Background and context

In 2006, Australia's pharmaceuticals industry employed over 34 000 people and had an annual turnover of approximately $17 billion, including almost $3.4 billion in export earnings.¹

The Pharmaceuticals Partnerships Program (the Program) is a $150 million Australian Government program designed to fund companies that forecast a capacity for financing and performing ‘additional' high quality pharmaceuticals research and development (R&D) in Australia. R&D activity undertaken in 2004–05 was estimated to be $643 million^.2

The Program, which is delivered by the Department of Industry, Tourism and Resources (the department)³, commenced on 1 July 2004 and is funded until 30 June 2009. Companies were able to apply for funding in one of the Program's three rounds held in 2003, 2004 and 2006. Program funding is provided for a ‘portfolio' of projects rather than an individual project. Recipients may, with departmental approval, substitute or add suitable projects to their portfolio. This is to accommodate the likelihood that only one in five compounds that enters clinical testing reaches the market.⁴ Successful applicants have between two and 69 projects in their portfolios.

The Minister for Industry, Tourism and Resources (the Minister) has delegated responsibility for the Program to the General Manager of AusIndustry's Innovation and Collaboration Programs Branch. The Pharmaceuticals Committee (the Committee) of the Industry Research and Development (IR&D) Board provides expert advice to AusIndustry and the Program Delegate.

To determine the level of funding to be provided to each recipient, a financial baseline (referred to as the agreed base level or ABL) is set. The ABL is the average of the company's previous three years of audited R&D expenditure. All expenditure above this ABL is considered to fund additional R&D activity. Recipients are able to claim a refund of 30 cents for each dollar spent above the ABL.

An evaluation of the first year of the Program (2004–05) found that the incentive provided by a 30 cents in the dollar payment was too small to significantly change companies' investments in R&D. The refund has been increased to 50 cents for each dollar spent on eligible R&D activity in Round Three (2007–09). This increase is intended to provide a greater incentive for companies that had previously not applied for Program funding.

Grants offered to applicants in Rounds One and Two were between $1.8 million and $10 million, which is the maximum available to any recipient. The eleven successful applicants from Round One were offered $87 million and the seven successful applicants from Round Two were offered $47 million.

During the first two years of the Program, $54.1 million of additional R&D activity was reported and recipients received $16.2 million in payments.

This audit

The objective of this audit was to assess the Department of Industry, Tourism and Resources' management of the Pharmaceuticals Partnerships Program. The audit focused on how the department:

• promoted the Program and assessed applications for funding;
• managed the funding agreements; and
• managed the Program's governance arrangements.

Overall conclusion

The Program is a relatively small but complex program, providing funding to recipients for a portfolio of R&D projects. Pharmaceuticals R&D is, by nature, high risk and portfolios are likely to change over the period of the funding agreement. Recipients may regularly vary their agreements, and carry under and overperformance against financial forecasts into future years.

Overall, the Program is being managed effectively by the department. The communication strategy developed by AusIndustry was effective in promoting the Program across the pharmaceuticals industry. AusIndustry has also developed and implemented effective processes for assessing and ranking applicants against the Program's eligibility and merit criteria. Key decisions made by the Program Delegate were also appropriately documented.

A Compliance Management Strategy has been developed and implemented to monitor recipients' compliance with their funding agreements. However, recipients' risk ratings were not always consistent with the risk criteria outlined in the strategy and not all criteria used to assess recipients' compliance risks were included in the strategy. Compliance targets should be based on recipients' risk ratings and revised as necessary when these ratings change. This will enable monitoring activities to address current and emerging risks.

The Program is supported by a sound governance framework. The department has assessed the Program's risk rating as ‘high' because of its considerable underspend against recipients' financial forecasts. Payments to recipients in the first two years of the Program were almost 60 per cent and 40 per cent less than their revised financial payment forecasts. In AusIndustry's view, this is because of the high risk nature of pharmaceuticals R&D activity and was the reason for incorporating into the Program a number of features designed to manage this risk. However, allowing recipients to carry under and over performance into future years also means that the risks associated with the Program's underspend may increase in the later years of the Program.

Also, if the Program's risks are to be effectively managed, recipients' performance needs to be recognised as a major source of risk and included in the risk analysis underlying the Program's Risk Management Plan.

Currently, there is no ongoing assessment of whether the Program is meeting its overall objective, or two of its sub-objectives. Performance data is collected for all Program sub-objectives, but only expenditure data is reported.

The proposed Program evaluation scheduled for the first half of 2007–08 will measure some important aspects of the Program but it will be difficult to deliver a complete assessment on whether the Program's overall objective is being met because the industry wide data being collected does not address the quality of the R&D activity being undertaken.

The ANAO has made two recommendations to improve the management of the Program. The report also highlights a range of lessons (based on departmental and ANAO experience) to bear in mind for future R&D assistance programs.

Key Findings

Program awareness and assessing applications for funding (Chapter 2)

Awareness and promotion of the Program

Pharmaceuticals companies had three opportunities to apply for funding under the Program in application rounds held in 2003, 2004 and 2006. For each round AusIndustry developed and implemented an effective communication strategy. AusIndustry assessed the effectiveness of its promotional activities in May 2005. Survey responses to its Customer Satisfaction Survey indicated that 86 per cent of applicants knew that information relating to the Program was available from the Hotline and website. The Program evaluation undertaken in late 2005 also found that eligible companies that did not apply for funding were aware of the Program and information sources.

Assessment process

Applications were assessed against the Program's eligibility criteria by AusIndustry and against the merit criteria by the IR&D Board's Pharmaceuticals Committee (the Committee). The ANAO reviewed the 26 applications received in Round One and the 11 applications received in Round Two. There was evidence to support the eligibility of each applicant; and assessment checklists were completed for each application and countersigned by a second reviewer. Delegations were also appropriately exercised in each round.

For the merit assessment process, applicants provided financial data and information for each R&D project in their portfolios. The ANAO found that:

• the Committee assessed and ranked applicants against the Program's merit criteria;
• Committee members' potential conflicts of interest were managed well and in accordance with pre-established procedures;
• the Probity Advisor, appointed to oversee the assessment, found that the process was transparent and met probity requirements; and
• after each round the assessment criteria were reviewed and amended for practicality and better alignment with the Program's objective.

Management of funding agreements (Chapter 3)

Negotiating the funding agreements

To receive funding under the Program, each successful applicant must sign a funding agreement (agreement) with the Commonwealth. AusIndustry commenced negotiating the agreements with successful applicants from Round One in April 2004 and from Round Two in April 2005. Funding was offered from 1 July of the same year. Delays in finalising the agreements in both Rounds meant that there were no agreements in place by 1 July in either year. Delays were generally caused because an applicant's portfolio of R&D projects had changed since the application had been submitted. Despite the delays, recipients' access to funding was not affected as payments are made in arrears and all agreements were signed before the first payment was available in October of that year.

Recipient reporting and calculation of payments

The amount of grant funding offered to each recipient is based on the expenditure forecasts provided in their applications. Payments are made quarterly, in arrears and calculated from the financial information submitted each year by recipients in their quarterly and annual reports.

A payment to the recipient is due if the quarterly report includes actual R&D expenditure for that quarter that is greater than one-quarter of the ABL.⁶ The payment based on the annual report is a ‘balancing' payment. A payment will be due if the recipient's actual audited expenditure for the entire year exceeds the full ABL and the payment due exceeds the combined total of payments made in any of the previous three quarters. In addition, the payment due to a recipient will be affected by:

• any overpayments that have already been made;
• the recipient receiving other government grant payments; and/or
• underperformance or overperformance in previous years.

An overpayment can occur when the actual annual payment due is less than the combined total of quarterly payments already made. In 2004–05 and 2005–06, six companies were overpaid approximately $1.5 million. The amounts varied between $8000 and $700 000. Under the agreement, these amounts must be repaid to AusIndustry and should be accounted for by the department as either a prepayment⁷ or a receivable⁸. AusIndustry recorded these overpayments as an expense. AusIndustry advised that, in future, all overpayments will be correctly recorded.

Funding offered to each recipient is based on their forecast R&D expenditure. In practice, recipients' actual expenditure can differ considerably from their forecast expenditure. The agreement, in certain circumstances, allows:

• unused funding resulting from a recipient's underperformance (where forecast expenditure exceeds actual expenditure) to be carried forward into the following year; and
• additional funding earned from a recipient's overperformance (where actual expenditure exceeds forecast expenditure) to be paid out or used to offset underperformance in the previous year or future years.

The ANAO observed that, across the two-year period, there were 20 instances where recipients underperformed against their expenditure forecasts. Of these, 12 recipients were unable to carry forward their unused funding as they did not meet the conditions of the agreement.⁹ As a consequence, the Program is considerably underspent. To manage this underspend, funding foregone by recipients in 2004–05 and 2005–06 was made available to Round Three applicants.

Managing compliance

Managing a recipient's compliance with their agreement should provide assurance that the grant funding is being used appropriately and that each recipient is meeting the conditions for receiving that funding. AusIndustry has three mechanisms for managing a recipient's compliance: varying the agreement; its Compliance Management Strategy (strategy); and ad hoc reviews.

Variations to funding agreements

AusIndustry accepts that there will be some variation at the portfolio level due to projects failing, new projects starting and expenditure forecasts being revised. To address the changing circumstances of recipients, the agreement allows for the Program Delegate to approve variations to the portfolio. The ANAO considers that varying the agreement is a practical way of addressing the difficulties recipients have in forecasting their R&D projects and expenditure. As of October 2006, 16 variations had been requested and these have resulted in the addition of 27 projects and the removal of 11 projects. Overall, these variations did not affect the Program's future funding profile.

Compliance Management Strategy

AusIndustry has implemented a Compliance Management Strategy to monitor recipient compliance with their agreements. This strategy sets out the:

• basis for determining a recipient's risk rating;
• activities to be undertaken at each compliance level; and
• number of activities (targets) that will be undertaken annually for each compliance level.

Determining recipients' compliance risk ratings

A recipient's compliance risk rating is assessed against the risk criteria outlined in the strategy. This risk rating is revised as necessary after the quarterly and annual reports have been evaluated. The ANAO reviewed the recipients' compliance risk ratings for 2004–05 and 2005–06, and found the ratings were not always consistent with the risk criteria in the strategy. For example, in six instances, AusIndustry did not apply a ‘high' rating although the risk criteria for this rating had been met. As a consequence, recipients may have received a lower level of compliance monitoring. The strategy also needs to include all criteria used by AusIndustry to assess recipients' compliance risks.

Levels of compliance activity and compliance targets

The strategy escalates compliance activity through four levels. Monitoring activities are primarily company visits and the evaluation of recipients' quarterly and annual reports. The number of activities (or targets) to be undertaken annually for each compliance level are also outlined.

The Program's operating procedures and the strategy indicate that at least one visit will be made to each recipient from Rounds One and Two in the first two years of the Program. As of March 2007, only three of the 11 recipients from Round One have received a compliance visit whereas all six Round Two recipients have been visited.

Recipients have submitted all necessary reports. Of the 101 reports due, 52 were received on or before the due date. All other reports were received within 30 days of the due date. The annual report includes an audit statement verifying the actual expenditure and that the expenditure complies with the Program guidelines.

Setting compliance targets

The recipient's risk rating determines the extent of monitoring activity to be undertaken. These risk ratings should be the basis for setting annual compliance activity targets. However, this currently does not occur. AusIndustry advised that the compliance targets are based on previous outcomes and Program developments. The strategy is updated annually in April/May (in preparation for the next financial year). The compliance targets set at this time should be based on the recipients' risk ratings and revised if these ratings change. This will ensure that the activities being undertaken are addressing current and emerging risks.

Ad hoc reviews

The Program's operating procedures and funding agreements outline that an ad hoc review will be conducted when a recipient's annual report shows:

• actual expenditure is less than their ABL;
• the annual payment is less than 75 per cent of the forecast payment; or
• milestones have not been met to a sufficient degree.

In 2005–06, AusIndustry conducted two ad hoc reviews. The ANAO's analysis of the financial information reported by recipients in their annual reports indicated that an additional four recipients in 2004–05 and an additional five recipients in 2005–06 had met the requirements for a review. AusIndustry advised that it did not conduct a review if the recipient requested a variation to their agreement or where they were able to satisfy AusIndustry that an ad hoc review was not necessary. Two recipients will also be required to substantiate their continued participation in the Program as part of a compliance visit in 2006–07.

Ad hoc reviews were part of the Program's Compliance Management Strategy for first year of the Program (2004–05) but were removed in later years. As an ad hoc review is a compliance activity, the ANAO considers that, in any future programs, the review should form part of the strategy. Acceptable alternatives to a review should, ideally, be identified in the strategy and Program's operating procedures. Also, where a review is triggered but not conducted, there would be benefit in AusIndustry re-assessing the need for a review following receipt of the recipient's next quarterly report. This would alert AusIndustry to any ongoing compliance issues.

Governance arrangements (Chapter 4)

Planning

AusIndustry's planning documents are comprehensive and outline the responsibility and reporting requirements at each level. The plans are updated at least annually, or more frequently if changes impact on the Program. They also provide a structure for activity to be reported monthly and quarterly to AusIndustry's Executive Committee and monthly at the department's Portfolio Managers' Meeting.

Risk Management

AusIndustry's risk management framework supports the delivery of the Division's primary role, which is delivering the policy objectives of each of our programs. This framework consists of a series of related plans. These include: the AusIndustry Risk Management Plan; AusIndustry Risk Priorities for Programs; and Program Risk Management Plan.

Program risks

The Program Risk Priority, which compares risks across all AusIndustry's programs, has been rated as ‘moderate', for each year of the Program. At the program level, risks are assessed against the five Key Risk Areas (KRAs) in the Program Risk Management Plan.¹⁰ The Program has been rated consistently as a 'high' risk because of underperformance against the financial management KRA. The current strategies to treat this financial risk include: carrying forward recipients' underperformance; re-phasing expenditure into future years; re-allocating funding to recipients in the final round; and/or paying out a recipient's overperformance.

The ANAO's analysis of AusIndustry data has shown that the total payments made were almost 60 per cent and 40 per cent less than agreed forecasts for years one and two respectively. The current treatment strategies are compounding this effect as, generally, they are moving underperformance (that is, expenditure is less than forecasted) and budget allocations into the remaining years.

Risks associated with recipients

The current Program Risk Management Plan identifies a number of risk categories but does not identify recipients' performance as a major source of risk, although some of the mitigation strategies are directed towards this. AusIndustry advised that the recipients' compliance risk ratings are considered collectively when assessing the Program's risks. However, it was unable to provide documentation to support how these ratings are considered when identifying Program risks. If Program risks are to be effectively managed, the inclusion and analysis of recipients' compliance risks need to be documented and incorporated in the Program Risk Management Plan.

Performance management

An appropriate performance management framework should enable the department to monitor and measure the Program's progress towards achieving its objective and sub-objectives. The Program's overall objective is to increase the level of high quality pharmaceuticals R&D undertaken in Australia.¹¹ The Program also has the following sub-objectives:

• promoting additional, high quality R&D across the pharmaceuticals industry above what would have been done in the absence of the Program;
• encouraging the development of medicines for global markets; and
• encouraging partnerships and linkages between multinational firms and local players.

Industry baseline data

The department collects biennial expenditure data for pharmaceuticals R&D activity in Australia from the Australian Bureau of Statistics.¹² It has recently been advised that this information is available annually and will now use 2003–04 data as the baseline to measure the increase in industry wide R&D activity generated by the Program.¹³ However, this data does not address the quality of R&D activity being undertaken. Consequently, there is no baseline data available to assess whether an increase in the level of pharmaceuticals R&D being undertaken is of the same quality required by the Program.

Recipients' performance data

Recipients are required to provide, in their annual reports, performance information relating to the Program's three sub-objectives. This includes: the commercialisation of research; R&D collaborations and contract research; and actual expenditure. AusIndustry collects this data on behalf of Innovation Division. AusIndustry reports expenditure data but commercialisation and collaborations data are not reported by either AusIndustry or Innovation Division. Innovation Division advised that this information may be used for policy development, when providing advice to the Minister and will be used for the proposed evaluation in the first half of 2007–08.

R&D expenditure data

The reported increase in R&D activity was $15.8 million (9.7 per cent) in 2004–05 and $38.3 million (16 per cent) in 2005–06. The total payments made in 2004–05 were $4.7 million and, in 2005–06, $11.5 million. This data indicates that, although there has been an increase in R&D activity, the Program is considerably underspent against its allocation of $150 million.¹⁴ For the first year of the Program the increase in R&D expenditure by recipients was broadly in line with the 12.6 per cent ($71.7 million) growth in R&D expenditure industry wide. Industry data is not yet available for 2005–06.

Performance reporting

External reporting

Reporting of all AusIndustry Output One programs, including this Program, are aggregated in the department's annual reports. Therefore, very limited Program information is available publicly. The IR&D Board and the department only briefly mention Program activities in their annual reports.

Internal reporting

Monthly and quarterly reports provided to the AusIndustry Executive Committee for both years of the Program were reviewed. The monthly reports primarily focus on program delivery with indicators covering: the number of applications in a round; the number of successful applicants; and the time taken to negotiate agreements. While these indicators are useful for assessing the quality of AusIndustry's service delivery and the quantum of activity undertaken, they do not measure the progress being made towards achieving the Program's objective or sub-objectives.

Quarterly reports list outcome performance indicators such as: additional R&D expenditure; the number of new collaborations, and the number of pharmaceuticals that reach product registration. AusIndustry collects this information on behalf of Innovation Division. However, as previously noted, with the exception of expenditure data, this information is not reported within the department but will be used when evaluating the Program.

Agency response

The Department of Industry, Tourism and Resources is pleased with the ANAO's conclusion that ‘the Program is being managed effectively by the department' (paragraph 11) and that ‘the Program is supported by a sound governance framework' (paragraph 13). The Department accepts the recommendations for the management of the Program. The adoption of minor improvements in the compliance management of recipients and their individual risk assessment will strengthen the delivery of the Program.

Footnotes

1 DITR analysis of export figures from International Merchandise Trade export data from the Australian Bureau of Statistics, provided 2 February 2007.

2 Gross Expenditure on R&D, by selected socio-economic objective for 2004–05 was advised by Innovation Division based on data provided by the Australian Bureau of Statistics.

3 Within the department, Innovation Division and AusIndustry share responsibility for delivering the Program.

4 Pharmaceutical Research and Manufacturers of America, Pharmaceutical Industry Profile 2007, Washington, DC: PhRMA, March 2007. Innovation Division advised that although this figure is for the American industry, it is considered to be representative of Australian statistics.

5 In 2004–05, the original forecast of $14.7 million was revised to $11 million, with actual payments of $4.7 million being made. In 2005–06, the original forecast of $19.7 million was revised to $18.8 million with actual payments of $11.5 million being made.

6 The quarterly payment is capped at 25 per cent of the maximum annual grant payment for the first quarter and this capped rate increases to 50 per cent and 75 per cent for subsequent quarters.

7 A prepayment is where the overpayment can be offset by subsequent payments as permitted by the agreement.

8 Where the Program Delegate considers that an overpayment will not be offset within a reasonable period of time, the delegate will declare the amount a debt and AusIndustry will seek repayment within 30 days.

9 Actual expenditure must exceed 75 per cent of annual forecast expenditure and the payment due must be at least 50 per cent of the maximum annual payment.

10 The five Key Risk Areas are financial management, outcomes and objectives, service delivery, program governance, and compliance and fraud.

11 Agreed in the Business Partnership Agreement between Innovation Division and AusIndustry, 4 October 2004.

12 R&D statistics were collected annually for business and biennially for higher education, general government and private non-profit organisations.

13 Prior to sourcing this annual data the department had intended using the average of 2002–03 and 2004–05 data.

14 The total payments made were almost 60 per cent and 40 per cent less than agreed forecasts for years one and two respectively.