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Executive Times |
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2005 Book Reviews |
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The Truth
About the Drug Companies: How They Deceive Us and What To Do About It by
Marcia Angell |
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Rating: ••• (Recommended) |
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Click on
title or picture to buy from amazon.com |
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Deceit 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 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 the next day, “A new round in the national
debate over prescription drugs opened today with a study from researchers at
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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ã 2005 Hopkins and Company, LLC The recommendation rating for
this book appeared in the April 2005
issue of Executive Times URL for this review: http://www.hopkinsandcompany.com/Books/The
Truth About the Drug Companies.htm For Reprint Permission,
Contact: Hopkins & Company, LLC • E-mail: books@hopkinsandcompany.com |
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