Drug Baron

Drug prices are (unnecessarily) high because R&D is (unnecessarily) inefficient


Let me put it in bold text and a large font, lest there be any misunderstanding of DrugBaron’s position:

Healthcare costs are manifestly too high and completely unsustainable in the medium term.  That includes drug prices.

This is not inconsistent with the two recent articles (here, here) on drug pricing, which set out to defend the mechanism by which prices are set for proprietary medicines, for at least two reasons.  Firstly, drugs and medical devices represent a minority (by some estimates as little as 10%) of healthcare spending, so even dramatic falls in drug prices would hardly move the overall budget.  And secondly, approval for the mechanism of setting drug prices does not equate to approval for paying the prices demanded.

The open letter to Henry Waxman, berating his ill-conceived intervention on drug pricing, drew (perhaps unsurprisingly), considerable support from the broadly-defined drugs industry and howls of protest from healthcare consumers.

The voices of disagreement, though, focused on the actual prices – branding them, probably correctly, as “unaffordable” (among some stronger language) – rather than, as DrugBaron had done, on the mechanism that yielded those prices and the appropriateness of Congressman Waxman’s intervention.

Repeating the central point: governments should defend Gilead’s right to charge whatever it wishes for Solvaldi™ while it remains patent protected – simply because that is the contract implicit in the patent.  Without strong patents, there would be much less innovation, to the detriment of us all.

But that is not the same thing as saying that governments (or other healthcare providers) should pay what is demanded

That, historically, they have done so is driven primarily by the powerful “entitlement culture” that pervades Western democracies, and grows stronger with each passing decade.  Everyone expects to have access to every possible medical intervention, no matter the cost.

Yet, ironically, it is this entitlement culture, and the social and political pressure that results, which underpins the unsustainable cost of healthcare.  Paying high prices (and not just for proprietary drugs) supports a hugely inefficient healthcare market, bloated by public cash spent to satisfy the demands of those who equate inputs with outputs.  It sustains broken R&D strategies within vast, global pharma companies.

Refusing to pay for inefficiency is the only way to drive essential reforms.  That may well include refusing to pay what is demanded even for life-saving drugs.   The pressure is building, and the revolution may be nearer than you think.

Two considerations underpin drug pricing: the delivery of value and the need to repay the development costs.  While the value delivered clearly exceeds the cost of development across the entire medicine cabinet, all parties are happy and drug pricing remains far from the top of the political agenda.

But since about the turn of millennium (and perhaps a little earlier), two trends have changed the landscape.  Firstly, the incremental clinical efficacy of each new generation of approved drugs has been smaller than the last one (on average, although there are, of course, clear exceptions).  This trend has been propelled by obvious  drivers, such as the exhaustion of low-hanging fruit and the fact that the bar for further improvement gets higher and higher as time passes.  It is also turbo-charged by pharma strategy focusing deliberately on incremental innovation (rather than ground-breaking advances) as a result of “short-termism” among investors.

Secondly, the cost of each approved drug has spiraled, as total R&D spending has climbed exponentially yet approval rates have been flat or even declining (not withstanding what is probably a real up-tick in the most recent couple of years).  Estimates of R&D spending per approved drug range from a little over $1billion to as much as $5billion depending on how you do the maths (the simplest the ratio of total R&D spending worldwide to the number of approved drugs, which yields something close to the upper end of this range).

Arguably, we reached a point some time ago where the total development costs exceeded the total value delivered – with the grumpy public paying for the difference

Of course, both these macro-trends conceal considerably heterogeneity.  A handful of approvals each year deliver huge gains in clinical outcomes for patients.  In recent times, the majority of these unambiguous utility drugs have been in rare (and sometimes ultra-rare indications) – but the latest, Gilead’s Sovaldi™, addresses a far more common condition: hepatitis C infection, which thrusts the debate squarely to the top of the political agenda.  That’s because pharma increasingly have to recoup their development costs for the whole pipeline from a tiny number of these unambiguous utility products.  The incremental innovation products cannot win such large markets or such high margins, and do not pull their weight on the balance sheet – so the slack has to be taken up by the occasional “home run” products.

That drives up the price of “home run” products until, assessed now one by one rather than across the whole medicine cabinet, even the individual “miracle” products looks like dubious value for the public purse.

Similar heterogeneity exists in the price of development.  Bringing a new formulation of an existing drug to market may cost 100-fold less than a new treatment for Alzheimer’s Disease.

The most obvious solution to this mismatch between cost of development and value delivered – to cut costs by retreating further towards incremental innovation – delivers only a temporary fix.  A fix because it drives down R&D costs immediately but revenues fall only slowly as “home run” products deliver continued sales; but temporary because those “home run” products will perforce be replaced by reformulated mediocrity.  Ultimately value delivered may fall even further than development costs incurred.

The real solution, of course, lies in R&D productivity – the number of worth-while products delivered per dollar of R&D spending

Reversing this decline offers a sustainable future for pharma.

Everyone knows that.  Why then do we see little signs of the real changes needed to deliver it?

Two reasons: the first is the entitlement culture that leads the general public to expect their healthcare providers to deliver to each and every one of them the very latest in healthcare innovation, even – as with many of the newly approved cancer drugs – the benefit they deliver is marginal and the cost enormous.   Cushioned by this expectation, pharma have operated on the assumption that the public will sanction whatever payment is necessary to sustain drug R&D no matter what the efficiency of that process – an assumption that has clearly proven true over a period of decades.

In such an environment, improved efficiency of R&D is a “nice to have”, not a necessity for survival.  More efficient R&D would translate to better profitability (nice) but as long as your productivity wasn’t materially worse than your rivals, your survival was never in doubt.

Second, there is a pervasive assumption (bolstered, if not peddled, by pharma company management wanting to relieve any pressure from their investors to improve efficiency) that external and unavoidable issues place a ceiling on efficiency.  Biology is complex, they argue, making it almost impossible to know where to find the next “home run” product (Roger Perlmutter of Merck described the odds of finding a drug that actually works as “a bloody miracle”).  On top of complex biology, the regulatory framework that ensures patient safety is ever more burdensome.

But these two issues provide both a cushion and a screen that conceals the biggest failings in current pharma R&D strategies.

DrugBaron has argued in the past that there are INTERNAL factors that R&D managers CAN control that deliver the greatest hit on productivity

Three posts elsewhere on this blog have highlighted key components of R&D strategy that could be changed for the better:

Top of the list is the grading of capital allocation to projects from small to large.  Only as the unavoidable risks (due to biological complexity, regulatory demands and commercial reality) are gradually discharged in a step-wise manner should further capital be allocated to a project.  Not a dollar more than is needed to reach the next de-risking milestone should ever be committed.  Yet pharma have, if anything, moved in the opposite direction with a “pick the winners” strategy where selected projects are allocated massive resources from the outset.

Second, and related to the first point, is the need to manage culture so that doomed projects are killed at the first possible opportunity.  Corporate structures and culture, particularly (but not only) in large pharma, often bias the “kill or continue” decision in favour of continue – with disastrous consequences for R&D efficiency.

Third, but certainly not least, is the addiction to new and jazzy platform technologies.   Ostensibly marshaled to counter the “complexity of biology” problem, these cutting-edge “aids” for drug discovery and development actually contribute massively to the low productivity of R&D in large pharma environments.  The problem lies in a lack of transparency of the cost of developing, maintaining and using such capabilities – as with the first two, a problem that can be solved.

So contrary to the lazy mantra that drug development is just tough, and that little can be done to alleviate the problem – just blame the biology – there are viable, practical steps that can be taken to address the R&D efficiency problem.  Whether, properly implemented, they can make a sufficient difference to make discovery and development of truly innovative drugs economically viable at prices society is willing to pay for their medicines remains to be seen.  The only thing that seems certain is that without some strategy to improve R&D efficiency, the drugs industry is on a collision course with the public that they cannot win.

But things are about to change.  The cushion is deflating rapidly

The letter from Congressman Henry Waxman to the chief executive of Gilead, challenging the price they have set for Sovaldi™ is only the most recent and most visible manifestation of the ground-swell against the perceived high price of drugs.  The message is clear: high prices will not be paid, whether or not it costs that much to develop new innovative medicines.

And while DrugBaron criticized Waxman for his intervention as potentially damaging, by undermining the absolute right of Gilead to command whatever price they wish for Sovaldi™ under the implicit contract of the patent system, that does not imply support for high prices.  And in any case, attempting to argue for the status quo when it comes to drug pricing would be a challenge akin to that faced by Canute.  Public opinion is set, and public opinion always wins in the end.

And public opinion hardening against high priced drugs isn’t the only cold wind blowing.  The recent pursuit of Allergan from Pershing Square’s Bill Ackman and his allies at Valeant highlights another force pushing against complacency in the old R&D models.  As DrugBaron noted recently, together with David Shaywitz, the threat to jettison R&D in the pursuit of improving shareholder returns is very real.  That threat, like hardening public opinion on pricing, has the potential to shake the pharma industry to its very foundations.

Ultimately, if the public and investors alike cease to tolerate the sustained mismatch between dollars consumed in R&D with the value of the output, the only solution is new R&D strategies.  If pharma will not, or cannot, provide them then other, nimbler, players will undoubtedly fill the breach.  The demand for innovative medicines is insatiable, and the prize is there for those bold enough to step up to the plate.

But forcing the changing of the guard will not be straight-forward.  The public and pharma executives face a high-stakes game of chicken.  If the demand for lower prices is not met, will the public be prepared to go without the very best drugs?  Over the coming months and years, we will see the whites of their eyes.  The billion dollar questions is, quite simply, who will blink first.