Can a dose of digital cure the drug industry of its ills?

Morgan Stanley Bluepapers, a product of our Research Division, involve collaboration from analysts, economists, and strategists across the globe and address long-term, structural business changes that are reshaping the fundamentals of entire economies and industries around the globe.

Digitalization has transformed virtually every sector, from retail and media to travel and finance; but it's been slow to gain a foothold in the healthcare industry, which is heavily specialized and regulated, walled in byzantine mazes of patents and intellectual property rights, and guarded by scientists, well-heeled research labs, and some of the largest corporate players, from hospital systems and health insurers to Big Pharma.

It's no surprise that, so far, digitalization in healthcare has been somewhat skin deep. Think fitness trackers, consumer electronic medical records, or outpatient management and billing. It has yet to, say, double the rate at which laboratories are creating breakthrough drugs or lower the cost of treatment and medications. Online retail hasn't revolutionized how much consumers are paying for their prescriptions.

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Now, as cash-rich technology companies make meaningful moves into healthcare, disruption and change are coming to the drug industry, according to a new Morgan Stanley Research Bluepaper, "Digitizing Drug Development: How Much Can It Save?" To understand the implications of how technology and healthcare intersect, Morgan Stanley's global therapeutic, healthcare services and technology teams joined forces, debating and researching emerging trends over the past year.

Digitalization, they conclude, may hold the key to improving drug development and supply-chain management, delivering greater efficiency and transparency that can result in new, better, and cheaper drugs and healthcare, with far-reaching ramifications for both tech and healthcare companies and investors, as well as regulators, policymakers, care providers, and patients fueling the populist backlash against rising costs.

Indeed, Morgan Stanley's joint analysis suggests that companies could realize more than 20% in potential annual research and development savings by 2030. That translates to an average savings of $330 million per approved drug.

Improving healthcare through disruption

Digitalization has already made its mark in some segments of healthcare, notably consumer wearables, medical devices, and evidence-based medicine. Over the past couple of years, however, major tech companies have ramped up their investments in healthcare ventures, suggesting that they will broaden their reach.

"A year ago, we observed a sharp increase in technology company investments targeting healthcare inefficiencies," says Katy Huberty, who covers the technology hardware sector. She notes that tech executives now account for around 7% of healthcare company board seats, adding: "The rise in partnerships and board cross-fertilization signals an increased interdependence that can't be ignored."

Although the biopharma sector hasn't adopted digitalization in a meaningful way, changes here could have significant implications for society and investors. "Technology can potentially reduce prices for individuals, while improving the efficacy of R&D and enabling more medical breakthroughs," says Ricky Goldwasser, who covers healthcare services and co-authored the Bluepaper report. "As soaring drug prices stress the healthcare system, political and public pressure may force biopharma to seek efficiencies and lower costs."

Faster, more, better

One way that digital can have a clear impact: helping the drug industry develop, test, and get approval to market new medicines or devices. Wearable devices or mobile apps that track a range of physical traits to gauge how patients are doing in large clinical trials can bring in real-time data and updates. These are now largely collected via periodic visits to labs or hospitals, which are time-consuming, labor-intensive, and costly.

They also depend on human reliability, both in the trial patients and those collecting the data. Simply getting all of the subjects enrolled in trials to show up regularly for their check-ins can be a challenge, Goldwasser notes. Subjects must relate their experience of a drug or treatment from memory, and delayed responses don't always make for the best data. Equipping patients with connected mobile devices attuned to collecting specific information — for example, pulse rates or blood pressure — can eliminate the guesswork and provide far greater data with more reliability.

Digital could speed analysis and diagnostics. Researchers can apply artificial intelligence to analyze large-scale trial datasets that encompass biological, chemical, behavioral, and other factors, comparing results with broader networks of existing datasets to identify patterns, outliers, or flag results that need immediate attention.

Researchers can also employ digital tools in the front-end development process. For example, large pools of research data are available on various chemical compounds and their toxicological profiles. Employing AI to comb through the records of a certain compound for known laboratory results can eliminate trial and error and reduce the time needed to identify potential leads.

In the promising field of genetic engineering using CRISPR, the breakthrough biotechnology that lets researchers edit genetic sequences with as much precision and ease as text applications allow writers crafting a sentence, digital tools could revolutionize how fast scientists can edit into existence and test cures for any number of gene-based afflictions.

"Across all therapeutic areas, we estimate that IT-driven savings could represent on average 18% of Phase 1 costs, 27% of Phase 2 costs, and 22% of Phase 3 costs," says Vincent Meunier, who covers the European pharmaceutical sector.

Prognosis for drug companies

For drug companies, digitalization potentially cuts both ways. On the one hand, it could enhance R&D, help companies market treatments more effectively, and streamline other areas. On the other hand, the greater transparency that digitalization often brings might curb the drug industry's pricing power.

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Similarly, the effects of technology integration are still a topic of debate. "Some drug companies believe that data can transform clinical trials and are pursuing partnerships, while others are pushing back," says Meunier. Indeed, industry participants and experts seem to fall into two camps, he says: One group believes that over the longer term, increased use of technology will improve the clinical trial process, while the other believes that technology will aid in discoveries, but won't become a major driver. Either way, "emerging cracks in Big Pharma's pricing power may force healthcare companies to embrace change sooner than many expect," Meunier says.

To help investors gauge the implications of digitalization, Morgan Stanley's team of analysts devised a matrix based on price transparency and technology integration. They then outlined four different scenarios:

• Rainbow's End: A win-win for biopharma, this combination of high integration and low price transparency results in reduced R&D costs and outcomes, but with little to no change in pricing.
• Balancing Act: High integration offers reduces development time and costs, but purchasers realize greater costs savings, as value-based pricing gains wider acceptance.
• Status Quo: Technology enhances innovation but isn't a major driver in new discoveries. Drug companies raise list prices less aggressively, but market-based pricing remains.
• Doomsday: Legislative/regulatory changes put pressure on prices; technology has little impact on R&D efficacy.

Tech's heavy hitters

While the impact of digitalization on drug companies hinges largely on price transparency and technology integration, investors should also consider how the shift to digital has played out in other industries, including media, retail and travel. "New disruptive companies always win, but incumbents can outperform if they are early to adapt," says Huberty.

To be sure, a number of factors offer biopharma companies some degree of protection. Intellectual property rights to research results, drug compounds, treatment methodologies, testing, diagnostic and manufacturing patents, all present high hurdles to digital disruptors. The scientific expertise and regulatory knowledge required to develop, test and get approval to market drugs also give incumbents a significant edge. Even so, the increased investment and interest by tech leaders "is worth watching," Huberty notes.

Meanwhile, healthcare initiatives aren't embedded in tech-company valuations, with the biggest potential upside for some of the largest players. "Any clear progress impacting the cost or efficacy of drugs could accelerate earnings contribution from these healthcare investments," says Huberty. "That could impact technology company share prices positively."

This article is adapted from the Bluepaper report, "Digitizing Drug Development: How Much Can It Save?" (Apr 6, 2017). Institutional clients can ask their Morgan Stanley representative for the full report, or access it directly. Wealth Management clients can ask their Morgan Stanley Financial Advisor for a copy, or access the report by logging into their Morgan Stanley Online account. Get more Morgan Stanley Research and Ideas, or find a Financial Advisor.