Pharmaceutical Research Costs: The Myth of the $2.6 Billion Pill

Health Letter, September 2017

By Sammy Almashat, M.D., M.P.H.

Spending on prescription drugs in the U.S. reached an estimated $457 billion in 2015.[1] This spending is expected to grow by an average of about 7% annually until 2018.

In response to public outcry over high drug prices, the drug industry has always claimed that exorbitant prices are needed to recoup the money invested in researching and developing the drugs. To this end, in 2016, the drug-industry-funded Tufts Center for the Study of Drug Development published a study claiming that it costs drug companies an average of $2.6 billion to develop a drug to the point of approval by the Food and Drug Administration (FDA). This figure was roundly criticized by non-drug-industry-funded researchers.

An earlier drug-industry-funded estimate, debunked

The 2016 Tufts Center estimate was the latest in a long line of drug-industry-funded figures. In 2011, the drug industry claimed that it cost $1.2 billion to bring a drug to market. This estimate prompted a critique in the British Medical Journal in 2012, which, replicating the methodology employed in a 2003 Tufts Center paper, arrived at a much lower actual cost.

The BMJ authors began with a slightly higher figure of $1.3 billion. They noted that half of this included lost “opportunity cost,” which is what a company would have earned had it invested the research money in an index fund of pharmaceutical companies. (The authors argued that including this is inappropriate in calculating the research costs from which profits are eventually earned.) Half of the remaining $650 million was recouped by the company through tax breaks. The remaining figure, approximately $330 million, actually represented the average for only the costliest 20 percent of drugs: those that were developed in-house. Adjusted for all new drugs, the true average was just $90 million per new drug, less than one-tenth of the industry’s claimed total. And this figure included all the failed drugs that never reached the market.

Updated 2016 estimate also inflated

In 2016, the Tufts Center issued an updated estimate of average drug development costs, claiming that the cost had more than doubled, from their claimed $1.1 billion in 2003 to $2.6 billion (both in 2013 dollars) per drug. The 2016 estimate employed largely the same methodology as the 2003 estimate.

Of the new $2.6 billion estimate, only $1.4 billion represents the actual cost of developing a drug, with the remaining $1.2 billion representing the lost opportunity cost of foregoing investments with annual returns of 10.5%. The $1.4 billion in estimated actual costs of developing a drug was the focus of a critique by the prominent pharmaceutical industry expert James Love, of the nonprofit Knowledge Ecology International.

Love pointed out that the $1.4 billion figure was based entirely on the estimated average cost of $339 million for the human trials (known as Phase I, II and III trials) required for approval of a drug by the FDA and that this value was markedly higher than that which would be obtained through the industry’s own estimates of per-human-subject costs of pre-approval clinical trials. Moreover, the Tuft study’s estimate of the average cost of Phase III trials, which are by far the most expensive component of human trials, was $255 million, considerably higher than a 2014 estimate of $163 million that was released by a drug industry consulting firm.

Love also criticized the study’s methodology, which resulted in the claim that nearly one-third (31%) of the actual cost of drug development was spent on discovery research and pre-human studies, pointing out that the study did not base this estimate on any study exact cost data from companies. Love noted that the final estimate of $430 million ($1.1 billion after accounting for foregone investments resulting from this expenditure) to conduct pre-human research on a drug seemed high.

Another point to remember about the $2.6 billion figure is that, like the 2003 estimate, it was based only on drugs that were developed entirely in-house, by the pharmaceutical manufacturer or by other companies acquired by the pharmaceutical manufacturer after development of the drug had already commenced. Therefore, the figure represents only the most expensive subset of all approved drugs and overestimates the cost of developing an average drug, given that public funds, including federal funds from the National Institutes of Health, contribute up to a fifth of the research costs of many newly approved drugs and vaccines. The public contribution to the development of truly innovative drugs is even greater. A 2015 study of 26 innovative and groundbreaking drugs or drug classes approved by the FDA between 1984 and 2009 found that only a minority of these drugs were developed solely within the industry.

Some of the most expensive drugs, which have generated billions of dollars in annual revenues for drugmakers, have primarily come from the public sector. A prominent example is the hepatitis C drug sofosbuvir (SOVALDI). The drug’s maker, Gilead, did not invent the drug, but rather bought the marketing rights for the already-developed drug from a small biotechnology company, which, in turn, developed the drug largely through the federally funded research of its founder, who is a faculty member at Emory University. Despite having nothing to do with the innovative stage of sofosbuvir’s development, Gilead made more than $10 billion from sales of Sovaldi in its first year on the market, recouping the amount it paid to acquire the drug within just the first year of the drug’s approval.

Moreover, a trend that was not present at the time of the 2003 estimate casts further doubt on the $2.6 billion figure. Recent years have seen a surge in the proportion of drugs approved for rare diseases, known as “orphan” indications, which in 2016 accounted for 41% of all drugs newly approved by the FDA. Drug companies recoup, through a tax credit, half of all research monies spent on the clinical testing of a new drug for an orphan indication. The research costs to develop an orphan drug also are lower than those for non-orphan drugs, due mainly to smaller clinical trials.

Finally, the Tufts Center relied for its estimate on drug-industry-reported data that have, to this day, never been disclosed to the public for independent analyses. It is curious that an industry that goes to such great lengths to claim that it is focused exhaustively on research has not thus far disclosed the actual research expenditures for each of its drugs. Because of the industry’s secrecy, numerous state bills have been proposed to force drugmakers to disclose a detailed breakdown of the research and development costs for drugs that have gained FDA approval.

Ending monopolies that are justified solely by inflated research costs

Even if the $2.6 billion figure was a true estimate of the average cost to bring a drug to market, the drug industry recoups its investments many times over through monopoly pricing, making it consistently one of the most profitable industries in the world, with profits far exceeding research expenses. Although the industry has a self-touted image as an innovative, research-driven enterprise, the largest drugmakers spend more on marketing their products than on research and development. Ultimately, the debate over the pharmaceutical industry’s research and development investments has enormous implications for health care in the U.S. The drug industry has been able to charge such exorbitant prices because companies enjoy years-long monopolies on their brand-name drugs. These monopolies, in turn, are only politically viable so long as the industry can claim that they are necessary for drug development. But history has shown that some of the most innovative research for new drugs is done successfully within the public and non-profit academic sectors.

Given this history, there have been calls to replace the current monopoly pricing system with a prize fund for truly innovative drug research that would ensure lower prices and greater access to medicines. In March, Senator Bernie Sanders (I-VT) introduced a bill in Congress that would create such a fund. And in the same month, Senator Al Franken (D-MN) and 13 other Senators introduced the Improving Access to Affordable Prescription Drugs Act (Affordable Meds Act), which would, among other things, shorten periods of monopoly protection for certain new drugs and require drugmakers to disclose detailed information on their research and development costs. However, neither bill has yet been passed, due undoubtedly to the tremendous power of the pharmaceutical lobby in Washington.


References

[1] Office of the Assistant Secretary for Planning and Evaluation. Observations on trends in prescription drug spending. ASPE issue brief. March 8, 2016. https://aspe.hhs.gov/system/files/pdf/187586/Drugspending.pdf. Accessed August 18, 2017.

[2] Ibid.

[3] DiMasi JA, Grabowski HG, Hansen RW. Innovation in the pharmaceutical industry: New estimates of R&D costs. J Health Econ. 2016;47(May):20-33.

[4] Avorn J. The $2.6 billion pill–methodologic and policy considerations. N Engl J Med. 2015;372(20):1877-1879.

[5] Love J. The 2016 Tufts estimates of the risk adjusted out-of-pocket costs to develop a new drug. Knowledge Ecology International. April 12, 2016. https://www.keionline.org/node/2464. Accessed August 18, 2017.

[6] DiMasi JA, Hansen RW, Grabowski HG. The price of innovation: new estimates of drug development costs. J Health Econ. 2003;22(2):151-185.

[7] Pharmaceutical Research and Manufacturers of America. 2011 annual report. http://phrma-docs.phrma.org/sites/default/files/pdf/phrma_2011_annual_report.pdf. Accessed August 21, 2017.

[8] Light DW, Lexchin JR. Pharmaceutical research and development: what do we get for all that money? BMJ. 2012;345(August 7):e4348.

[9] DiMasi JA, Hansen RW, Grabowski HG. The price of innovation: new estimates of drug development costs. J Health Econ. 2003;22(2):151-185.

[10] Light DW, Lexchin JR. Pharmaceutical research and development: what do we get for all that money? BMJ. 2012;345(August 7):e4348.

[11] DiMasi JA, Hansen RW, Grabowski HG. The price of innovation: new estimates of drug development costs. J Health Econ. 2003;22(2):151-185.

[12] DiMasi JA, Grabowski HG, Hansen RW. Innovation in the pharmaceutical industry: New estimates of R&D costs. J Health Econ. 2016;47(May):20-33.

[13] Ibid.

[14] Love J. The 2016 Tufts estimates of the risk adjusted out-of-pocket costs to develop a new drug. Knowledge Ecology International. April 12, 2016. https://www.keionline.org/node/2464. Accessed August 18, 2017.

[15] DiMasi JA, Grabowski HG, Hansen RW. Innovation in the pharmaceutical industry: New estimates of R&D costs. J Health Econ. 2016;47(May):20-33.

[16] EvaluatePharma. Orphan Drug Report 2015. October 2015. http://info.evaluategroup.com/rs/evaluatepharmaltd/images/2014OD.pdf. Accessed August 18, 2017.

[17] Love J. The 2016 Tufts estimates of the risk adjusted out-of-pocket costs to develop a new drug. Knowledge Ecology International. April 12, 2016. https://www.keionline.org/node/2464. Accessed August 18, 2017.

[18] Ibid.

[19] Stevens AJ, Jensen JJ, Wyller K, et al. The role of public-sector research in the discovery of drugs and vaccines. N Engl J Med. 2011; 364(6):535-541.

[20] Kesselheim AS, Tan YT, Avorn J. The roles of academia, rare diseases, and repurposing in the development of the most transformative drugs. Health Aff. 2015;34(2):286-293.

[21] Avorn J. The $2.6 billion pill–methodologic and policy considerations. N Engl J Med. 2015;372(20):1877-1879.

[22] Pollack A. Sales of Sovaldi, new Gilead hepatitis C drug, soar to $10.3 billion. New York Times. February 3, 2015. https://www.nytimes.com/2015/02/04/business/sales-of-sovaldi-new-gilead-hepatitis-c-drug-soar-to-10-3-billion.html. Accessed August 18, 2017.

[23] Avorn J. The $2.6 billion pill–methodologic and policy considerations. N Engl J Med. 2015;372(20):1877-1879.

[24] Joszt L. Nearly half of new drugs approved in 2016 were orphan drugs. AJMC.com. January 17, 2017. http://www.ajmc.com/newsroom/nearly-half-of-new-drugs-approved-in-2016-were-orphan-drugs. Accessed August 18, 2017.

[25] Internal Revenue Service. Form 8820, orphan drug credit. https://www.irs.gov/uac/form-8820-orphan-drug-credit. Accessed August 18, 2017.

[26] EvaluatePharma. Orphan drug report 2014. October 2014. http://info.evaluategroup.com/rs/evaluatepharmaltd/images/2014OD.pdf. Accessed August 18, 2017.

[27] Appel A. PhRMA wins most battles against states’ price transparency laws. Bloomberg BNA. July 25, 2016. https://www.bna.com/phrma-wins-battles-n73014445219/. Accessed August 18, 2017.

[28] Sachs R. Pharmaceutical transparency bills: Targeting disclosures purposefully. Harvard Law School, Bill of Health blog. April 13, 2016. http://blogs.harvard.edu/billofhealth/2016/04/13/pharmaceutical-transparency-bills-targeting-disclosures-purposefully/. Accessed August 18, 2017.

[29] Anderson R. Pharmaceutical industry gets high on fat profits. BBC. November 6, 2014. http://www.bbc.com/news/business-28212223. Accessed August 18, 2017.

[30] Claypool R. Pharmaceutical industry profits exceed industry’s self-reported R&D costs. March 31, 2017. https://www.citizen.org/sites/default/files/pharma-profits-and-r-and-d-report.pdf. Accessed August 18, 2017.

[31] Anderson R. Pharmaceutical industry gets high on fat profits. BBC. November 6, 2014. http://www.bbc.com/news/business-28212223. Accessed August 18, 2017.

[32] Kesselheim AS, Tan YT, Avorn J. The roles of academia, rare diseases, and repurposing in the development of the most transformative drugs. Health Aff. 2015;34(2):286-293.

[33] Delinkage.org. Sen. Sanders introduces Medical Innovation Prize Fund Act. March 2, 2017. http://delinkage.org/sen-sanders-introduces-medical-innovation-prize-fund-act/. Accessed August 18, 2017.

[34] S. 771. 115th Congress (2017-2018). Improving Access to Affordable Prescription Drugs Act. https://www.congress.gov/bill/115th-congress/senate-bill/771/text. Accessed August 21, 2017.

[35] Congress.gov. S.495 – Medical Innovation Prize Fund Act. 115th Congress (2017-2018). https://www.congress.gov/bill/115th-congress/senate-bill/495/actions. Accessed August 18, 2017.

[36] Congress.gov. S.771 – Improving Access to Affordable Prescription Drugs Act. 115th Congress (2017-2018). https://www.congress.gov/bill/115th-congress/senate-bill/771/actions. Accessed August 21, 2017.

[37] Silverstein S. This is why your drug prescriptions cost so damn much. Mother Jones. October 21, 2016. http://www.motherjones.com/politics/2016/10/drug-industry-pharmaceutical-lobbyists-medicare-part-d-prices/. Accessed August 18, 2017.