Big drugmakers are submitting to investors’ short-sightedness instead of doing the right thing.
FORTUNE — Earlier this year, drug giant Pfizer (PFE) announced plans to slash spending on research and development by a third. Its shares closed that day up more than 5%. Two days later rival Merck (MRK) went the other way, saying it would maintain existing R&D levels. Its shares fell by nearly 3%. Investors had sent Big Pharma a very clear message: Stop spending so much money to create new drugs, even if you’re losing exclusivity on your older drugs through the so-called patent cliff. It’s cheaper to just buy developed molecules from private startups.
Unfortunately, such sentiments elevate short-term dollars while ignoring long-term sense. They’re reflective of Wall Street’s callous indifference toward America’s health, even when that health is literal.
Right now Big Pharma has plenty of startups to acquire. But that wealth of opportunity won’t last much longer. Just take a look at venture capital investment in pharma, since it’s the financial engine that drives new drug development. High-level data indicate plenty of venture dollars are flowing into the sector, but the vast majority is going to mature companies that VCs won’t let wither on the vine. Early-stage startups are having a much tougher go of it, with 17% fewer raising venture capital during the first three quarters of 2011 than during the same period in 2010.
Moreover, a number of veteran VC firms are formally ending their pursuit of pharma startups. Scale Venture Partners, which began life 16 years ago as Bank of America’s (BAC) in-house venture group, recently stopped making any life sciences investments in new companies. And Morgenthaler, a 43-year-old firm, recently said it will invest only in tech companies going forward (its health care team will try to raise an independent fund). Overall, a recent National Venture Capital Association (NVCA) members’ survey found that 41% of respondents plan to decrease their number of pharma investments over the next three years. The therapeutic areas expected to be cut deepest are cardiovascular and diabetes.
Why? Most VCs point their fingers at decreased guidance and transparency from the FDA, which makes it difficult for both companies and their investors to understand future costs. “It just takes a lot longer now to get approval than it used to, or to even know what the FDA is thinking,” says Kate Mitchell, co-founder of Scale Venture Partners and former chair of the NVCA. “One of our companies, Prestwick Pharmaceuticals, supposedly was put on a ‘fast track,’ but it still took another three years before receiving FDA approval. It’s incredibly frustrating and means we need to invest more to keep the companies running.”
At the same time, non-health-care sectors like software have become less capital-intensive and quicker to commercialize. So if you’re a “generalist” VC firm, the temptation to abandon or de-emphasize pharma is hard to resist.
It’s an unsettling state of affairs. Big Pharma is succumbing to Wall Street’s worst instincts rather than demonstrating corporate and civic responsibility. Just let the next guy handle the fallout, and pray there’s an existing cure for what eventually ails me. VCs at least have a viable survival strategy, and I agree that the FDA needs to get its house in order. At the same time, however, VCs are ignoring recent research showing that their investments in life sciences actually outperformed those in software companies in the U.S. over the past decade. It might feel better to fund and flip a mobile app firm in 24 months than to back an unproven pharma startup, but that doesn’t necessarily make it the smarter long-term investment.
What we face is a looming imbalance in which demand for new drugs far outstrips supply. Maybe we’ll look back and rue the day that short-term financial considerations were given priority over long-term planning — at least those of us lucky enough still to be alive.
This article is from the December 12, 2011 issue of Fortune.