March 12, 2007 | A few months ago my firm invested in two diagnostic companies and we were very much not alone. In the first half of 2006, nearly $300 million of venture capital flowed into the United States and European diagnostics industries, which greatly eclipsed the amount invested in 2005. Anecdotally the VC’s are back and seem very excited about the broader disease management and personalized medicine investment opportunities. Clearly we have successfully emerged from the “nuclear winters” of 2003 and 2004 when approximately $100 million was invested in the diagnostics industry in each year.
It is well understood that overall health care costs are dramatically reduced with early detection and therefore further disease progression is curtailed. Even with early clinical detection, or at the time when symptoms are present, the disease burden is already quite meaningful. It is equally well understood that payors are wasting money on drugs which are not very effective on certain patient populations. Today’s detection and analytical tools are enabling tailored diagnosis and treatment planning. For instance, 50 years ago clinicians could diagnose leukemia whereas today we now know there are nearly 40 types of leukemia, each of which would be treated differently. Survival rates for leukemia have improved from negligible to now approaching 70%.
Observed Tony Shuber, CTO of Predictive Biosciences —one of our new portfolio companies — “there are no magic bullets out there for all cancers, and with the increased efficacy of all these new therapies, we are able to compartmentalize patients and dramatically improve survival rates.”
In addition to the numerous policy challenges, there are other issues that diagnostic companies must navigate. From an investor’s perspective it is deceivingly expensive to bring a new test to market, and those costs are expected to only increase. From marker discovery and validation to test development and clinical hurdles, analysts have estimated that it could be as much as $100 million to bring a broad based screening test successfully to market. How that is funded is very tricky, certainly when VC’s are expecting to make 5-10x their initial investment. Identifying and then funding to those interim development milestones is critical. Corporate partners and pharma will need to play an increasing role in funding downstream clinical studies and marketing activities.
Overall general market acceptance is challenging as well. Payors are nervous that the prescribing behavior of doctors may be slow to change given that there is not presently enough pharmaco-economic data to confirm the benefits. “Will we be able to demonstrate the potential of these diagnostic technologies and translate that into clinical practice?” questioned Shuber of Predictive.
And patients themselves will struggle to appreciate the idea of targeted therapies as the medical profession is able to sub-segment patient populations especially when patients will be denied a certain treatment because the diagnostic test implies the therapy will be ineffective.
Another meaningful challenge speaks to the heart of the business model itself: the CPT-code approach to reimbursing diagnostic tests is completely divorced from the value delivered. In order to move to a more holistic disease management paradigm, the savings to the healthcare system needs to be reflected in the pricing model for diagnostic technologies. For example, it is estimated that the typical reimbursement for a herceptin-2 test is slightly more than $300, yet the value provided to the healthcare system may be as high as $24,000 if it results in the proper treatment regimen.
The convergence of information technologies and medicine has created a patient population which is demanding more data and understanding for what ails them, or may ail them in the future. VC’s rational economic beings (well, maybe not all are) are relying on the fact that over time this demand for better understanding and the value proposition and reimbursement hierarchy will need to normalize. As evidence of that, there is increasing pharma collaboration activity with the diagnostic companies which will be a source of future revenue and funding, as well as probable exits. All of this underscores that the environment for diagnostics companies is improving.
Ultimately these companies will only be good VC investments if “the performance of these new tests results in decreased — and meaningfully decreased — mortality rates...and they can be incorporated into existing, established clinical algorithms...then this will drive clinical acceptance” concludes Shuber at Predictive. So yet again it really is all about the data.
Michael A. Greeley is managing general partner of IDG Ventures. He can be reached at: mgreeley@idgventures.com.
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