simply as “licensing.” Recent statistics suggest that more than a third of the new drugs launched by large pharmaceutical firms are obtained via licensing, often from a young and small biotech startup. This underrepresents the importance of licensed drugs because they tend to be more therapeutically and commercially impactful than those developed in-house by large firms.

Thus, it seems safe to say that licensing is a highly important activity for the modern pharmaceutical industry. Accordingly, these firms do not spare efforts to get the most out it—in a typical year, a big pharma firm may identify and review several thousand licensing leads while following through only in a handful of cases.

The low ratio of completed deals to leads reflects a crucial aspect of licensing. Firms need to make sure they are licensing the “right” technology (i.e., one which they have the expertise to develop and that fits the firm’s portfolio and medium-term strategy). Much of the complexity of doing this has to do with the technological novelty of licensed drugs, most of which are unvalidated at the time of licensing, and about which the selling firm knows a lot more than any other scientific team in the world.

To deal with these complexities, large pharmaceutical firms employ multi-disciplinary teams through the scouting and screening process; but that’s not all. While the overarching goal of licensing is clear (developing a new drug), the specific hurdles that will appear along the way are highly uncertain and contracting parties may have different hierarchies for what is most important to accomplish (e.g., should the molecule be optimized for emphasized safety or efficacy? How soon should findings be published in an academic journal?).

The question for the buying firm then becomes, how to keep the selling party engaged throughout the (typically long) process? These considerations explain why reaching agreements is such a highly involved process, which usually takes the better part of a year or longer.

Picking Up the Pieces of a Phase III Failure

My analysis focused on the licensing behavior (and the fate of licensed drugs) in the aftermath of a distinctive kind of large, negative shock in the industry—the Phase III failure. Phase III trials are the largest, longest, and most expensive stage of drug development—the monumental last hurdle to overcome to reach the market. Unfortunately, experimental drugs fail to produce satisfactory results at this stage—as many as 50% by some estimates.

When these failures occur, organization-wide anxiety levels go up automatically. They mean that the years-long, collective work of many professionals in the organization will not pay off. Perhaps more importantly, Phase III failures raise questions about the future (e.g., what product will fill the pipeline gap left by the failed drug?). Phase III failures are a true test of an organization’s character—a time when measured, level-headed decisions are particularly important.

I studied the problem by constructing a sample that covered the licensing and development activity of 20 of the largest pharmaceutical firms worldwide between 2000 and 2015. The sample contained about 400 Phase III failures, scattered across therapeutic areas, firms, and time. Even though these failures are not completely random events (e.g., they are more common in cancer), there is a lot of randomness relative to the specific time at which they occur.

This was an important observation for my first analysis, where I looked at how much licensing there is in the immediate aftermath of a Phase III failure. Because the precise timing of failures is given by factors that are close to random in practice (e.g., patient recruitment, the molecule’s specific therapeutic properties), these events could be seen as natural experiments. I found that, in the year that follows a Phase III failure, licensing activity about doubles; firms seem to react to failures.

In general, does this type of reaction ultimately help the firm overcome the adversity or only further aggravate it? To answer this question, I followed the development histories of all licensed candidates, separating them into those licensed “in a rush” (within a year of a Phase III failure) and those licensed under normal conditions. The former group was significantly less likely (about 10% less) to reach the market than the latter group. This result portrays rushed post-Phase III failure licensing as self-added insult to injury.

Some evidence indicates that contracting issues may be to blame for this outcome—rushed negotiations that lead to contractual “lose ends,” which increase the chances of inter-organizational frictions and, ultimately, derailed collaborations. Insufficient or weakened due diligence standards may also be relevant.


Leading industry figures have suggested that the industry’s current productivity struggles may not just be a matter of the underlying science—decisions and personal accountability may also play a role. This argument resonates loudly in the present context—because success is so elusive (i.e., most drugs fail the process), the incentives faced by research and development leaders lead them to prize activity (number of deals, pipeline size, new trials) rather than accomplishment. As illustrated by this case study, this scenario could be a fertile ground for decisions that may end up being damaging overall, if there is no system of checks-and-balances in place.

Manuel Hermosilla is an assistant professor in the Carey Business School at Johns Hopkins University, where he studies diverse aspects of new product innovation, with a focus on the biopharmaceutical industry. He is an active member of the Institute for Operations Research and the Management Sciences (INFORMS).