The relevant question is not whether inflation has come to stay or whether it is just a base effect that will level off again next year. The question that every biotech investor should−indeed must−ask is what impact inflation, should it become permanent, will have on the operational performance of his or her companies.

Generally speaking, inflation can have both positive and negative impacts on companies, but depending on the phase of the product life cycle, there are special situations for biotech companies: Under an inflationary regime, companies will have the flexibility to raise prices, but companies with more pricing power, coming from stronger competitive positions, will be able to do so more easily than companies without that pricing power, i.e. in businesses where customers resist to price increases. Consequently, in an inflationary environment, the former will be able to raise prices even more than the actual inflation rate, while the latter will miss it. With biotechnology companies, however, the ability to raise prices applies only those who are already revenue generating and to companies whose products and services are considered essential and non-discretionary, such as pharmaceuticals, which are in high demand regardless of the economic environment. This can help to insulate biotech companies from the negative effects of inflation, as they “simply” need to adjust the prices of their products and hence maintain their profitability.

Biotech companies in their pre-revenue stage do not have the ability to raise prices. In their case, inflation will increase the costs of research and development, a significant expense item for all biotech companies, but without them being able to pass on these higher costs. Instead, higher costs will worsen the loss situation on one side and will reduce available resources for innovation on the other side. This is all the more since health system spending increase will only take place−if at all−with a substantial time gap.

Rising costs on the one hand, higher uncertainty on the other: together are they poison for investors. With the consequence, that the more risk averse among them will shift their focus to lesser speculative investments. And so will inflation also affect the ability of biotech companies to raise capital from external investors.

Author: Peter Thilo Hasler, founder and Research Analyst of Sphene Capital, article orginally published in European Biotechnology Magazine Summer 2023