Would Lower Prescription Drug Prices Curb Drug Company Research & Development?

The U.S. House Democrats’ Medicare prescription drug proposal effectively gives the Medicare program authority to negotiate deep price discounts with pharmaceutical companies. The Departments of Veterans Affairs and Defense already enjoy the benefits of such negotiations – saving 40-50 percent off the retail price of drugs, which is what most major industrialized countries save. The drug industry opposes giving such authority to Medicare, claiming that reduced prices will cut into profits and starve research and development (R&D). Last year, Public Citizen issued a major report on R&D issues, which received considerable national media attention. It was also used by ABC News in its recent Peter Jennings special Bitter Medicine. Here are ten reasons why lower prescription prices would not curb R&D:

  • New drug discoveries are much cheaper than the industry claims: A year ago the industry claimed it cost $500 million to discover a new drug (including failures). A more recent study from a Tufts University research institute, which receives most of its funding from the drug industry, put the figure at $800 million. Actually the $800 million figure is no more than $240 million for the following reasons: the industry counts the opportunity cost of capital, not actual cash outlays, which inflates the estimate by about 50 percent; and the industry’s analysis does not reduce the costs of R&D by 34 percent, which is the amount that is tax deductible. In addition, the study only looks at the most innovative – and therefore most expensive – drugs being developed. But about half of new drugs are "me-too" drugs, which often replicate existing successful drugs.
  • Huge profits allow for price elasticity: The U.S. pharmaceutical industry is the most profitable domestic industry – by a long shot. Profits of the top 10 drug companies jumped 33 percent during the recent economic slowdown – climbing from $28 billion in 2001 to $37.3 billion in 2002. Over the last 32 years, Fortune 500 drug company profits have gone from 9 percent in 1970 to 18 percent in 2001; whereas, all Fortune 500 industries’ profits went from 4 percent in 1970 to 2 percent in 2002. Such extraordinary rates of return mean that prices can be significantly reduced. Companies would still get a healthy return with minimal affect on innovative R&D efforts.
  • Lower prices will induce demand: A 1999 study by Merrill Lynch found that if Congress passed legislation resulting in drug prices being cut 40 percent for all Medicare beneficiaries profits would only decline 3.3 percent due to the increased demand created by lower prices.
  • Drug companies will shift priorities: The top U.S. drug companies actually take more of their income as profit (18.5 percent in 2001) than they spend on R&D (12.5 percent). Partially reversing this ratio can compensate for reduced profits due to price cuts.
  • Experience in Europe: To control drug costs European countries either impose price controls or limit drug company profits. Yet European drug companies – such as Glaxo, Aventis, AstraZeneca and Roche – are very successful, highly profitable and just as innovative as U.S. companies. From 1990-1999, European-based companies introduced 183 new chemical entities to the world market whereas U.S. drug companies introduced 161.
  • Future research costs will decline: Drug company R&D is getting more sophisticated and cost-efficient. Technological advances in areas such as genomics and combinatorial chemistry allow researchers to investigate many more new molecules than they could in the past. This will allow manufacturers to reduce costs and increase their chances of finding promising new drugs.
  • Industry R&D risks are significantly reduced by taxpayer-funded research: The federal government has helped launch some of the most medically important drugs in recent years and received little, if anything, for its investments. An internal National Institutes of Health document shows that taxpayer-funded scientists conducted 55 percent of the research projects that led to the discovery and development of the top five selling drugs in 1995.
  • Drug company advertising is growing faster than R&D: Major drug companies are increasingly resembling marketing machines rather than inventors of drugs. Drug industry spending on advertising increased at a far greater rate (32 percent) in 2000 than spending on R&D (13 percent). Such advertising is fueling a major increase in drug costs.
  • Price cuts could foster more drug innovation: According to Food and Drug Administration data, only about 22 percent of the new drugs brought to market in the last two decades were innovative drugs that represented important therapeutic gains over existing drugs. Most were "copycat" or "me-too" drugs, which typically don’t offer new breakthroughs. This suggests that much R&D could be curtailed without significant detriment to public health. It also means that R&D could get refocused onto finding more breakthrough drugs.
  • R&D is the drug industry’s lifeblood: Without research, the drug industry cannot discover new and potentially lucrative drugs. It is counterintuitive that the industry would reduce R&D. If anything, the reduction of drug prices could intensify R&D prompting companies to come up with more discoveries that would sustain profitability despite reduced prices.