Why Expensive Drugs Can Still Be a Bargain?

Addressing the common misconceptions about drugs: their development costs, pricing, and affordability.

Elena Solopova | February 17th, 2024

Last year, Deloitte found that the average cost of developing a new drug rose to $2.3 billion, which compares to the GDP of Belize.

Just because drugs can be incredibly expensive to develop, we can’t ignore legitimate concerns around drug pricing and affordability. A previous article “Rethinking Evil Pharma: Is it a Good Career for Helping People and How to Get Involved on Campus?” touched upon a common misconception that drugs are invented by academia and sold by the industry. I brought my concerns to Peter Kolchinsky, the author of The Great American Drug Deal, a co-founder and managing partner of RA Capital, a healthcare reform advocate, and a founder of the non-profit No Patient Left Behind. Building on Peter’s ideas, I considered how the pharmaceutical industry impacts healthcare, including drug development costs, pricing, genericization, and ultimately affordable healthcare.

First, let’s put drug costs into context. Even with how much we spend on drugs, it is only a fraction of the overall healthcare expenditure. In 2021, the total prescription drug spending was $378 billion, constituting 8.8% of the overall national healthcare expenditure of $4.3 trillion, according to the Centers for Medicare & Medicaid Services. Yet, this fraction serves as an incentive to spur investment into the research and development (R&D) of novel medicines.

To appreciate the drug development costs, it helps to think like people who invest in it, such as Peter. The projected return on investment in pharma R&D from Deloitte was 1.2% in 2023, which is drastically lower than in most industries. This statistic blends all projects, and no doubt some investors and companies are more successful or else they wouldn’t stay in business if they did this poorly. Still, this number underscores the high costs and risks of investing in drug development. Because most drug candidates inevitably fail, we mustn’t think about the cost of making a drug by working backward from only the drugs that make it to the market and focusing solely on the manufacturing costs of the successful drugs. Instead, we should think “forward,” as Peter says, from the whole portfolio of bets – an important concept for investing, neatly explained here by No Patient Left Behind – that we must fund to ascertain which programs might succeed. When you think of the drug development cost as investing in a portfolio of bets, it becomes clear that a successful drug must generate enough to make the whole portfolio worth funding.

While successful drugs need to generate enough profit to sustain the investments and so are often very expensive, it doesn’t mean that those profits should be unlimited. The pharmaceutical industry already has a built-in mechanism for controlling the profits from most drugs. That’s why despite new branded drugs coming to the market each year, the percent of total healthcare spend that goes to drugs stays fairly consistent year after year.

Think about the expense of branded medicines like paying off a mortgage, a clever comparison Peter uses to explain the model for drug pricing. Just like the high price of branded medicines, those mortgage payments are temporary. Similar to how the house eventually becomes yours to live in at a much lower expense than rent, branded drugs go generic when their patents expire and become available at much lower prices.

Statins are one example of how generic medicines save money while continuing to save lives. These small molecules inhibit the production of cholesterol by the liver cells. Research in Heart showed statins lessened the risk of death by 39% in patients with heart disease. Findings from JAMA agree that generic statins continued to help people and saved an estimated $11.9 billion per year for the US alone. The Harvard Business Review saw Pfizer’s statin Lipitor decreased in price by 95% following the end of its exclusivity period about 14 years after its launch. That’s the idea behind the patent system: a temporary period of market exclusivity in which the inventors and their investors can profit, after which the public gets the inventions at a lowered cost forever.

Still, Kannappan et al. asserts that decreasing the drug price sooner than the median of 14 years before branded drugs go generic could harm people by thwarting drug development. Making the novel drugs inexpensive right away, notwithstanding their market value, would make investing in the next drugs’ development unattractive, leading the capital management funds to divest from the biopharmaceutical industry.

There are areas where that’s already happened because investors see too little reward. Consider how we have a mounting crisis of antibiotic resistance, yet few companies are developing antibiotics because there isn’t a market for them. The new antibiotics market is limited by the future sales volume and price, which often don’t justify investing in their development. Antimicrobial resistance not only makes antibiotics more difficult to develop but even successfully developed new antibiotics are used sparingly to stave off additional antimicrobial resistance. Similar to how the lack of financial incentives dissuades the industry from creating new antibiotics, limiting the profits associated with the high cost of drugs will discourage developing drugs altogether. Hence, reducing the prices of novel drugs would have a detrimental impact in the long run.

If drugs are inherently expensive, how can they be affordable? We are paying into insurance via premiums and taxes so that insurance plans would use those funds to make drugs affordable for the relatively few among us who need them at any one time. Insurance fails to insure people when it saddles sick people with high out-of-pocket costs. Thus, when people cannot afford their medicines, insurance isn’t doing its job. Hence, if we want to continue to develop new medicines, the solution to making them affordable lies in reforming insurance rather than controlling their prices. Although drugs need to be temporarily expensive to fuel the costly and risky drug development, they need not be cost-prohibitive thanks to insurance.

Lastly, Peter Kolchinsky shared a couple of words about the importance of understanding how the pharmaceutical industry functions:

“It took me over a decade of being a biotech investor before I woke to the danger of the public’s justified anger about how unaffordable some medicines were for some patients.

I realized that most of us were doing science, developing and commercializing medicines, and funding companies without a foundational understanding of the economic and financial first principles that made our work possible. We are like fish doing our work in a lake that the public has declared a swamp and wants to drain thinking that medicines are just lying around to be plucked from the mud.

My advice to everyone who is looking to come into the biomedical innovation lake is to appreciate the water that is vital for their work and to learn to read the needs of the society we serve on land, to serve those needs, and to communicate the value of our work to the public. Because when we don’t, we may find ourselves robbed of the means to do our work.

What the public wants is affordable medicines. We need to lower out-of-pocket costs and we need to ensure that all drugs go generic without undue delay. And even if you spend 99% of your time at the bench, a successful career for the next 50 years will likely require putting 1% of your time consistently towards understanding the ecosystem as a whole, learning some of what you might think others will handle (like shaping policy), and pitching in to preserve our ecosystem. Anything you really care about will likely require that you not only do your job but also perform your civic duty. The resources available at www.racap.com and www.nopatientleftbehind.com can help you with that.”

I’d like to thank Peter Kolchinsky and Chris Morrison, the editor at RA Capital, for contributing
their ideas and writing to this article.

References:

[1] George Parrett, “Pharma R&D return on investment falls in post-pandemic market.” Deloitte United Kingdom, 9 Jan. 2023, https://www2.deloitte.com/uk/en/pages/press-releases/articles/pharma-r-d-return-on-investment-falls-in-post-pandemic-market.html.

[2] “NHE Fact Sheet | CMS.” Centers for Medicare & Medicaid Services. 13 Dec. 2023, https://www.cms.gov/data-research/statistics-trends-and-reports/national-health-expenditure-data/nhe-fact-sheet.

[3] Kolchinsky, Peter, “The Investor’s Paradox.” No Patient Left Behind, 20 Aug. 2021, www.nopatientleftbehind.org/about/our-videos. (embed the link in the text, please).

[4] Hippisley‐Cox, Julia & Coupland, Carol, “Effect of statins on the mortality of patients with ischaemic heart disease: Population based cohort study with nested case–control analysis.” Heart, 92(6), 752–758, 10 Oct. 2005, https://doi.org/10.1136/hrt.2005.061523.

[5] Rosenblatt, Michael, ‘The Real Cost of “High-Priced” Drugs’, Harvard Business Review, 17 Nov. 2014, https://hbr.org/2014/11/the-real-cost-of-high-priced-drugs.

[6] Lin, Shuo-yu, Baumann, Kyle, Zhou, Chenxuan, Zhou, Weiyu, Cuellar, Allison. E, & Xue, Hong, “Trends in Use and Expenditures for Brand-name Statins After Introduction of Generic Statins in the US, 2002-2018.” JAMA Network Open, 4(11), 22 Nov. 2021, https://doi.org/10.1001/jamanetworkopen.2021.35371.[7] Kannappan, Sunand, Darrow, Jonathan J., Kesselheim, Aaron, S., Beall, Reed F., “The timing of 30-month stay expirations and generic entry: A cohort study of first generics, 2013-2020.” Clin Transl Sci. 2021 Sep;14(5):1917-1923, 31 May 2021, https://pubmed.ncbi.nlm.nih.gov/33982425/.