Wednesday, March 2, 2011

Are Pharmaceutical R&D Costs Exaggerated?

Here is a link to a recent paper (pdf) by Donald Light and Rebecca Warburton titled "Demythologizing the high costs of pharmaceutical research", (BioSocieties, February 2011) which systematically critiques the estimates of pharmaceutical-related R&D costs routinely promoted by the research-based pharmaceutical companies. As put by Andre Picard in a recent Globe and Mail article, "Drug R&D costs are less than estimated - so why the high prices?",

It costs, on average, $1.3-billion (U.S.) in research and development to bring a new drug to market. That level of investment in R&D by Big Pharma justifies the high cost of prescription drugs.

Those statements are repeated so often that they have come to be accepted as fact.

But are they fact or fiction?

So, what do you get when you crunch all those numbers?

According to Dr. Light and Dr. Warburton, the net median R&D cost of developing a prescription drugs varies from $13-million to $204-million, depending on the kind of drug.

Over all, they estimate R&D costs $59.4-million for each new drug.

That is a far cry from $802-million or $1.3-billion.

Its worth it to read both the newspaper article and the original paper - the newspaper article summarizes the arguments quite a bit.

Particularly egregious, IMHO, is the inclusion of a "cost of capital" in the R&D costs. The cost of capital is used to decide whether to embark on a project by seeing whether it will make a return higher than you could get by just investing the money - i.e. by subtracting the cost of capital, or money. That's fine, but I don't think that what most people or policy makers have in mind when they hear about the R&D costs to bring a drug to market - the numbers are misleading if the reader doesn't understand that cost of capital is included.

Furthermore, the $1.3 billion or $802 million estimate includes an assumption that the cost of capital is 11% - which strikes me as high. I wish I could guarantee myself an 11% return on the stock market!

11% a year, over several years... really adds up ;)

Another interesting issue is for which drugs these numbers are being reported. According to Light and Warburton, the numbers commonly referenced by the pharmaceutical industry reflect the most expensive-to-develop 1/5 of all drugs. Again, I don't think this is what most people understand when discussing the average cost to develop pharmaceuticals.

Another interesting aspect of the Light and Warburton article (there are many ;) ) includes a discussion of risk and a comparison of pharmaceutical companies to Intel.

In other industries, huge investments to develop new products, like a new chip from Intel,do not lead firms to make the argument for government-protected prices by claiming that‘You owe us for all our R&D costs, plus what we would have made had we not undertaken the project in the first place’.
The corporate risk of R&D for companies like Pfizer or GlaxoSmithKline are thus lower than for companies like Intel that have only a few innovations on which
sales rely.

which raises all sorts of interesting questions about the principle of technology-neutrality in patent law, and whether its effective violation in the pharmaceutical area is really wise policy.


Anonymous said...

Including the cost of capital is appropriate, and, in my view, 11% is not particularly high. For example, currently the allowed generic cost of capital for regulated assets in Alberta is 9%.

Norman said...

I've only just skimmed the Light and Warburton paper. It's very interesting and certainly raises a number of methodological problems - I'll have to re-read it more carefully.

But it does seem to me that including the cost of capital is appropriate. If the return to a pharma company cannot cover the cost of capital, then it won't raise the capital, and the research won't get done. To my mind, the reason we want to know drug costs is to know whether the need to promote the research justifies the high price. If that is right, then surely the costs that are essential to the research being undertaken must be included. The authors say "Calculating the cost of capital is a widely accepted exercise to determine whether a project
should be undertaken; but as a claim on public money or citizens’ cash, it is unreasonable." The authors seem to agree that if the cost of capital is not covered, the project will not be undertaken. I don't understand why they say incuding these costs is unreasonable. So far as I can see, they do not offer any argument at all on p. 8, where the point is discussed at greatest length - it looks to me like an unsupported assertion.

Alex Stack said...

One question, though, is not whether cost of capital is appropriate for the sort of analysis Norman is making - its whether that's what people or policy-makers understand when they hear about the "cost" of something. I'm not concerned with calculating or including the cost of capital in general - the question is how is the number being used by the pharmaceutical industry to advocate for certain policies?

One Mea Culpa - I was precipitous about the 11% being a high number - it sounded high to me, but having said that its not like I've been keeping track of the generic cost of capital.