New Study Expected to Significantly Overstate Drug Industry R&D Costs

Nov. 28, 2001

New Study Expected to Significantly Overstate Drug Industry R&D Costs

True Figure Is Likely at Least 75% Lower

WASHINGTON, D.C. ? A new study, which is expected to claim the average cost of developing each new prescription drug far exceeds $500 million, once again significantly overstates real R&D costs, according to the national consumer group Public Citizen. The study was prepared by the Tufts Center for the Study of Drug Development and is scheduled for release in Philadelphia on Friday, Nov. 30.

In its last study on the cost of developing a new drug, completed in 1991, the Tufts Center pegged the figure at $231 million. That figure then became the basis of claims by the drug industry?s trade association, the Pharmaceutical Research and Manufacturers of America (PhRMA), that the cost of developing a new medicine, including successes and failures, was $500 million. The updated Tufts study, prepared by Joseph A. DiMasi, is expected to use the same methodology as the original study.

In July 2001, Public Citizen published a detailed critique of the original DiMasi study. It demonstrated that the actual after-tax cash outlay for developing a new drug, including failures, was $110 million ? about 75 percent less than PhRMA?s estimate using the DiMasi study. Public Citizen?s analysis was based on a major study analyzing the DiMasi report prepared by the congressional Office of Technology Assessment (OTA). OTA found that DiMasi?s original study included significant expenses that are tax deductible and was inflated with theoretical costs that drug companies don?t actually incur. Public Citizen?s study was titled Rx R&D Myths.

PhRMA commissioned the accounting firm of Ernst & Young to respond to the Public Citizen report. Public Citizen rebutted to the Ernst & Young critique.

But Ernst & Young failed to rebut the Public Citizen?s separate findings that were based on PhRMA data, which showed R&D costs for all new drugs brought to market (including failures) to range between $71 million and $150 million. This analysis (contained in Section II of Rx R&D Myths) was not based on the DiMasi methodology but on PhRMA?s own claims about how much the industry spends on R&D compared with the number of new drugs approved by the Food and Drug Administration. Below is a more detailed critique of the DiMasi report.

Detailed Critique of the DiMasi Methodology Used in Original Study and

Other Key Prescription Drug R&D Issues

  • DiMasi?s original $231 million figure does not represent what companies actually spend to discover and develop new molecular entities. It includes the expense of using money for drug research rather than other investments. It also does not account for huge tax deductions that companies get for R&D. Therefore, it substantially overestimates net expenditures on R&D.
  • According to the OTA?s 354-page report on pharmaceutical R&D: “The net cost of every dollar spent on R&D must be reduced by the amount of tax avoided by that expenditure.” Therefore, the OTA revised DiMasi?s calculation, subtracting expenses that are tax deductible and the opportunity cost of capital.
  • The tax deduction reduces the cost of R&D by the amount of the corporate marginal tax rate (currently 34 percent). This means, in effect, that every dollar spent on R&D costs $0.66.(1) The OTA concluded that DiMasi?s original $231 million figure (in 1987 dollars) was $171 million (in 1990 dollars) after accounting for the R&D tax deduction.
  • The opportunity cost of capital accounts for slightly more than half (51 percent) of DiMasi?s total figure. After subtracting tax deductions and the opportunity cost of capital, OTA found that DiMasi?s after-tax R&D cash outlay for a new NME was $65.5 million (in 1990 dollars). That is the estimate of how much the drug companies in DiMasi?s study actually spent on new chemical entities, including failures. Public Citizen inflated this figure to year 2000 dollars and found that actual after-tax cash outlay for NCEs (including failures) was $110 million ? based on DiMasi?s data.
  • It should be noted that five of the seven previous R&D cost studies that DiMasi references did not include opportunity cost of capital in their calculations.(2)
  • It?s important to stress that DiMasi?s figure is the R&D cost for all new chemical entities (NCEs) ? which are the most expensive class of new drugs. Not all new drugs brought to market are NCEs. The R&D costs for all new drugs is detailed in Section II of Public Citizen?s July report. Public Citizen found that the R&D costs for all new drugs brought to market, based on PhRMA?s data, ranged from $71 million to $118 million. The R&D costs for NCEs was $150 million, on average.
  • Evidence suggests that the time required to conduct clinical trials on new drugs is also decreasing. A January 2000 report by the Tufts Center for the Study of Drug Development stated that clinical testing time declined by 19 percent for drugs approved in 1996-1998 when compared with drugs approved in 1993-1995.(3)
  • The advent of technologies such as genomics and combinatorial chemistry, has led, according to investment analysts at Lehman Brothers, “to a growing school of thought that the cost of discovering new biological targets and the cost of creating drug leads is falling.”(4) The Boston Consulting Group predicts that drug companies will increase the number of new drugs (NCEs) they produce annually by five-to-tenfold by the year 2003.(5)
  • Industry R&D risks and costs are often significantly reduced by taxpayer-funded research, which has helped launch the most medically important drugs in recent years and many of the best-selling drugs, including all of the top five sellers in one recent year surveyed (1995). An internal National Institutes of Health (NIH) document, obtained by Public Citizen through the Freedom of Information Act, shows how crucial taxpayer-funded research is to top-selling drugs. According to the NIH, 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. (See Section III of report) PhRMA has not challenged the NIH document.
  • Drug industry R&D does not appear to be as risky as companies claim. In every year since 1982, the drug industry has been the most profitable in the United States, according to Fortune magazine?s rankings. During this time, the drug industry?s returns on revenue (profit as a percent of sales) have averaged about three times the average for all other industries represented in the Fortune 500. It defies logic that R&D investments are highly risky if the industry is consistently so profitable and returns on investments are so high. (See Section V)
  • Drug industry R&D is made less risky by the fact that 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 “me-too” drugs, which often replicate existing successful drugs. (See Section VI)
  • In addition to receiving research subsidies, the drug industry is lightly taxed, thanks to tax credits. The drug industry?s effective tax rate is about 40 percent less than the average for all other industries, according to the Congressional Research Service. (See Section VII)
  • Drug companies also receive a huge financial incentive for testing the effects of drugs on children. This incentive called pediatric exclusivity, which Congress recently voted to reauthorize, amounts to $592 million in additional profits per year for the drug industry ? and that?s just to get companies to test the safety of several hundred drugs for children. It is estimated that the cost of such tests is less than $100 million a year. (See Section VIII)
  • The drug industry?s top priority increasingly is advertising and marketing, more than R&D. Increases in drug industry advertising budgets have averaged almost 40 percent a year since the government relaxed rules on direct-to-consumer advertising in 1997. Moreover, the Fortune 500 drug companies dedicated 30 percent of their revenues to marketing and administration in the year 2000, and just 12 percent to R&D. (See Section X)

Endnotes

(1) Office of Technology Assessment, U.S. Congress, “Pharmaceutical R&D: Costs, Risks and Rewards,” 1993.

(2) Joseph DiMasi et al., “The Cost of Innovation in the Pharmaceutical Industry,” Journal of Health Economics, 10:107-142, 1991.

(3) Kenneth I. Kaitin and Elaine M. Healy, “The New Drug Approvals of 1998, 1997 and 1996: Emerging Drug Development Trends in the User Fee Era,” Tufts Center for the Study of Drug Development, January 2000, published in PAREXEL?s Pharmaceutical R&D Statistical Sourcebook 2000, pg. 117.

(4) Lehman Brothers, “Drug R&D Costs, Success Rates, and Emerging Technologies: A Look at Three Future Scenarios,” 1997, published in PAREXEL?s Pharmaceutical R&D Statistical Sourcebook 2000, pg. 80.

(5) Boston Consulting Group, “The Pharmaceutical Industry Into Its Second Century: From Serendipity to Strategy,” January 1999. pgs 51-56.