Quora Question: Is the High Cost of Drugs Justified?

A new study finds that most seniors don't receive the blend of prescription drugs that they need. REUTERS/Srdjan Zivulovic

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Answer from Christopher VanLang, Ph.D in chemical engineering who works in the pharmaceutical industry:

The argument that the high cost of drugs is necessary to support R&D is certainly a hot topic question. It will tend to quickly spiral into an emotional argument about greed. However, there are a decent number of frameworks that you can point to that would indicate that it is the rational and justified thing to do. Do I necessarily agree with all of these arguments? Probably not. But the people who pay for our R&D funding think this way and, if that's the justification that we have to use, then so be it.

This comes back to the phrase that Martin Shkreli loves to use: "maximize shareholder value." To different people this means different things. It could mean short-term stock value (see Valeant). It could be ensuring the long-term success of the company (see the opposite of Dow-DuPont). It could mean ensuring the development of a single drug (many orphan drug companies).

For the people who actively work in the industry and who do the day-to-day work of making drugs, our mission is clear: get life-saving drugs to patients. However, the people who fund our mission don't necessarily see it that way. Biopharma is in a tough bind because the company's value comes from shareholders who generally invest in high tech stocks. Without using names, which company would you invest in?

  • Mkt cap= $518 Billion, P/E ratio = 9.98, EPS = 9.40, R&D expenditures = 3% of net sales
  • Mkt cap = $281 Billion, P/E ratio = 18.59, EPS = 5.48, R&D expenditures = 11.4% of net sales
  • Mkt cap = $170 Billion, P/E ratio = 23.72, EPS = 1.24, R&D expenditures = 16.0% of net sales
  • Mkt cap = $137 Billion, P/E ratio = 31.43, EPS = 1.56, R&D expenditures = 17.0% of net sales
  • Mkt cap = $399 Billion, P/E ratio = 35.74, EPS = 1.41, R&D expenditures = 13.4% of net sales
  • Mkt cap = $238 Billion. P/E ratio = 405, EPS = 1.25, R&D expenditures = 8.8% of net sales.

The companies in order are Apple, JnJ, Pfizer, Merck, Microsoft, and Amazon. Unsurprisingly, you can pick out the drug companies based on their R&D spend. Thus, every dime that gets spent in computer engineering or software making your stupid phone application is a dime that isn't being spent toward making drugs. Thus, pharmaceutical companies are in the uncomfortable position of begging the hedge funds that pick and choose where the world's money gets invested in that they should find it in their hearts to invest in making drugs rather than in the next penis picture sharing app.

The below figure from JAMA showing the R&D spent as a percentage of revenue is telling. No industry spends as much as biopharma. These numbers doesn't even include the surplus help we get from the NIH. Frankly, the increase in internet R&D only started going up in recent history because of Facebook's aggressive increase in R&D spending.

This competition in funding starts as early as VC funding. What's cooler? Investing in a cool tech company that will IPO in three to five years that will make billions or investing in a high-risk biotech that will IPO in five to seven years and won't have a product until year nine? Drug companies are losing out in the innovation sector because the financial sector is much more willing to invest in low-risk, high-reward ventures like tech rather than high-risk, low-reward ventures like biotech.

So those are the people we have to convince. They generally don't know much about how the industry works but they do understand that R&D costs money, and an easy way to increase the earnings per share is by cutting R&D. As discussed in "Does pharma only develop drugs for those who can pay?," when sales are good and the investors aren't complaining as much, drug companies do siphon their extra earnings into high-risk, low-reward areas like tropical and neglected diseases. The GSK malaria vaccine and the Sanofi dengue vaccine are two notable examples of companies developing drugs at a massive loss supported by the extra earnings provided by the high cost of drugs. However, if you think eight to 10 years is a long time for drug development, those programs took 20 years to complete.

Unfortunately, Eroom's law (Moore's law backwards) fantastically suggests that the cost of drug development is gradually going up over time. Certain pharmaceutical analysts, like Matthew Herper and Bernard Munos from Forbes, indicate that the cost for drug development isn't $2 billion per drug that the Tufts DiMasi analysis suggests but closer to $4 billion per drug; a number that executives are hesitant about admitting since no one would believe them. See The Truly Staggering Cost Of Inventing New Drugs.

This is what drug companies have to deal with. They have to satisfy the unrealistic performance expectations of the tech industry while staying in compliance with some of the strictest government agencies in the world, with the general public against them, all while dealing with the extremely unpredictable human body.

Even developing a drug that works faster, is more effective than everything else, has less side effects, is easier to take, works in third-world countries, and costs less than conventional therapies like Gilead's Sovaldi resulted in CEO John Martin resigning.

Is the high cost of drugs necessary? A lot of biopharma employees already work for a fraction of the costs that our colleagues are making in other industries, and we're willing to make drugs at a loss. Could we work with reduced costs of development? We'll survive and probably figure out how to make drugs even with shoestring budgets. But in 2012, $68 billion were spent in the US by companies contributing as much as 58 percent of the total biomedical spending in the US coming from R&D budgets that comprised 14 percent of their revenues.

The amount spent in drug R&D is directly correlated with drug sales, and that amount is always in danger of going down if the earnings per share go down with it. If you want drug companies to continue to spend money in R&D and want to make sure that the people financing those drug companies continue to fund those operations, you want those drugs to sell well.

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