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"The ability of pharmaceuticals to reduce the total expenditures for health care, as well as business costs, is important but secondary," concludes Calfee. Modern drug therapy means "patients and consumers...are gaining...better health, longer life, reduced pain and discomfort, and other blessings."
OK, grant some critics of the industry. Drugs dramatically cut some medical costs, they say, but the drug makers are reaping huge -- obscene, really -- profits. In fact, drug company profits as conventionally calculated do run to as much as 20 percent, while 5 percent profit margins are typical of many other American industries. That 20 percent figure, however, is deceptive, since the standard accounting procedures used to calculate drug company profits write off R&D costs as "current expenses." No other industry has nearly as high R&D expenses, so when other industries write off their R&D it doesn't have as much effect on their rate of return calculations. If pharmaceutical R&D were depreciated over time, then annual profits for the industry drop to around 9 percent.
That's still almost double the average rate of return. What explains it? Drug discovery and development is a notoriously risky business. "Some 5,000 to 10,000 molecules are screened and only one will make it to being a drug," explains Kees Been, vice president for business and marketing at Biogen Inc., a leading biotech pharmaceutical company based in Cambridge, Massachusetts . "From discovery to launch takes 12 to 16 years. Only 30 percent of all products ever invented returned more than what was invested in them," adds Been. That means that 70 percent of the drugs currently available for treating and curing people are in fact economic losers for the companies that developed them.
A 1999 study by Duke University economists Henry Grabowski and John Vernon for the Tufts University Center for the Study of Drug Development analyzed the sales of a cohort of drugs introduced between 1988 and 1992. The study found that the top 10 percent of new drugs accounted for more than half the total sales revenues of drugs. "The returns to R&D projects in pharmaceuticals have similar properties to that of venture capital investments," conclude Grabowski and Vernon. In other words, drug companies, like venture capital firms, throw money at a lot of different high-risk projects knowing that virtually none will pan out, but that a few may score real jackpots.
These jackpots cover the losses on the other projects and, perhaps more important, pay for future bets. In this way, revenues from such blockbuster drugs as Prozac for depression, Celebrex for arthritis pain, Viagra for erectile dysfunction, and Lipitor for controlling cholesterol levels do more than cover the costs of the majority of drugs that do not make a profit; they also fuel further research.
Investment in R&D for any given drug is not trivial. Typically, it costs between $300 million and $500 million to bring a single drug from being a gleam in a lab jockey's eye to delivery to the marketplace. Yet one argument that critics often make is that drug companies sell their pills for dozens, if not hundreds, of times more than it costs to make them. The liberal policy magazine American Prospect made just this case in its September 11, 2000, issue, in an article titled, "The Price Isn't Right." The piece cites an analysis that claims Bristol-Myers Squibb can manufacture a patient's 18-month supply of the popular cancer drug Taxol for just $500, but charges over 20 times more than the manufacturing costs.
This kind of "analysis" is just willfully stupid. For many products whose value is essentially embodied in intellectual property -- drug makers get a 20-year patent on new drugs -- copies can be manufactured very cheaply once the product has been developed. Hence, it may cost hundreds of millions of dollars to create the first copy of a computer program, but the second copy is little more than the cost of the CD onto which it can be downloaded. The same holds true for most pharmaceuticals. Manufacturing that first pill takes millions in conducting research and clinical trials, in processing regulatory filings and building a factory, in establishing distribution channels and generating advertising. The second pill may indeed take only pennies to make physically, but virtually all the money to create it has already been spent by the time that second pill goes into a pharmacist's bin.
"A pill is very small, so people have the intuition that it shouldn't have a high price," says Alison Keith, who recently stepped down as head of economic and science policy analysis at pharmaceutical giant Pfizer. "But a better way to think about our medications is that they are small tablets wrapped in huge envelopes of information."
A related charge regarding pharmaceutical costs is the idea that patients are actually paying for drugs twice -- the first time as taxpayers through government-funded scientific research and again as patients, when they go to their local drugstore to pick up their prescriptions. "Research funded by the public sector -- not the private sector -- is chiefly responsible for a majority of the medically significant advances that have led to new treatments of disease," argues The American Prospect.
Is that true? The annual budget of the National Institutes of Health, the major government grant-giving institution for medical research, was $17.8 billion in 2000 and is expected to rise to $20.5 billion this year. Meanwhile, the pharmaceutical companies' R&D budgets totaled $26.4 billion last year -- almost 50 percent more than the 2000 NIH budget. (Industry R&D expenditures equal more than 20 percent of what pharmaceutical companies make in total sales, making the industry the most research-intensive business in the world.) What roles do government and private-sector research actually play in the drug discovery and development process?
"Government-supported research gets you to the 20-yard line," explains Duke's Grabowski. "Biotech companies get you to the 50-yard line and [the big pharmaceutical companies] take you the rest of the way to the goal line. By and large, government labs don't do any drug development. The real originator of 90 percent of prescription drugs is private industry. It has never been demonstrated that government labs can take the initiative all the way" to drug-store shelves.
George Whitesides, a distinguished professor of biochemistry at Harvard University, similarly appreciates the role of often-government-funded research labs at universities in the early stages of drug development. But he stresses that "pure" research rarely translates into usable products. "The U.S. is the only country in the world that has a system for transmitting science efficiently into new technologies," he argues. That system includes research universities that produce a lot of basic science and get a lot of government money. In turn, startup companies take that lab science and develop it further. "Startups take 50 percent of the risk out of a product by taking it up to clinical trials," explains Whitesides. "Industry has an acute sense of what the problems are that need addressing." Without private industry to mine the insights of university researchers, taxpayers would have paid for a lot of top-notch scientific papers, but few if any medicines.
Frank Lichtenberg, the Columbia economist, has a slightly different take on the question of whether patients are paying twice for drugs. He cites the example of Xalatan, a glaucoma drug developed by Pharmacia & Upjohn. Last April, The New York Times ran a news story suggesting that although some of the original research on Xalatan was backed by a $4 million NIH grant in 1982, the "taxpayers have reaped no financial reward on their investment." Not so fast, says Lichtenberg. In 1999, Xalatan represented 7 percent of sales for Pharmacia & Upjohn, so Lichtenberg reasonably assumes that 7 percent of the company's $344 million in corporate income tax payments that year can be attributed to Xalatan. Thus Pharmacia & Upjohn paid about $24 million in income taxes on its 1999 sales of Xalatan. Just counting that one year of increased taxes as if it were the only return ever for a 17-year-old investment, Lichtenberg calculates that this yields a very respectable 11 percent return on the taxpayers' money. In fact, future sales are very likely to be higher, "so the return on the taxpayers' investment is likely to be considerably greater."