Billion-dollar babies

DollarMedEconomist, November 26, 2015. AS THEY announced the proposed merger of Pfizer and Allergan to create the world’s biggest drugmaker, on November 23rd, the two firms’ bosses stressed the scale that is needed to keep inventing blockbuster treatments. As Ian Read, Pfizer’s boss, put it, the merger will create “a leading global pharmaceutical company with the strength to research, discover and deliver more medicines and therapies to more people around the world.”

A more convincing explanation for the deal is that, by shifting Pfizer’s tax domicile from America to Ireland, where Allergan is domiciled, the combined group’s tax rate will fall from about 25% to 17-18%. But even leaving that aside, the common suggestion that size is needed to create a research-driven powerhouse does not stack up. The figure of $2.6 billion cited by PhRMA, the American drugmakers’ lobby, for the cost of developing a new drug, is questionable. And the industry is in any case moving away from a model in which giant firms throw huge sums at in-house research in a quest for ground-breaking new treatments.

Start with the $2.6 billion figure. Two years ago, when the number being bandied about was just $1 billion, even the boss of GSK, one of Pfizer’s biggest rivals, described it as a myth. Médecins Sans Frontières, a charity, claims that new drugs can be developed for as little as $50m and no more than $190m, even taking into account the cost of those that fail during clinical trials. Some of the assumptions used to arrive at the $2.6 billion figure are easy to pick apart. One example is the padded estimate for the drug firms’ cost of capital. But at least as important is that the figure is based on data from between 1995 and 2007. It says more about the failures and inefficiencies of the drug giants’ in-house laboratories back then than it does about how much it should cost to bring a new treatment to market now. That matters because the industry has been moving towards a new model.

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The main element of this model is that, rather than spending heavily in many different areas of cutting-edge research, the largest firms are increasingly buying in drugs that are already in the course of development. In some cases they do so by buying other established firms. For example, Pfizer acquired Lipitor, its blockbuster cholesterol-lowering pill, as part of its takeover of Warner-Lambert. Likewise, when Gilead bought Pharmasset, one of the assets it acquired was Sovaldi, a hepatitis-C treatment which is now one of Gilead’s biggest sellers.

Increasingly, the drugs giants are buying smaller, younger biotechnology firms which focus on a single-treatment approach—such as last year’s purchase by Merck, an American firm, of Idenix, which is pursuing a different route to inhibiting the hepatitis C virus from Sovaldi’s. Whether the target firm is big or small, buying in promising potential drugs is a good strategy. A study by Bain, a consulting firm, found that in the past 20 years those drug companies that consistently did well in various therapeutic areas were earning more than 70% of their sales from products developed elsewhere.

As the biggest firms have increasingly outsourced the early stages of drug discovery, they have cut back their in-house spending in those areas of research in which they are weak. But they have continued to spend heavily on what are more like beauty products than life-saving cures—think of Allergan’s Botox anti-wrinkle jabs, or Latisse, its lotion for thickening eyelashes. They have also continued to pump money into making incremental changes to their existing drugs, so as to claim some small advantage—and big price differential—over rival treatments.

Overall, the new approach seems to be helping to improve the industry’s efficiency. Tim Gamble, a consultant at Datamonitor Healthcare, says drugs in development are not failing at the rate they used to. Last year a record number of new medicines gained approval. Rising efficiency may also be the result of the way the study of the human genome is leading to a deeper understanding of diseases. James Bianco of CTI Biopharma, a small drugmaker, argues that the genomics revolution is making it faster and less risky to develop a new treatment approach, thus cutting the cost of basic research, whether at startups or global pharma giants.

But what about the price?

Promising as all this sounds, there is little sign yet of any improvement in the efficiency of drug research translating into cheaper medicines. The shareholders of a drugmaker expect it to charge as much as it can get away with; and since many drugs, for as long as their patent is in force, have no close competitors, the health systems and insurers they sell to may have little choice but to pay whatever they are asked for. Sometimes a drug’s new owner makes more from it than the old owner, simply by being more demanding on price. Pharmasset had been thinking of selling Sovaldi at between $36,000 and $72,000 for a course of treatment. But Gilead, having bid highly to win control of Pharmasset, put the drug on the market for $84,000.

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Some drug firms are also buying makers of long-established, out-of-patent treatments, realising that even these could bear higher prices if no other firm is supplying a “generic” copy of them. Turing Pharmaceuticals and Valeant have became notorious for buying the rights to some such medicines, and jacking up their prices.

Ensuring that the benefits of greater research efficiency are fully passed on to governments and health insurers would require drastic changes, such as, say, abolishing the patent system and finding some other way to incentivise basic research. Among the more imaginative ideas in this vein, the open-source pharmaceuticals movement is experimenting with using prizes as an incentive for teams of volunteer scientists to work on new treatment approaches. Once invented and tested, the drugs would be free for any firm to make.

Realistically, though, the chances that new approaches to research will dramatically cut the cost of medicines look slender. That leaves more administrative approaches. It could be made easier to import cheap copies of unpatented drugs made in other countries. Buyers of medicines could share more information about the different prices they are being charged for the same pills. They might be firmer in refusing to pay over the odds for new treatments that offer marginal gains. Medicare, America’s health system for the elderly, could be allowed to try to negotiate with the drugmakers, something it is banned from doing now. If the producers are becoming more efficient, the buyers should respond.

This entry was posted in Big Pharma myths, Mergers and Acquisitions, Pricing. Bookmark the permalink.

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