Executive Times






2005 Book Reviews


The Truth About the Drug Companies: How They Deceive Us and What To Do About It by Marcia Angell


Rating: (Recommended)




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Readers of Dr. Marcia Angell’s expose of big pharma, The Truth About the Drug Companies, may want to keep blood pressure medication close at hand. The former editor of The New England Journal of Medicine debunks the myths perpetuated by drug companies and their lobbyists. Among her premises: much of what is called research and development is spent on marketing; much original research is government funded at universities; me-too drugs abound while life saving drugs for developing countries are discontinued; and the relationship between pharma and physicians looks like bribery.


Here’s an excerpt, from the beginning of Chapter 3, “How Much Does the Pharmaceutical Industry Really Spend on R & D?” pp. 37-46:


Drug companies claim drugs are so expensive because they need to cover their very high research and development (R & D) costs. In 2001, they put these costs at $802 mil­lion (in 2000 dollars) for each new drug they bring to market. (Later, the consulting firm Bain & Company upped that to $1.7 billion per drug, but they included marketing expenditures.) Im­plicit in this claim is a kind of blackmail: If you want drug companies to keep turning out life­saving drugs, you will gratefully pay whatever they charge. Otherwise, you may wake up one morning and find there are no more new drugs. As Alan E Holmei president of the industry’s trade associa­tion, Pharmaceutical Research and Manufacturers of America (PhRMA), said in a radio interview, “Believe me, if we impose price controls on the pharmaceutical industry, and if you reduce the R & D that this industry is able to provide, it’s going to harm my kids and it’s going to harm those millions of other Americans who have life-threatening conditions.”


The industry admits that it charges Americans, particularly those without insurance, far more than it does people in other countries, but it insists it needs to do so in order to make up for the fact that other countries regulate prices. Americans must bear a disproportionate share of R & D costs, they say, because nobody else will or can. This argument is trotted out whenever there is the faintest whiff in the air that anyone is considering price controls in the United States. William Safire used it in a New York Times column where he warned, “The price of most new prescription drugs is high in the U.S. mainly because it in­cludes the producers’ huge investment in scientific research.”


The Black Box


Given that argument, it is crucial to ask how much it costs the industry to bring a new drug to market. Is it really $802 million? Getting an answer to that question is not as easy as it sounds, be­cause the industry will not supply the necessary data. Individual companies report total R & D expenditures in their Securities and Exchange Commission (SEC) filings, and PhRMA’s annual report gives industrywide averages for total R & D, as well as average figures for the breakdown of expenses by general R & D func­tions (where one of the biggest categories is “other”). But the companies do not make available the really important details, such as what each company spends, and for what purposes, on the development of each drug. They claim that that information is proprietary. As Representative Henry Waxman (D-Calif.) com­mented, “The basic problem is that all pharmaceutical costs, in­cluding research, are in a black box, hidden from view. There is no transparency.” This secrecy is odd for an industry that justi­fies its high prices by its high R & D costs.


We also don’t know what activities are included under the heading “R & D.” Much of it may really be marketing, which is counted as R & D because it looks better to have a large R & D budget than to have a large marketing budget. One clue that this may be the case is the fact that a growing fraction of clini­cal trials are Phase N studies. You will remember from Chapter 2 that these are studies of drugs already on the market—supposedly for the purpose of learning more about long-term effects and possible additional uses. But many Phase N studies are mainly ways to introduce doctors and patients to a company’s drug by paying clinicians to use it and then report some minimal infor­mation back to the company. In other words, they can be seen as promotional gimmicks.


Despite the fact that R & D is a black box, you can crudely calculate costs per drug simply by dividing the industry’s own figure for total R & D by the number of new drugs. That assumes, of course, a steady state—that about the same number of drugs enter the market each year and total R & D costs stay fairly constant. That is not quite the case. Nevertheless, this sim­ple calculation is a way of making a very rough estimate. If you look at the year 2000, when the industry claims to have spent $26 billion on R & D and ninety-eight drugs entered the mar­ket, the average pretax cost for each drug was, under those as­sumptions, no greater than $265 million, and the after-tax cost about $175 million. (Research and development costs are tax deductible, and the corporate tax rate is now about 34 percent.) That would be the maximum, since it is likely that PhRMA’s total R & D figure is inflated by activities that many would re­gard as promotional, and the industry receives generous tax credits as well as deductions. If you take the next year, when the industry claimed it spent $30 billion and only sixty-six drugs entered the market, the pretax cost per drug would be higher— $455 million—and the after-tax cost $300 million. As you can see, any attempt to determine the cost per drug is highly depen­dent on the number of drugs—a subject I’ll come back to later.


The consumer advocacy group Public Citizen performed a much more sophisticated analysis using the same approach. They looked at all the drugs that entered the market between 1994 and 2000 (thus smoothing out the yearly variations), and made appropriate allowances for the long lag time between R & D expenditures and the dates the drugs came on the mar­ket. They found that after-tax costs were probably less than $100 million for each drug approved during that period. Other independent analysts have reached similar conclusions. Even using PhRMA’s own figures for total R & D costs for the decade of the 1990s, it can be calculated that the cost per drug came to around $100 million after taxes. That is a lot, but it’s a far cry from the much-vaunted $802 million.


The Imaginary Number


So where did the $802 million figure come from? And why has it been uncritically accepted? The number was the finding of a group of economists, headed by Joseph DiMasi of the Tufts Center for the Study of Drug Development, and it was an­nounced with much fanfare at a press conference in Philadelphia on November 30, 2001.6 The Tufts Center is largely supported by the pharmaceutical industry, and this was an updating of an analysis done by the same group over a decade ago. The results this time were about twice as high. Ever since the press confer­ence, PhRMA and leaders and defenders of the industry have trumpeted the findings as a justification for high drug prices. Kenneth I. Kaitlin, the director of the Tufts Center, said, “Bring­ing new drugs to market has always been an expensive, high-risk proposition, and our latest analysis indicates that costs have con­tinued to skyrocket.” The president of PhRMA, Alan F. Holmer, welcomed the study as confirmation that “drug development is staggeringly expensive.”  The media seemed to accept it pretty much at face value. Under the heading “Research Cost for New Drugs Said to Soar,” for instance, The New York Times reported

the next day, “A new round in the national debate over prescrip­tion drugs opened today with a study from researchers at Tufts University estimating that the average cost of developing a new drug has more than doubled since 1987, to $802 million.”  The rest of the media carried similar stories.


It was not until a year and a half later that the Tufts group actually published their analysis and it became possible to see how it was done. What they did was to look at sixty-eight drugs developed at ten drug companies over about a decade. But the names of the companies and the names of the drugs were never revealed. Furthermore, all the data on the costs of those drugs were supplied by the companies to the Tufts group confidentially, and as far as I can tell, the authors were not able to verify the information. They were supposed to take the com­panies’ word, and we were supposed to take theirs. That situa­tion is extremely unusual in scientific publishing, where it is understood that the salient data will be made available to read­ers so they can evaluate the analysis for themselves.


But one thing is clear from the paper. The $802 million fig­ure has nothing to do with the “average cost of developing a new drug,” in the words of The New York Times.  It refers only to the cost of developing a tiny handful of the very most expensive drugs. Let’s look at this misunderstanding more closely, because it is crucial.


Every year the Food and Drug Administration (FDA) ap­proves a number of new drug applications, which means that those drugs can enter the market. That is what most people mean when they say “new” drugs. In 2002, for instance, the number was seventy-eight, as I mentioned in Chapter 1. But of the new drugs, only a minority are newly discovered or synthesized mol­ecules. The FDA classifies these as new molecular entities (NMEs). The others are just new versions of drugs already on the market. In 2002, only seventeen of the seventy-eight newly ap­proved drugs were NMEs. And of the NMEs, only a fraction are developed entirely by the drug companies themselves. Most of the rest are simply licensed or otherwise acquired from uni­versity or government laboratories or biotechnology companies.


The Tufts analysis was restricted to NMEs developed en­tirely within drug companies—what the authors called “self-originated NCEs” (the old term for NMEs). But these constitute only a tiny percentage of all new drugs. As you might expect, this handful of drugs cost companies more to develop than the others. It is cheaper to license a drug from someone else or make a new version of an old drug. In fact, the Tufts authors state that the drug companies they surveyed spent 75 percent of their R & D money (including the costs of Phase IV studies) on these few self-originated NMEs. I find this an almost unbelievably high percentage, and there is no way to verify it, but the point is the companies agree that they spend much more on self-originated NMEs than on other drugs.


Why didn’t the media catch on to the fact that the $802 mil­lion figure applied only to a sample of highly selected and very costly drugs? One possible answer is that the industry didn’t want them to. In their public relations, PhRMA and the drug companies strongly imply that $802 million is the average for all new drugs. Even the Tufts authors seemed to suggest that in the short summary of their paper, where they wrote, “The re­search and development costs of sixty-eight randomly selected new drugs were obtained from a survey of ten pharmaceutical firms. These data were used to estimate the average pre-tax cost of new drug development.” Nothing about which new drugs.


And Doubling It


There is a second problem with the Tufts estimate. It is not the actual out-of-pocket cost at all, even for the special group of drugs considered. That cost was $403 million per drug. The $802 million is what the authors call the “capitalized” cost—that is, it includes the estimated revenue that might have been generated if the money spent on R & D had instead been invested in the eq­uity market. It’s as though drug companies don’t have to spend any money at all on R & D; they could invest it instead. Or, in the author’s technical jargon, “the expenditures must be capitalized at an appropriate discount rate, [which is] the expected return that investors forego during development when they invest in pharmaceutical R & D instead of an equally risky portfolio of fi­nancial securities.” This theoretically lost revenue is known as the “opportunity cost,” and the Tufts consultants simply tacked it on to the industry’s out-of-pocket costs. That accounting maneu­ver nearly doubled the $403 million to $802 million.


The authors justified the maneuver on the grounds that, from the perspective of investors, a pharmaceutical company is really just one kind of investment, which they choose among other possible options. But while this may be true for investors, surely it is not true for the companies themselves. The latter have no choice but to spend money on R & D if they wish to be in the pharmaceutical business. They are not investment houses. So you can hardly look at the money spent on R & D as money that could have been spent on something else. The Tufts authors say adding opportunity costs is standard ac­counting practice, and that may be so, but in the context of pharmaceutical R & D, it simply makes no sense.


And there is a third problem with the estimate. It is in pre­tax dollars. But R & D expenses are fully tax deductible. On top of that, drug companies enjoy a number of tax credits worth bil­lions of dollars, including a SO percent credit for the costs of testing “orphan drugs”—those with an expected market of fewer than 200,000 people. As of the year 2000, the FDA had listed 231 orphan drugs since the tax credit was instituted in 1983. One of those is Retrovir, the first drug for HIV/AIDS, dis­cussed in the last chapter. With the worldwide HN/AIDS epi­demic, the market for Retrovir is far greater than 200,000, but it was considered an orphan drug nonetheless. In addition, the tax credit extends to other drugs if companies can make a case that they are unlikely to be profitable. (What other business gets such a deal?) Presumably, drug companies claiming these tax credits would have to share with the Internal Revenue Ser­vice information they are unwilling to share with anyone else— the R & D costs of individual drugs. One wonders whether and how often this information is audited.


In any case, when all the tax benefits are taken together, big pharma pays relatively little in taxes. Between 1993 and 1996, drug companies were taxed at a 16.2 percent rate, compared with an average tax rate of 27.3 percent for all other major in­dustries. Many experts believe that the R & D cost estimate should therefore be lowered by the amount of corporate tax avoided. These tax savings would reduce the net cost of R & D by a percentage at least equal to the 34 percent corporate tax rate (not considering tax credits). You could argue about whether this adjustment is reasonable, but if one accepts that it is, it would reduce the Tufts estimate of $403 million (before adding “opportunity costs”) to an after-tax net of less than $266 million per drug.


But remember, that would be the average out-of-pocket, after-tax R & D costs for only the new molecular entities devel­oped entirely in-house, not the average cost of all the drugs ap­proved. Most approved drugs entering the market are not really new, or they are acquired from other sources, or both. I would guess that the real cost per drug is well under $100 million. Were it anywhere near the claimed $802 million, the industry would not be so secretive about the data.


Following her scathing and believable indictments of the industry, Angell continues with specific suggestions for reform. After readers have gotten beyond the anger that will flow from the revelation of multiple deceits by these companies, there are opportunities to reflect on specific reforms. The examples Angell provides in The Truth About the Drug Companies provide ample ammunition for reform, and readers with a bias toward action, will support these reforms with legislators and regulators.


Steve Hopkins, March 23, 2005



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The recommendation rating for this book appeared

 in the April 2005 issue of Executive Times


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