TCS Daily

I Want a New Drug...

By Carlo Stagnaro - May 11, 2005 12:00 AM

Europe's pharmaceutical market is changing. The transformation has been under way for a long time, but recently a major change occurred: the Swiss giant Novartis acquired Hexal, the second largest generics company in Germany, and its strategic partner Eon Labs. After this €6 billion deal, Novartis' core business will move gradually from research & development based drugs towards producing and selling non-patented products. The company aims for world leadership in the sector. So far its share is around $3 billion, and its ambitious goal is to increase it up to $5 billion (around 10 percent of the total market for generics).

Novartis already controls 38 percent of the European market for generics through Sandoz; after the new merger it hopes to control about 58 percent. Novartis CEO Daniel Vasella also said he'd enlarge the company's role in emerging Asian markets, especially China and Japan. He also announced that, while no further acquisition is in his immediate view, he would not rule out buying a "jewel" should the opportunity arise.

But there is reason to be concerned about this development, which may have both "human and medical costs," according to Scott Gottlieb, a resident fellow at American Enterprise Institute and a former senior official at the US Food and Drug Administration and Medicare program. What is he talking about? Consider an example: "If Novartis, a highly profitable research-based company, had made the decision to bound into the low-profit commodity generic medicine business back then instead of now, it may well have been unable to mobilize the vast amounts of capital it needed to develop the breakthrough medicine Gleevec. That drug has revolutionized the treatment of what had been the deadliest form of leukemia." Then the question is: How many medicines will not be developed because of this shift towards generics?

The worst part of the story is that Novartis is not alone. Another pharmaceutical giant has taken a sudden interest in generics, namely the French firm Sanofi-Aventis. Again a European company. That is not a coincidence: in fact European health policies play a significant role in encouraging companies to shift from R&D to generics.

Price controls create an incentive for companies not to invest in new medicines; rather it pushes them to copy old, out-of-patent drugs. Several European countries set artificially low prices for new drugs.

Dr. Gottlieb points out that "when government policies explicitly place short-term savings ahead of long-term research and development, continued business growth favors squeezing pennies out of known chemicals far more than squeezing medical miracles out of the mysteries of science." Since healthcare is one of the most problematic parts of national budgets, a government's main goal becomes cost containment, often at the expense of prudence. Companies are urged to forsake profits on new drugs; they are rewarded with relatively higher profits on generics. As a result R&D activities grow more costly and less profitable. Companies are investing less and less on R&D precisely because of this.

Then another problem arises. In Gottlieb's words, "The branded innovators are able to sell new drugs only for ingredient cost plus a tiny margin, with no contribution to the R&D effort that birthed those drugs. This industrial policy favors local generics businesses while intentionally free-riding on U.S. drug consumers, who have been paying the full, R&D-freighted price for drugs all along. European and Canadian health authorities set higher-than-market prices on the oldest medicines and lower than necessary prices on the newest ones, engineering a slightly lower overall drug bill while forgoing any drug innovation, save what America is willing to provide on a subsidized basis."

Developing a medicine costs on average $800 million. That should explain more than any other figure why the EU finds it appealing to free ride on the US.

The driving force behind government interventionism is... government itself. If healthcare had not been nationalized in most European countries, governments would feel less urged to drive the markets. Thus markets might work better, reflecting the real demand for new drugs (and the willingness to pay for them). It is no surprise that EU companies invest in R&D far less than American ones: just 12.23 percent of their budget, vis-à-vis 19.22 percent in the US and 28.68 percent in Japan.

Even though in the US a large share of pharmaceutical market is more or less free from government interventionism, it isn't perfect. In fact, cost containment is a problem in the US, too. American firms have plenty of incentives not to invest in R&D. Gottlieb's fear is that the US pharma market will get more European over time, moving from R&D to generics. If that is the case, patients should cross their fingers and hope they get illnesses for which a treatment has already been developed.


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