TCS Daily

Understanding Risk and Reward

By Roger Bate - October 11, 2004 12:00 AM

Marcia Angell gets one thing right in her new book ("The Truth About Drug Companies") -- the level of profit for the pharmaceutical industry is above the average for the S&P 500. But as we saw last week with Merck's share price plummeting in response to the withdrawal of its product Vioxx, one reason for industry profitability is the extra risk inherent in the drug business.

It costs over $800 million to bring a new drug to market. Indeed, Sir Tom McKillop CEO of AstraZeneca said yesterday that it costs as much as $1.2 billion from inception to first sale. The cost is so high because the vast majority of compounds discovered and tested don't do anything useful, the ones that do might be toxic or have side-effects significant enough to make them unworkable. These defects won't be realized until after many years of trials, costing millions of dollars for each failure -- most compounds that make trials fail. The few that survive can make a fortune, but even then may have to be withdrawn, with lost revenue and potential litigation costs escalating.

But since the returns can be high, the U.S. research-based (non-generic) pharmaceutical industry currently spends upwards of $33 billion annually on R&D. Unfortunately, the fallout from Vioxx could be significant; much of it specific, some wide-ranging, and nearly all bad. The withdrawal of Vioxx may be evidence that the family of drugs, the Cox-2 inhibitors, once referred to as "super aspirins", are "turning out to be more like super disasters" said Dr. Sydney Wolfe, of the Naderite health-care watchdog groups Public Citizen. However, evidence shows that similar products on the market, such as Celebrex, are safe.

The impact of negative sentiment was immediate. The sober Financial Times said: "The withdrawal of Vioxx also raises questions about regulatory procedures that allow drug approval on short-term clinical trials with little experimentation on long-term effects."

The cost of drug trials is increasing, and is already at least 65% of the cost of developing new drugs. Longer trials as the FT implies is required, and Public Citizen demands, will deter research into novel drugs, particularly for diseases that affect relatively few people. Already drug companies focus increasingly on financial blockbusters -- usually treatments for chronic conditions that affect large populations. The result is they neglect products with more modest prospects, no matter how medically important or technically feasible they may be. For example, although they are tremendously critical and cost-effective, antibiotics and vaccines are out of favor. And with over a quarter of companies leaving the AIDS drugs research field in the past few years any further pressure on increasing costs of clinical trials will speed the flight.

Non-Profit Drug Discovery?

Into this unprofitable research void have stepped several private public partnerships such as the Medicines for Malaria Venture, which has several compounds in development, and gives the impression that a breakthrough may be just around the corner. Funded by the Gates Foundation and other philanthropic donors, ventures like MMV may yet deliver something. Many malaria experts are guardedly optimistic. But it's important to point out that except for the initial discovery of compounds, much of the research and development is undertaken by the private sector, which also manages the process of weeding out and abandoning the failures at the earliest possible stage. They're assigning staff and huge lab time to the project. This is a key reason MMV looks like it may be successful.

Another approach has been taken by Victoria Hale, the CEO of OneWorld Health, the world's first non-profit drug company. Her idea, also backed by the Gates Foundation, is to get drug companies to give her their undeveloped drugs, which potentially could be useful in combating some of the world's nastiest diseases. She says: "Right now we have an over-abundance of drug opportunities -- about 200 -- and we don't have time to review them all. They come from academia, industry and companies, and from individuals who own the rights."

Her top priority right now is leishmaniasis, also known as Baghdad Boil by the troops in Iraq. The disease kills over 200,000 people a year, infecting over ten million, the majority of them children in Asia and Africa. Using a drug, Paromomycin whose rights were owned by the World Health Organization, but with which the WHO had done nothing, she now has the drug under trial in India. Within a few years we may have a new treatment for this age old disease. Hale seems very sincere, and within a few years we'll know whether her approach is working for leishmaniasis and other diseases like chagas disease.

While Hale's approach is certainly novel and interesting, for widespread success we will need the much maligned but hugely innovative research-based industry to re-engage in fighting the diseases related to poverty. Like most economists, I am normally against contrived markets, in this instance for drugs, but somehow it has to be possible for those suffering from diseases like leishmaniasis, malaria and meningitis to receive treatment.

Research-based industry needs encouragement to work in unprofitable areas. Guaranteeing markets by Government procurement, or by proving tax breaks or patent extensions on other drugs, or other artificial remedies may work. These approaches are being discussed with regard to AIDS drugs. If implemented they might be extended to other areas.

But while the industry's profit is undermined in its successful areas of research it's unlikely to devote sufficient effort into combating diseases that, from a business perspective, are only tangential.

If Dr. Angell and Public Citizen continue to attack the industry, they may well get increased traction with politicians who already want to make short run political gains by lowering drug costs, without considering the long run implications. Discussing the findings of a new research paper on the size of drug markets, the economist Alex Tabarrok recently pointed out,

"We can expect... that a 1% reduction in price will reduce the growth rate of new drug entries by 4% and a 10% reduction in price will reduce new drug entries by 40%. That is a huge effect. I suspect that the authors have overestimated the effect but even if it were one-half the size would you be willing to trade a 10% reduction in price for a 20% reduction in the growth rate of new drugs? No one who understands what these numbers mean would think that is a good deal."

The anti-pharma actions will make big pharma less profitable, without lowering the risk of investment. And that will mean fewer new drugs.


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