Drug making is a difficult venture. As if getting a drug through from discovery into marketing wasn't hard enough, every successful drug ultimately faces the same fate -- patent expiration -- after which its sales drop off significantly.

In this week's episode of Industry Focus: Healthcare, Kristine Harjes and Todd Campbell go through each of the steps involved in getting a drug to market, how high the failure rate is for each, and a few strange and interesting facts around this heavily regulated industry. Also, for investors who want to get into the space without taking on too much risk, Industry Focus shares a few companies and niches that are set up to do well regardless of the success of any one drug.

A full transcript follows the video.

This podcast was recorded on May 25, 2016. 

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Wednesday, May 25th, 2016, hump day of life-cycle week. On this show, we're looking at a therapeutic drug, starting from its discovery, and following its life cycle onward. I'm Kristine Harjes, and here to help me tell the tale is Motley Fool healthcare contributor Todd Campbell coming in via Skype. Todd, how's it going?

Todd Campbell: It's going great. This is going to be a really fun show, Kristine. It's going to be really informational for people. We're going to talk about discovery, development, approval, marketing, patent expiration. We have a lot to cover.

Harjes: I think one of my favorite things in planning for this episode was uncovering how many different companies are nestled within this process that you don't even really think about that much; but they're there, and a lot of them are probably traded. We're going to provide a lot of interesting investing ideas on this show. 

First things first, I think we should name our drug if we're going to be tracking it over its whole life. What do you say?

Campbell: I think that's a great idea!

Harjes: You have to tell me what you think. I was thinking we name it Foolmab.

Campbell: That's actually too easy to pronounce, but we'll go with that.

Harjes: (laughs) You're right, we need a few more J's and weird syllables in there. But for the purpose of the podcast, I think that we should keep it simple, because Lord knows, I'm going to trip over it enough already.

Campbell: Foolmab it is.

Harjes: Foolmab is born on this lovely May day. First thing in his life would be discovery.

Campbell: This is going to be a lot of fun, because we're going to walk through all these different stages with Foolmab. We're going to show you how the sausage is made -- or isn't made -- because there's such a chance for failure at any one of these stages along the way.

Harjes: Where the sausage falls apart.

Campbell: In discovery, you have the greatest chance of failure. This is where all of the exploratory work is being done. Everything is investigational at this level. You're basically taking a concept that you might have, and you're trying it out. This is all about the Petri dish.

Harjes: Yeah, this is where you have the dartboard, and you're just slinging darts at it.

Campbell: Absolutely. You're going to start out with an idea. It's all lab work, then maybe you're going to start to do some preclinical work where you'll take a drug, and we'll try Foolmab out in maybe some mice, and see how those mice react to it. Again, no human clinical trials at this stage. This is all just... we're throwing the darts and seeing what sticks.

Harjes: At this point, it's typically private companies that are involved. You also have your NIH-type grant companies -- you can't really call it a company. Not really a whole lot that's investable here, yeah?

Campbell: Right. You have educators hard at work at places like UCLA that are doing the hard work of researching some of these concepts. They're getting funded by NIH. NIH has a massive $30 billion budget that they dish out in grant money to help support the development of these, or the discovery of therapies. 

On the other side, you have very young companies. Sometimes, they're being started or spun out of these universities. And most of the time, they're backed by venture capital, which means that the average mainstream investor does not have an opportunity to invest in these. And that might not be a bad thing.

Harjes: Yeah, if they were public, I would imagine they would be extremely risky at that point.

Campbell: Very much so. Then, if you look at it and say, "I'm an investor and I want to have exposure to the discovery stage," probably the best approach there is to consider who's supplying the beakers to the lab. In that case, probably the biggest out there is Thermo Fisher (NYSE:TMO).

Harjes: Yeah. They're a really interesting company. You can get that exposure to the discovery phase of things, but they're not quite as risky. They're a big company. They bring in a lot of money. And they have a fairly diverse business.

Campbell: Yeah. We're talking about a company that does $16 billion in annualized sales. This is not a small company. It's a big company. And it's profitable, and it's growing. Sales were up 10% last quarter year over year. It's a profitable company. It's generating out earnings every quarter for their investors. So yeah... this is a good de-risked way of investing in the discovery generations of therapies, regardless of who develops the drug. I want to be involved in the discovery of the next generation of therapies. TMO is a good way to do that.

Harjes: Foolmab is born, and goes into development. As a lot of our listeners will know, there are three phases of developing a drug. You have your Phase 1 trials, Phase 2, and Phase 3. Todd, do you want to give us a quick rundown of what the difference in those phases are?

Campbell: Absolutely. You have the three phases. Foolmab will have to go through all three of these phases, as will most drugs. There's an exception, and we'll get to that in a minute. Phase 1 is more to figure out the dosing. We have this great idea, and preclinical studies. Now, let's figure out, with a small trial in humans, what the safe dose is that we can give to people. That's Phase 1.

Phase 2, you're now saying, "I have the dose. Now let's make sure it's safe. By the way, we'll also look to see if it works as a secondary endpoint." That's Phase 2. Phase 3 is, Phase 2 showed that there's some efficacy; it showed that it is safe. Let's it roll it out to a lot of people, and make sure that this drug is as good as we think it is based on our Phase 1 and Phase 2 studies.

Harjes: One company that I want to highlight here is a company that manages all the paperwork involved. As you can imagine, this is a really complicated process. You have to keep track of everything, there's a lot of information being created that needs to be stored. The company is Veeva Systems (NYSE:VEEV). You might be familiar with them because of their CRM Life Sciences IT for sales and marketing. They also have this Veeva Vault part of the business that does exactly this -- keeps track of all the R&D information.

Campbell: Right, and Veeva is an interesting stock, because not only can you participate in the development stage, but Veeva also participates in the commercial stage, which we'll get to in a minute. Another stock that might be intriguing for investors to check out is Quintiles (NYSE:Q). The reason that Quintiles is interesting is that they help run all of these clinical trials. So they're going to be working with the Bristol-Myers of the world in figuring out where are we going to recruit patients? How are we going to manage all of those patients; how are we going to manage that data? So, that's another company in the development stage that might be worth checking out.

Harjes: Yeah, they're known as a CRO, which is a contract research organization. I believe they actually have an agreement to merge with IMS Health. Is that right?

Campbell: Right. In that case, they're also going to move a little bit into the commercial stage, as well. That deal could be a pretty important one. This is a stock I'm watching. I don't currently own it, but I'm very intrigued by it. I want to see how that integration goes with that merger. If that goes well, this might end up in at least this Fool's portfolio.

Overall, you and I, on the show, we talk a tremendous amount about clinical-stage companies. Usually it's Phase 1, Phase 2, Phase 3 drugs. Investors should probably remember that, whenever we're talking about those kinds of drugs, Phase 1 is highly risky, Phase 2 is a little less risky but still pretty risky, and Phase 3 is also risky. You look at historical failure rates in clinical trials, and in cancer alone, 50% of Phase 3 trials still fall short. So if you're looking for investment ideas that don't have the risk of trial failure, then Veeva and Quintiles are two you might want to keep in mind.

Harjes: Another one that I would consider very low risk is actually a healthcare REIT, which is a real estate type company. They're HCP (NYSE:HCP). They have over 1,000 different properties in senior housing, post-acute care, life science, and medical office building. A good chunk of that is going to be the actual place where you're doing this discovery and development work. We're familiar with the demographic trends here. We know that more and more drugs are being created every day because people are living longer, so they need more drugs. HCP stands to capitalize on that.

Campbell: What's nice about HCP, too, is that the facilities that all this drug research and everything is occurring in, they're complex facilities. You can't just go down the street and rent from another person. They're building these out for clients who have very specific needs. As a result, they don't have a whole heck of a lot of churn in their leases.

Harjes: Yeah, another point to add to that is, once you get approval for your drug, you can't change it. If you have a specific process in place, you're going to keep using that process.

Campbell: Exactly. And we're going to get down to another idea shortly. I don't want to jump too far ahead, but we're going to talk about the process of creating biologic drugs that people can invest in. But I suppose we could jump to approval, if you're alright with that, for Foolmab.

Harjes: Let's keep with what you just mentioned about bioprocessing right before we move on. I believe you were referring there to Repligen (NASDAQ:RGEN), right?

Campbell: Yeah, absolutely, that's the stock I was hinting at. This is a company that makes proteins and things that are needed for the biotechnology company to create their biologic medicine. Biologic drugs are complex. They're made in living organisms. Because of that complexity, Repligen has carved out a very intriguing niche, supplying them with vital tools they need to create these drugs. They're not a huge company. They only have about $100 million in annualized sales. But they are growing by double digits.

Harjes: Since we're talking about Foolmab, I want to explain why we're using "mab" there. A lot of drug names will end in these three letters, M-A-B. It stands for monoclonal antibody. Repligen, so much of their revenue is tied to the development of these monoclonal antibodies, which is the fastest-growing segment of the biologics market. These are drugs like Humira and Soliris. Really important niche of biotechnology.

Campbell: A significant number of drugs that are in trials right now, and making their way through, are biologics. Theoretically, with thousands of more drugs in development than there were, say, 10 years ago, their tailwinds should be pretty good for this company.

Harjes: Let's now turn to the approval process. You make it through your Phase 1, 2, and 3. You have an application ready to go to the FDA. What happens?

Campbell: Right. You figured out the dose, you've shown that it's safe, that it helps treat the condition you're targeting. Now it's time for you to put your application together and submit it to the FDA, the regulator that's in charge of either giving the go or no go to the market drugs in the United States.

Harjes: So Foolmab files its new drug application. In theory, it should get a decision roughly 10 months after this application is accepted.

Campbell: Right. The FDA will typically accept an application within a couple months of it being submitted. Sometimes faster. At that point, the clock starts ticking. It's a 10-month PDUFA date. If you ever see that as you're going through earnings releases -- PDUFA -- that is the date at which the FDA is scheduled to issue its decision. The decision can come before that. And of course, extensions can be granted that will push that date out.

But that's the target date for the decision on the drug. There is a thing called "priority review" that can get granted for drugs that are targeting life-threatening diseases, like cancer, that can deliver game-changing improvements over standard of care. In those cases, priority-review decisions are usually on a timetable of six months or less.

Harjes: What's interesting is, there can be a market for these vouchers at time, which is kind of a quirky concept.

Campbell: Yeah, there's a thing called a pediatric voucher. The whole idea was, if we can try and incentivize drugmakers to focus on rare diseases that affect children, then we'll get those cures more quickly. The way they did that was by providing a voucher that, if a drug that targets a rare disease in a child gets approved, this voucher can then expedite the approval of a future drug. What's happened is that companies are turning around and getting these vouchers, and then reselling them to other companies. I think the biggest sale so far was for $350 million. These vouchers are not chump change.

Harjes: Yeah, I get the impression that the FDA is not a huge fan of what has become of these processes.

Campbell: Yeah, the vouchers basically give you accelerated approval, a priority review regardless of what the drug targets. So you could be testing cholesterol rather than a rare disease. They're like, "Why should we be giving a voucher out that makes us have to speed a drug along and take resources away from a drug that maybe really should have our focus in approval?"

Harjes: Yeah, it's the whole theory of a zero-sum game. If they do more attention on this, that's less attention on something else that could be potentially even more game changing.

Campbell: Right. And I don't want to forget this point, either, for investors -- when you're considering the approval, let's say a company comes out and says, "Yay, we have an approval for Foolmab!" Investors should not automatically think, "Alright, blockbuster billion-dollar drug! I have to get on board! I have to own this stock!" There can be hiccups in that approval that can derail the commercialization efforts of the drug.

Harjes: Hiccups for Foolmab? What are you talking about?!

Campbell: I know, this isn't inhaled insulin. But there could be some risks.

Harjes: Yeah. Commercialization is not always a cut-clear-dry path. Something that matters quite a bit is the label that eventually gets slapped on the drug. This matters quite a bit for commercialization. If you have, for example, a warning on the label that says, "There's a huge risk of something devastating if you take this drug," it's going to be a heck of a lot harder to actually sell that drug to the doctors and to patients.

Campbell: Right. These are called "black box warnings." All you have to do is basically google "Foolmab + label," and you can read the label, and if it has the black-box warning, you have to spend a little extra time considering, are doctors going to feel OK prescribing this drug? If it's for something that's not a life-threatening condition, a black-box label can create quite a hurdle for a drugmaker to overcome.

Harjes: Another hurdle for the drugmakers to deal with at this point in the life cycle is pricing, and negotiating that reimbursement structure with the payers. 

Campbell: Right. When we get into the marketing phase of the life cycle, we have to deal with a lot of different issues. We have to make sure that you have the infrastructure in place, too, as far as sales people who can go out and call on doctors and try and pitch the drug. You have to have the manufacturing in place to be able to produce the drug at enough scale to be able to fulfill need. There's all sorts of other things that are involved in the commercialization aspect. No matter what, if you can secure reimbursement from payers like insurance companies, doctors aren't going to prescribe it; patients are going to pay for it.

Harjes: This is, again, a place where Veeva Systems comes in with the CRM family of applications. They will allow you to market successfully and also compliantly, which is huge. We see this happen every once in a while, where doctors are not exactly being marketed to fairly. This was a big deal in China with GlaxoSmithKline a while back. It is something that comes up from time to time, because it's a tough landscape to deal with. You want to make sure you're playing by the rules here.

Campbell: Right. On the label, the FDA will tell you what the approved use is. A doctor can prescribe a drug for an off-label use -- they're allowed to do that. But a drugmaker cannot recommend Foolmab for something that is off label. It has to come from the doctor's own decision, rather than marketing that's put in front of him by the drugmaker. That's where some of these companies have run afoul in the past, where they're going out and making claims that they really are not cleared to be making.

Harjes: Let's say you've cleared that phase. Foolmab is successfully being marketed to doctors. It's out there, everybody knows about it, it's been prescribed. Years go by, and what happens?

Campbell: The one thing that everybody has to know about the life cycle of a drug, for the drugmaker, is that it's a defined endpoint life cycle. You are basically forced to compete once your patents expire. 

Harjes: And there are sort of ways that drugmakers will try to get around this; but yeah, Todd, what you said hit the nail on the head. It does come to an end. Eventually, you're going to face competition from generics that are a heck of a lot cheaper than your original branded version.

Campbell: Right. Generics came on the scene in a big way in the late 90s, expanded dramatically throughout the 2000s, and now, roughly 80%-85% of all prescriptions that are written are for generic versions of drugs. These drugs are cheaper. They can cost 80% less than the brand name. As a result, sales for the drugmaker of Foolmab will fall dramatically once the patent on Foolmab expires.

Harjes: I feel like we haven't mentioned a company in a while. What's one of your favorite generic drugmakers?

Campbell: There's a couple that I really like. On the traditional generic-drug side, I happen to like Mylan Labs (NASDAQ:MYL)Teva Pharmaceuticals (NYSE:TEVA) is another one that we've talked about on the show that's intriguing. Those are two companies that investors might want to consider. They're the two biggest out there, if you will, in the generic-drug space. 

There's also a very young emerging generic industry that's associated with biologic drugs. These companies are creating alternatives that aren't exact copies of biologics, but they work similarly. They're called biosimilars. That's an area that people should be focusing on, as well.

Harjes: There's a really interesting article on fool.com walking you though a bunch of things you need to know about biosimilars. If any of our listeners are interested, send us an email at industryfocus@fool.com, and I'll send you that article. It's by Brian Orelli, who's one of our healthcare writers.

Patent expiration is definitely devastating. But I would argue that the true end of a drug's life is actually when it gets replaced by something new that's more effective, and people stop taking it. Eventually, this drug, Foolmab, stops being manufactured, and the new generation takes over. So it goes, Foolmab!

Campbell: Right. Patents last 20 years, but drug development is expanding so quickly now -- what we know about the human genome and the genome of disease is just exploding. As a result, drugs are coming on that work faster, better, that are safer, in a much shorter time period than that 20-year window.

Harjes: Yeah. It is kind of a beautiful life cycle. Todd, I'm happy to have walked through Foolmab's life with you. Thanks so much for sharing the journey with me!

If my timing is correct, it's that time of the show where the closing music comes on. Listeners, have you noticed the new tunes recently? Thanks a bunch to Motley Fool's production expert Steve Broido, and our very own man behind the glass, Austin Morgan, for making that happen. 

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

Kristine Harjes has no position in any stocks mentioned. Todd Campbell owns shares of Mylan. The Motley Fool owns shares of and recommends Veeva Systems. The Motley Fool recommends Mylan and Teva Pharmaceutical Industries. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.