I'm really busy this morning, and probably won't be blogging much, but there's an interesting debate going on in the comments threads about the return on investment in the pharmaceutical industry. You have to be very, very careful with this stuff, because there's enormous survivor bias in stock screens. A pharma that has a long, bad run of no good drugs disappears from the sample through merger or failure. Sadly, this is pretty common, which is why so many pharmaceutical firms have obviously compound names. If you have relatively binary outcomes--companies are either very profitable, or not profitable at all--then if you drop the non-performers from the sample, being in the pharmaceutical business will look like a license to print money. The fact that so many new entrants find it so hard to actually grow to pharma size indicates that it might be a little harder than it looks.
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How profitable is Pharma?
31 Jan 2008 07:05 am
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Comments (103)
Big pharamceutical companies would better survive a failed drug program... given that a huge part of the cost of bringing a new drug to market is the FDA approval process, which is going to be expensive no matter who you are, a small company that tries and fails will probably just go out of business. One that succeeds probably gets bought by a bigger one...
I'd also be interested in the numbers of failed firms.
a huge part of the cost of bringing a new drug to market is the FDA approval process, which is going to be expensive no matter who you are
More expensive than the cost of being litigated to death, though? Even drugs that go through the FDA process, like Vioxx, can end up creating enormous liability problems for drug companies. Imagine if thalidomide had been available in the US market, instead of blocked by the FDA... even more lawsuits.
Dhalgren,
There are lots of new players every year, you just never hear of them because they never make it to the market with a drug or treatment, or they get bought out by the bigger players.
I thought the argument on the earlier comments thread was chiefly about the relative effectiveness of government research and private research. There are some people who just don't understand that, while the government is good at basic research (which is non-excludable), private companies are better at creating specific products that fulfill the needs of consumers.
Hence, as Paul Romer argues, the Soviet Union had a very impressive collection of scientists doing some first rate research, and yet was unable to translate that into real welfare gains for its people.
According to some here, private innovation is of little importance and government innovation is always (or at least generally superior). To them, then, the Soviet Union should have been a flourishing paradise.
Anyway, those of us who understand something about economics know that private innovation is hugely important and that for that reason we allow companies (like the drug companies) to get monopoly profits out of their new products, at least for a time.
Technological improvements are the key to increases in the standard of living over time. We threaten that technological progress (which is largely driven by the private sector) at our peril.
Let me put some perspective on what a new pharma company is up against.
I am a medicinal chemist that has worked at large pharma for 13 years. In that time I have worked on 6 different drug discovery projects doing either lead optimization or lead discovery. The projects have had life spans of 12 years, 10 years, 7 years, 3 years, 2 years, and 1 year (my present project).
Two of these projects made it into the clinical trial stage, one died just short of it (the 10 year long project, and the one I personally worked on the longest). Of the remaining three, one was canned, one is on life support, and the last is too young to make any judgment yet.
If I am lucky, I will have worked on two projects that lead to marketed drugs (the two projects in the clinic), but the odds are actually against both on a historical basis, even at that stage. It is quite probable that at the 20 year mark of my career, I will have worked on no market-successful projects. This is not uncommon in my field- there are far more failures than successes.
Ah, well, Yancy, it's probably because you're such an intellecually stunted fool who rejects the importance of evidence.
[/sarcasm]
My wife worked at a biotech for several years; we bailed out before it was bought up. They actually did produce one marketable (and highly effective) drug, but failed financially even so.
As someone who works in the industry, I can tell you first hand that Megan is absolutely right on this one. Pharma is enormously profitable if you're successful, but the odds of being successful are pretty slim, especially if you're not one of the major pharmaceutical players, who by this time have all been merging together to firm up ailing drug pipelines.
Pharmaceuticals has to be profitable in order to encourage the level of risk taking that's necessary to bring drugs to market. Note that it's not just a bunch of large companies that do this, it's a lot of smaller pharmas and biotechs who are supplying much of the innovation these days in the pharmaceutical field. The reason investors are willing to dump large sums of cash into operations, like the small biotech I work for, is because of the potential payout on success.
The truth is that most pharma and biotech ventures fail, and they are enormously costly operations to run, both in terms of labor and capital costs. No one would willingly undertake this kind of risk if the profitability is legislated out of the sector. We're already starting to see real problems in pharma innovation because of a variety of factors, which I won't get into here, but if price regulations suddenly limit profitability, the number of new drugs hitting the market will slow to a trickle.
According to some here, private innovation is of little importance and government innovation is always (or at least generally superior). To them, then, the Soviet Union should have been a flourishing paradise.
That logic wouldn't get past a freshman who took Intro to Philosophy.
There is an interesting post here by Greg Mankiw about the profitability of drug companies. He cites a CBO report which argues that their profitability tends to be overstated and that they are in truth only modestly more profitable than the average company.
A quick glance at the P/E ratios of the major drug companies confirms that:
Company P/E
J&J 14.0
Wyeth 11.3
BMY 15.9
PFE 9.8
AMGN 11.6
* (All data taken from MSN Money.)
And the average P/E for the S&P 500 is 14.8. So, the stocks are not trading at abnormally high valuations--indeed, most of them seem to be trading at a below average P/E, indicating that making money in the pharma business is not as easy as some have made it out to be.
By the way, Freddie, logic has never been your strong suit. Nor has economics. Why don't you leave these discussions for more informed and thoughtful people?
Don't lose heart though. Everyone must have a comparative advantage in something. Even you. I'm sure you can make a valuable contribution the next time Megan posts something about the JCrew catalog.
Even if this: "According to some here, private innovation is of little importance and government innovation is always (or at least generally superior)(sic)" wasn't an complete strawman, this: "To them, then, the Soviet Union should have been a flourishing paradise" in no way follows from it.
You can see that, if you can see beyond the politics of resentment for a moment, can't you? You don't really think one follows logically from another, right? I chose my critique carefully; that's such an elementarily flawed line of logic that the most disinterested undergrad could see it.
Freddie, that was a bit of hyperbole. I offer a link so you won't have look it up yourself. It was but a rhetorical flourish, as should have been obvious. The substance of the argument was that, although it was able to produce very fine scientists, the Soviet Union was not able to translate their research into welfare gains for the people. Part of the reason for that is no doubt the heavy military expenditures which took resources away from the consumer sector. But a major reason was also that governments are much better at basic research--which is a public good--than at the sort of R&D private companies do to create particular proprietary products that improve the lives of their customers. This is well known among economists.
The argument about the Soviet Union is also in the interview with Paul Romer I linked to on the last thread. Much of what I have been arguing here derives from his work on endogenous growth. If you are interested, you should read more about it. Romer makes much of the role that monopoly (or monopolistic competition) plays in innovation, technological change and growth. After you read more about his work, you might have an easier time participating intelligently in these sorts of discussions.
One strange thing about the Pharma critics behavior is that they aren't acting on their economic model.
They tell us that pharma is incredibly profitable and if done slightly differently would be even more profitable AND do more good.
Yet, they don't set up pharma companies consistent with their models. This is strange because if they're correct, such companies would do a lot of good and be incredibly profitable, making it possible for them to do even more good.
And, the competition with their good companies would cause the existing bad companies to either go out of biz or change their ways.
If pharma critics are correct, there's no down side and considerable upside to them doing pharma companies.
Yet they don't.
A lot of the discussion from the last few days has been covered in an excellent PBS Frontline Documentary. It includes interviews with (former) CEOs of Merck and Eli Lilly, Princeton Economist Uwe Reinhardt, and industry critic/former editor of NEJM Marcia Angell.
The FAQ section gives a cursory explanation on the issues of opportunity cost, price discrimination, profitability, R&D vs. Marketing...etc.
The video isn't available online but the website contains everything that was discussed in the documentary, and more. I found it to be a very useful resource before writing a paper on the economics of pharma a few years ago. Have a look.
p.s. If anyone is interested in peer-reviewed articles that cover these issues, just holler and I'll try to post that info in the comment section.
Anyone remember the late 90's when stock prices were going up and up and up? Except that the stock prices for big pharmas didn't--they remained flat. As a friend who works for one said at the time, "If we are so profitable as everyone thinks, then why hasn't our stock price risen along with all those other companies?"
There are lots of new players every year, you just never hear of them because they never make it to the market with a drug or treatment, or they get bought out by the bigger players.
Actually, there's a third category: small, specialized companies which are contracted by larger pharmas to perform one or two focused tasks.
A friend of mine works for one such company in Oregon. They employ less than fifty people and their sole service is research in delivery mechanisms, typically for use in clinical trials -- pills, essentially. Most of the employees are chemists who figure out what works, what doesn't, what chemical reactions contribute to one or the other, dissovling rates of various coatings in different human body environments, etc. Also a few alternative concepts that are straight out of science fiction. The company contracts with Pfizer and works very closely with Pfizer staff, but has the efficiency advantages of a small, independent entity: no bureaucratic red tape, no lengthy procurement procedures, flat office management style with a strong team-building environment, etc.
Combine three or four such entities and drum up investors, and you might have the foundation of a new pharma; but why do that, and take all of the associated risks, when you can focus on one or two areas that you love and let a large corporation write the checks and accept most of the liability?
"The FAQ section gives a cursory explanation on the issues of opportunity cost, price discrimination, profitability, R&D vs. Marketing...etc."
cursory, is a good descriptor..
http://www.organicconsumers.org/toxic/drugsinwater.cfm
might help them round it out a bit.
I invested in 5 little pharma stocks in the past year: ASPV, BVF, AXCA, VPHM, and KG. Two of them were bought out for modest (~25%) premiums, and the other three are down significantly from where I bought them, even though all are profitable and trade at low valuations. For example, VPHM, which I bought at 14.05 is at 8.80. Look at the valuation. Despite having half of its market cap in cash, it's trading at only 7x its trailing twelve months earnings and 10x its forward estimated earnings, with a PEG of .5. That abysmal valuation gives you an idea of how risky the market thinks even profitable drug companies are, since they are always at the mercy of litigation, regulation, etc.
RWE:
There are some people who just don't understand that, while the government is good at basic research (which is non-excludable)
I'm not sure the government is good at basic research. It pays people to do research and write a bunch of papers, and occasionally something useful comes out of it, but that doesn't mean the government is good at basic research--it's just means that it's not hopelessly incompetent.
I'm not saying that the government is bad at basic research, either--just that there's really no way to gauge its performance because we have nothing to compare it to. At most we can say that it has a comparative advantage in doing the kind of basic research that isn't profitable to private companies, but like everything the government does, its priorities are out of order because they're not subject to market demand.
Also, basic research isn't always non-excludable, which is one reason some companies (mostly big ones with lots of cash on hand) do some basic research. Even if you can't keep the fruits of your research secret indefinitely, you can often keep it secret long enough to get a head start on turning it into a patentable product.
Brandon, I agree with you. What I really meant was that when important basic rsearch is non-excludable the best option is for government to fund it because there just aren't adequate incentives for private firms to pursue it on their own.
Indeed, even when research is excludable, there can be positive externalities that justify government subsidies. Of course, this line of argument is prone to abuse. Government might choose to fund things (like ethanol) chiefly for political, not economic, reasons.
Anyway, my main point was that we can wreck private incentives with impunity--by imposing price controls, for example--are sorely mistaken. Government is not particularly good at meeting the needs of individual consumers. It can do some good by subsidizing research, but it cannot replace private innovation.
I suspect you would agree with that.
"Anyway, my main point was that we can wreck private incentives with impunity--by imposing price controls, for example--are sorely mistaken."
My apologies. That should read:
"Anyway, my main point was that those who think we can wreck private incentives with impunity--by imposing price controls, for example--are sorely mistaken."
Over at my day job, I run a pharmaceutical trade magazine. Every summer, I write the Top 20 Pharma and Top 10 Biopharma annual report, based on drug revenues. For my From the Editor page in 2006, I decided to compare the sales figured for the Top 20 Pharmas ranked in the first year of the report (FY2000) and that year (FY2005). The number #1 company in the 2006 edition had almost double the revenues of the #1 in the 2001 edition.
The number one company in 2006 consisted of a combination of the #2 company and the #9 company of 2001. There are also other mergers within the lists over that time frame- Sanofi and Aventis, AHP and Wyeth, and probably a lot others between top 20 and non-top 20 pharmas I simply don't remember.
Anyway, my main point was that we can wreck private incentives with impunity--by imposing price controls, for example--are sorely mistaken. Government is not particularly good at meeting the needs of individual consumers. It can do some good by subsidizing research, but it cannot replace private innovation.
So how do we ensure that the needs of individual consumers are met when those needs don't align with maximizing profit? Berg seems to think that the invisible hand will push investment in needed research; but that hand is reaching for profit, not utility.
I just don't see how we can avoid some kind of public intervention in the private sphere, here. Wasn't there at one time talk of public-private partnerships? Maybe the public sector can guide the invisible hand a bit? (Berg won't like that, I'm sure.)
Wasn't there at one time talk of public-private partnerships?
Why talk, when we already have similar examples to guide us, such as US defense contracting or Japan, Inc.? In the first case, we see that very big projects can be completed successfully, but with an inordinate amount of waste. In the second case, and it worked great until the market turned south -- and suddenly, nobody had a clue what to do because the process of running the entire market via large companies had left both the legal infrastructure and the population at large with very little experience in small business technique and private entreupreneurial skill.
Personally, I like the idea someone suggested last thread: determine what areas of pharma research are underserved, hang out a suitably large cash prize for a well-defined discovery in each, and then let the various private entities compete to see who can reach it first.
A little over a year ago googling +"drug development"+"cost of capital" gave two links to news releases from the Tufts Center for Drug Development, and then the third link (again from the Tufts Center):
http://www.cptech.org/ip/health/econ/dimasi2003.pdf
where we read on page 32:
"These studies of the profitability of new drug development have not found evidence of significant and sustained excess profits. The estimated internal rates of return are quite close to the cost-of-capital. The much higher R&D cost estimates of for this study raise a question about the recent profit experience of the pharmaceutical industry. However, Grabowski and Vernon (2000) found substantial growth in pharmaceutical sales for 1990s drug cohorts. A new study [Grabowski et al., 2002] on pharmaceutical profitability using some of the cost results in this study and recent sales data is qualitatively consistent with the outcomes of the earlier profitability studies (i.e. the internal rate of return is close to the industry cost-of-capital)."
And the average P/E for the S&P 500 is 14.8. So, the stocks are not trading at abnormally high valuations--indeed, most of them seem to be trading at a below average P/E, indicating that making money in the pharma business is not as easy as some have made it out to be.
That's not really what those P/Es mean. The low P/E reflects a lack of positive-NPV investment opportunities for the firms, and/or the short lives of the firms' earnings streams.
Bob, the valuation should reflect the present value of the earnings streams (ar free cash flows) from here to eternity. If making money in the pharma sector were as easy as some have suggested, their returns on reinvested earnings would be enormous and their valuations would be well above the market average.
So what I (and Fred) wrote was correct.
I just don't see how we can avoid some kind of public intervention in the private sphere, here.
Ah, you were just itching to go there, weren't you? /grin
"It's a sunny day, so I don't how we can avoid having public intervention in something, because something, somewhere, isn't totally screwed up yet."
Liberalrob:
Berg seems to think that the invisible hand will push investment in needed research; but that hand is reaching for profit, not utility.
Profitability--what people are willing to pay for something minus what it costs to make--is a proxy for utility. It's not perfect, especially when externalities come into play, but for most purposes it's the best one we have.
Maybe the public sector can guide the invisible hand a bit? (Berg won't like that, I'm sure.)
That's exactly what patents are for. Innovation is a public good, and as such it tends to be underproduced in a free market. Patent (and copyright) protection acts as a subsidy to increase the incentive to innovate.
So what's your objection to the status quo? Do you think that pharmaceutical innovations are underproduced? Overproduced? That we're getting the wrong kinds of innovations? How do you propose that we address this?
Anony-mouse:
If it's the company I'm thinking of, there's a lot more than 50 people now. Still, very flat structure, great place to work, etc.
Sigh. Has anyone here heard of expectation value?
http://en.wikipedia.org/wiki/Expected_value
http://www.dartmouth.edu/~chance/teaching_aids/books_articles/probability_book/Chapter6.pdf
http://www.referenceforbusiness.com/encyclopedia/Ent-Fac/Expected-Value.html
I hope that's not too many links, and anyone is free to crack open a book on this stuff. One error I did find in the wikipedia article was that the payoff for the roulette example is $35; it's not. It's $34, $35 less one dollar to play.
The point is, that the risk of any one trial in a series of trials is irrelevant. In an earlier example, I used a lottery game in which one thousand lottery tickets were used costing one dollar each, with a payoff of $1 million.
The expectation value for this game is just [-$1]*999+[$(1,000,000-1)]*1=+$990,000. So each investment is 'risky' in the sense that each individual trial has only a one-in-a-thousand chance of succeeding, but one is also equally certain that repeatedly playing the game will result in a net win.
Yes, the qualitative argument beloved by the drug company apologists is that each individual trial is 'risky', and this justifies the huge payouts on individual winners. This is easy to use as an emotive ploy, just as the "The industry spends One Billion Dollars per trial" is an emotive one.
What matters is the expectation value, and to get that, you have to plug in some actual numbers. If anyone needs assurance that the business heads of such companies act more like cold calculators trying to make this number as large a positive number as possible, and a lot less like Dan Dare jumping with an untried new parachute, or flying an experimental plane with all the corners cut in a life-or-death situation, well, consider that I just gave you the assurance.
And of course, experience tells us that, for the big guys at least, the 'risk' seems to be a rather profitable one, year after year after year . . .
Of course, there are ways to minimize risk and maximize return, for example, one could do something like this:
http://www.gooznews.com/archives/000947.html
Has anyone here heard of expectation value?
I have. And your lottery analogy is perfectly apt, in the event that you have large amounts of money to burn through waiting for the big payout (also assuming that the probabilities can be accurately calculated, which I somewhat doubt in the drug context). A long-shot lottery ticket--even with a positive expected value--isn't a rational investment if you really need that dollar to buy some food.
Note also that the lottery analogy--like real life--requires that the payout be big relative to the cost--if we start capping drug prices and thereby reducing the payout, the expectation value drops, possibly into negative territory. This has been our gracious hostess' argument from day one, and there's nothing in anything you say which refutes it.
Finally, note the point of the original post, which is that there is a survivor bias. Little companies often don't have a big portfolio of drugs in the pipeline (or, analogy-wise, a lot of cash to buy lottery tickets) so they sometimes end up betting the farm on a couple of products, and losing. That is, indeed, "risky."
SoV:
No one has yet answered the question I asked in the other thread: If the pharmaceutical racket is so profitable, why aren't more people getting in on it?
Even if we assume that there's a winner-take-all effect with respect to drugs treating a particular condition, we should still expect to see enough entities competing to bring the best drugs to market that the chances of winning any particular race fall and the chances of having a blockbuster drug displaced by an even better drug increase, reducing the profitability of the industry as a whole.
The sort of profitability you claim pharmaceutical companies have is not sustainable without huge barriers to entry. Not just barriers to selling a particular drug (i.e., patents), but barriers to entering the pharmaceutical market at all.
Obviously the massive capital requirements are one barrier, but I don't think this is an adequate explanation, since there plenty of corporations, and even a few individuals, that have or could raise enough cash.
SOV, you let us know when you find that million dollar lottery with only one thousand $1 tickets, eh? But very quietly, please, we don't want to let the whole world in on it.
Back in the real world, we're talking about "lottery tickets" costing over $100 million apiece. That makes it rather difficult for even a big corporation to keep playing until it wins - and as I read the news, some of the big pharmaceutical companies are keeping new drugs in their pipelines only by buying out the little companies that got a winner on their first (and only) play. That's good for the little companies with winners, but there must be close to a hundred failures for every winner. But I guess you socialists just expect people to keep risking their money without the lure of a big payoff if they get lucky...
The fact that so many new entrants find it so hard to actually grow to pharma size indicates that it might be a little harder than it looks.
This will be confirmed by anyone who has worked in or around Pharma for any length of time.
This:
SoV: No one has yet answered the question I asked in the other thread: If the pharmaceutical racket is so profitable, why aren't more people getting in on it?
and this:
Obviously the massive capital requirements are one barrier, but I don't think this is an adequate explanation, since there plenty of corporations, and even a few individuals, that have or could raise enough cash.
Seem to me to be subjective calls. What would convince you that 'more people are getting in' and opposed that 'not enough people are getting in'? The same for the massive capital requirements. Without the numbers attached, we simply don't know if the market is already saturated, or crying out for new entries. One thing, however:
The sort of profitability you claim pharmaceutical companies have is not sustainable without huge barriers to entry. Not just barriers to selling a particular drug (i.e., patents), but barriers to entering the pharmaceutical market at all.
I'm not making any sorts of claims for (the amount of) profitability. I'm saying that the argument that justifies the high cost of drugs is an emotive one, not a quantitative one. Now, if I'm ever in a gambling situation, I might be induced to feed the one-armed bandits a succesion of $5 tokens for a half-hour or so. I might lose $200; I might win $5,000. But the odds of me losing $200 are a lot higher than the odds of winning the higher amount. I can afford to play these odds because losing $200 doesn't mean that much to me and I'm not expecting to make a profit.
The big companies, spending $100 million a shot? You better believe that they wouldn't be spending that money unless they had some reasonable calculation that suggested the expected value of the play was positive, and highly positive at that.
And again, a look at the fortune 500 companies suggests that for some companies at least, the payoff is quite handsome.
I'm saying that the argument that justifies the high cost of drugs is an emotive one, not a quantitative one.
Your very own argument refutes this, at least in principle. If the lottery payoff is capped by statute at $10 instead of $1 million, the expectation value of a 1/1000 lottery ticket is negative. In the face of long odds or large costs (or both, as in the drug industry), the big payoff is essential to the positive expected value.
Nobody is asserting (I don't think) that successful drug companies aren't profitable. The broad claim is that capping the price of drugs will reduce innovation. Given that capping the price is equivalent, in your analogy, to reducing the lottery payout, and given also that neither the price of the ticket nor the odds will be affected by the proposed cap, the expected value of the ticket will drop, which will result in fewer people being willing to take the risk.
Really, is anyone actually disagreeing with anyone here?
In case anyone is keeping score, I was accused of 'starting trouble'. Let's look at this post here:
SOV, you let us know when you find that million dollar lottery with only one thousand $1 tickets, eh? But very quietly, please, we don't want to let the whole world in on it.
Note the derisive tone, as well as trying to push the assumption that this is something I believe happens in the real world, as opposed to an example that shows that 'high risk' is not the important factor, it's the expected value of return.
Back in the real world, we're talking about "lottery tickets" costing over $100 million apiece. That makes it rather difficult for even a big corporation to keep playing until it wins - and as I read the news, some of the big pharmaceutical companies are keeping new drugs in their pipelines only by buying out the little companies that got a winner on their first (and only) play. That's good for the little companies with winners, but there must be close to a hundred failures for every winner. But I guess you socialists just expect people to keep risking their money without the lure of a big payoff if they get lucky...Posted by markm
Need I comment on the hostility, the lack of content? Or the fact that I have done _nothing_ to deserve this sort of abuse?
Good.
The only other thing I wish to comment on is the "$100 million . . . that's a LOT of money" comment. Yes. It is a lot of money. I don't think anyone is denying this. But if a company runs, say, seven of these trials. and one of them generates profits of $1 billion, then this has been money quite profitably spent. And again, I don't think that this sort of money would be ventured if the odds of any given trial drove the expected value negative, or even too low. Each trial has a one-in-six chance of success? Go for it? One in thirty? Probably not(to get even a fifty-fifty chance, n=Log(1/2)/Log(29/30)~21 trials, ie, dropping over $2 billion to get an even shot at a return of $1 billion. For the on-in-six chance about four trials - a fifty-fifty shot at $1 billion for plunking down $400 million.)
"Why is everybody so mean to me? All I did was call Rob Lyman, Mixner, Yancey, and about a dozen other people 'morons'. But I really am a proponent of civilized discussion. It's true that my ususal line is quite dishonest one: I incessantly demand citations but won't offer them (at leat not legitimate ones), and I rely chiefly on ad hominems while decrying even the slightest hint of derision directed at me. But really you should all listen to me anyway, despite my consistently venomous and intellectually mediocre contributions here."-Stench of Mediocrity
'high risk' is not the important factor, it's the expected value of return.
In principle, the expected value of returns in any investment should equal the cost of capital, or capital will flow to the investment with higher expected values.
Need I comment on the hostility, the lack of content?
I see the hostility, but there is most assuredly content: markm is pointing out that lowering the big payoff lowers the expected value, and in the absence of a concomitant reduction in volatility/risk, the investment becomes a worse one.
Thus, "high risk" isn't an "emotive" argument for high payoffs in pharma, it's an argument based directly on your own expected value calculations.
I don't think that this sort of money would be ventured if the odds of any given trial drove the expected value negative, or even too low.
Exactly. So if you capped the payout for drugs, the expected value of a new drug would go down and less money would be invested in drug R&D.
What do you think you're arguing against? You've just restated the argument in a nutshell.
So, thinking about this in the proper way (finally! I hope), what would the managers of a pharmaceutical company do if they were half-way competent?
Well, they'd probably go for the least riskiest/most lucrative options. They'd try to field products that cost relatively little to develop, had a relatively good chance of passing review, and had the promise of relatively high profits.
Congratulations. You've just described a good fiduciary motive for the 'Me Too' drugs. Let me quote something from Ezra's blog:
http://www.prospect.org/csnc/blogs/ezraklein_archive?month=01&year=2008&base_name=a_new_page_for_pharma#104117
Economic theory? Meet the system in question. Drug innovation is drying up, and pharma's priorities are increasingly misdirected. As Merrill Goozner, author of The $800 Million Pill, writes, "The financial incentives formed by the stock market force R&D decision-makers to focus most of their attention on developing blockbuster drugs for proven mass markets. Minor aches and pains, allergies, depression, cholesterol management, acid indigestion – the rewards for a successful new entry in one of these categories, whether or not it represents a significant new advance over previous therapies, are measured in the billions of dollars in sales." The result? "Between 1989 and 2000, 58 percent of the 361 new molecular entities (NMEs) approved by the FDA were considered “standard” for review purposes, that is, they did not represent a significant advance over existing therapies. And in the first ten months of 2007, when the FDA approved just 14 NMEs, eight were considered standard – almost the exact same percentage as the earlier era." In other words, they were profit drugs, rather than new drugs.
Put more simply, there's agitation to reform the pharmaceutical market because the current structure isn't working very well. We're not getting optimal bang for our buck, or anything near it. For instance: Many of us who focus on drug pricing focus on patents. As Goozner says, "a series of laws and court rulings have given manufacturers the right to obtain new patents for minor changes in chemical structure, changes in routes of administration, and new uses for old products. These patent extenders provide substantial financial rewards to firms that focus their research attention on extending the marketability of their existing products instead of focusing on the truly new and innovative." That's not a wise set of incentives to lay down in your pharmaceutical market, and it explains why there's growing support for a parallel discovery track focused on prizes, rather than patents; why comparative effectiveness research is a major item on any health wonk's wish list; why many of us want the government to assume the cost for medical trials; and on, and on.
Iow, from a 'just fiscally prudent' perspective, the perspective I would demand from the managers of any company I had stock in, innovation is not a good thing.
Sure, if it hits, great. But if it doesn't, that's a whole lot of money down the rat hole. And if you do that too many times (and that's a rather small number), you'll find yourself answering to a rather angry board. Probably they would rather icilly tell you that developing a more effective AIDS vaccine is all very well, but that doesn't put money into the hands of the stockholders.
I don't make this argument as something I'm necessarily defending, btw. My point is that I can construct arguments that are at least as plausible as the ones being offered up that purport to claim they are trying to preserve 'innovation'.
PS, you fool, you're misquoting SoV. I'm not a moron, I'm a noisome little excrescence. Get it right, dude.
Let it never be said that I don't stick up for those outside of my tribe, or provide links when necessary to prove somebody wrong.
Iow, from a 'just fiscally prudent' perspective, the perspective I would demand from the managers of any company I had stock in, innovation is not a good thing.
This is a decent argument, but reducing potential rewards for innovation by capping profits (especially profits on lifesaving drugs, where the political pressure to give them away is greatest) doesn't solve the problem, it makes it worse.
Jiggering the patent system to make Clarinex (a metabolyte of Claritin) hard to patent or to make it possible to patent known drugs with new applications (or even known applications, such as THC and glaucoma) for the company that pays for the trials might help.
On the flip side, 42% innovation doesn't seem that bad to me. How many other industries get anywhere near Rthat high?
Rob Lyman, don't forget the other ones: "idiot", "dishonest little weasel", "twit", "joker", "lightweight", "nut-job" and "negligible persona." All in one post, and that's not even to mention the accusation that you have "orange-stained underpants."
But really, I take it all back. SoV is clearly a believer in civilized conversation. Mea culpa.
I don't think that this sort of money would be ventured if the odds of any given trial drove the expected value negative, or even too low.
Exactly. So if you capped the payout for drugs, the expected value of a new drug would go down and less money would be invested in drug R&D.
What do you think you're arguing against? You've just restated the argument in a nutshell.Posted by SG
Sigh. Let me try one more time. The argument is that some sort of cap - any cap - will 'discourage innovation'. That is _not_ what I have been pointing out. I am saying that the money flows to areas of greatest expected return, regardless of 'innovation'. Therefore the 'discouraging innovation' trope is inapplicable.
This is the sort of stuff that would play well at Cafe Hayek, btw, and the same sort of argument that would be used for any business, and to justify saying that no profit is 'too high' on principal alone. If that is what you truly believe, then you should come right at and say it, rather then behaving as if this argument applies only to drug companies. That is pure ideology talking, and a waste of my time.
Now, as I was saying, the argument about caps 'discouraging innovation' just doesn't make sense. If, for example, my project ROI falls from $4 billion to $3.5 billion because of caps, I will still undertake it (all other things being equal), diminished return or not. The only time this argument would make apply is at the margins, which are by definition, marginal. (This is the same type of argument that 'proves' that any tax increase will have a deleterious effect on the economy.)
To show that this will not necessarily discourage innovation, one could, for example, imagine capping the price of viagra. In fact, reduce the price so far that genuinely innovative drugs would have a higher ROI, thus redirecting investment dollars into better avenues of health research. I suppose one could argue that to the extent that there are better venture to invest the money in, that's where it will flow regardless of 'innovative drugs' . . . but then that does rather undercut the original argument, doesn't it?
I think I'll bookmark this thread for the next time someone says I'm just out to cause trouble, that I'm the one who initiates unpleasantness, etc.
I would say that the responses here give quite unmistakable evidence to the contrary.
If, for example, my project ROI falls from $4 billion to $3.5 billion because of caps, I will still undertake it (all other things being equal), diminished return or not.
Not if you can get $4 billion somewhere else. That's why opportunity costs are sometimes included in the "costs of drug development," although such costs are sufficiently speculative that it's somewhat deceptive to include them.
To show that this will not necessarily discourage innovation, one could, for example, imagine capping the price of viagra. In fact, reduce the price so far that genuinely innovative drugs would have a higher ROI, thus redirecting investment dollars into better avenues of health research.
I don't think (though I could be wrong, there are a lot of comments) that anyone has specifically argued that a Viagra-only cap will reduce innovation. I don't think a Viagra-only cap has been mentioned or proposed until just now. What has been argued is 1) cutting prices to European-style cost-plus or some variation thereof will reduce innovation, and 2) the government is not in a good position to determine what is and what is not a "better avenue." Neither of these positions are inconsistent with your argument.
But Scent, I have already retracted my charges. You are clearly a person of civility and charm. Rob Lyman convinced me of that ("nut-job" though he is). Indeed, I think I'll try to emulate your rhetorical style, which is something of a hybrid between the styles of Joeseph Goebbels and Hugo Chavez, both very effective rhetoricians.
SoV, it occurs to me that you're thinking--and reading--like a mathematician, which is causing the appearance of disagreement where there is none.
The distinction is easily understood by considering the difference between what a mathematician means by "generally" and what everyone else means by "generally." Here's what I mean:
The argument is that some sort of cap - any cap - will 'discourage innovation'.
To the extent that by "any cap" you mean, quite literally,m "any imaginable cap in this universe or any other" (i.e., what a mathematician means by "the general cap") the statement is both patently false and not what most of us are thinking. A cap on profits on ordinary aspirin will not discourage innovation. But what most of us mean by "a cap" is, roughly, a cap on profits from newly approved, patented drugs. Such a cap would cover both highly innovative lifesaving treatments and borderline-useless "me-too" drugs.
Since you have argued--probably correctly--that the "me-too" drugs are easier and cheaper to invent (higher probability of success and lower costs to discover), they might remain profitable under such a cap; indeed they might already be selling for prices low enough to fit under it and still make money. But "innovative" drugs really, really, need that huge markup to make the long odds worthwhile. Any capping system which does not take account of this will suppress innovation more than it will suppress me-tooism.
The only time this argument would make apply is at the margins, which are by definition, marginal.
In economics, the marginal cases are the ones that are close to the boundary. In other words, a cap on all drug prices would reduce the profitability of all drugs. Since each drug varies in how prifitable it is, the only ones that would not be produced are the ones that were profitable before the cap and are not profitable after the cap. These are marginal drugs. That doesn't mean they aren't vital, life-saving drugs. In fact, given that innovative and new drugs are more likely to have higher development costs than "me-too" drugs or variations on existing drugs, the innovative and new drugs are more likely to be the "marginal" drugs (in economics terms).
To avoid this, you'd have to have a selective cap or have the government price negotiation committee carefully negotiate prices so that expensive to create but necessary drugs were more profitable. Actually, you'd have to convince the drug companies that if they develop an expensive and vital drug, the government price negotiating committe won't suddenly demand that they sell it cheap.
Meanwhile, activists will be holding up pictures of sick poor people and demanding to know why the drug company gets to charge more for drug x than drug y when grandma needs drug x and is poor.
The argument about obscene profits is that any market where producers make higher than average (for the whole economy) profits will attract new investors until the profits drop to the average. So pharmaceutical companies wouldn't be able to sustain above market profits for long. Eventually, there would be more companies competing for drug sales.
And SoV, you have very thin skin... you need to chill out. It's not interesting to read the litany of ways in which you've been mistreated. You've been dishing it out, too... so take it.
The only other thing I wish to comment on is the "$100 million . . . that's a LOT of money" comment. Yes. It is a lot of money. I don't think anyone is denying this. But if a company runs, say, seven of these trials. and one of them generates profits of $1 billion, then this has been money quite profitably spent. And again, I don't think that this sort of money would be ventured if the odds of any given trial drove the expected value negative, or even too low.
No, but it's not like that overall value is high right now. The figures you just proposed, assuming they are accounting for all costs (IIRC there's been some qualifiers hung on that figure in previous discussion) are roughly indicative of spending $1 to get $1.43 back.
Comparatively, Intel, one of the largest and most innovative technology companies, spent $1 and got $1.27 back in 4Q07 ($2.3B profit on $10.7B revenue) for 51% 3Q-to-4Q increase and a 10% 4Q-over-4Q growth, and the market promptly hammered their stock by 14% because investors were following guidance of $10.8B revenue.
I still don't see the evidence for the root thesis here -- that innovation will maintain if we start capping all or portions of the pharma markets.
I think I'll bookmark this thread for the next time someone says I'm just out to cause trouble, that I'm the one who initiates unpleasantness, etc. I would say that the responses here give quite unmistakable evidence to the contrary.
No, don't. Someone else here (not me, I wash my hands of it) has doubtless bookmarked the other fifteen threads that prove the contrary.
In economics, the marginal cases are the ones that are close to the boundary. In other words, a cap on all drug prices would reduce the profitability of all drugs. Since each drug varies in how prifitable it is, the only ones that would not be produced are the ones that were profitable before the cap and are not profitable after the cap. These are marginal drugs. That doesn't mean they aren't vital, life-saving drugs. In fact, given that innovative and new drugs are more likely to have higher development costs than "me-too" drugs or variations on existing drugs, the innovative and new drugs are more likely to be the "marginal" drugs (in economics terms).
What, precisely, do you think I meant when I said 'at the margin'?
And SoV, you have very thin skin... you need to chill out. It's not interesting to read the litany of ways in which you've been mistreated. You've been dishing it out, too... so take it.
No. The claim was that I 'start things'. I think that claim has pretty much been exploded. And since I'm not a 'leftist' or a liberal weenie or whatever, when someone hits me, I hit back. Harder, and much more accurately, which again I think has been amply demonstrated.
Now, as I was saying, the argument about caps 'discouraging innovation' just doesn't make sense. If, for example, my project ROI falls from $4 billion to $3.5 billion because of caps, I will still undertake it (all other things being equal), diminished return or not. The only time this argument would make apply is at the margins, which are by definition, marginal. (This is the same type of argument that 'proves' that any tax increase will have a deleterious effect on the economy.)
I don't understand how you can say that the marginal drugs will be discouraged and yet this somehow still isn't discouraging innovation. If drug company returns on investment are reduced, they will stop researching drugs that they believe won't be profitable with the reduced profits. This will cause there to be less research. This pretty much defines "discouraging innovation."
In fact, the marginal drugs are probably the more innovative one while the "sure things" are probably mostly me-too drugs or variations on existing drugs... so reducing profits will disproportionately discourage innovation.
I was assuming that you were using "marginal" differently but I guess you were just contradicting yourself in a single paragraph...
No. The claim was that I 'start things'. I think that claim has pretty much been exploded
A wise person once told me that what I think has nothing to do with the truth of the matter. I suspect this axiom may have wider applicability.
And of course, "starting it" need not mean making the first move; it can mean a hysterical overreaction to , too:
when someone hits me, I hit back. Harder...
That's pretty much exactly what is meant by having "thin skin" and needing to "chill out." We all take it, and we all dish it out. Your refusal to respond to provocation in this thread has made for an interesting series of comments and the injection of some necessary linguistic precision. Maybe you should consider making this an everyday sort of thing.
I. Think about your essay topic. - What are you arguing about? Are you for or against it? How does it relate to your life or the life of your reader? If time allows, spend a day or so analyzing the issue.
II. Start Pre-writing. - Now that you have been thinking about the essay topic, start plotting it out. Decide what position you want to take, and begin doing some basic research on the subject. As you are doing the research, take note of information that surprises you, whether it is for or against your position, information that surprises you can be useful. For example: I once was doing research on FCC regulations and came across the fact that the FCC does not regulate violence in the media in any way. This fact ended up stunning my professor, as he had no idea of this and stated to me that he had always assumed that it was regulated. Teachers spend their time reading papers and anything that seperates your paper from the rest of the papers will have an effect on your grade.
III. Research, Research, Research. - The most useful thing you can have when writing a paper is information. Do enough research for two, or even three papers if possble. That way, when you sit down to assemble your paper, you will not have to worry about not having enough material to work with.
I was assuming that you were using "marginal" differently but I guess you were just contradicting yourself in a single paragraph...
Sigh. You're not very good at puns, are you? That statement is true both in the sense of 'at the boundary', and in the sense 'small compared to the whole'. Iow, wordplay.
I don't understand how you can say that the marginal drugs will be discouraged and yet this somehow still isn't discouraging innovation. If drug company returns on investment are reduced, they will stop researching drugs that they believe won't be profitable with the reduced profits. This will cause there to be less research. This pretty much defines "discouraging innovation."
You're making the assumption that the marginal drugs are the 'good ones'. Is that what you really want to maintain? That statistically speaking the drugs that most people really need as opposed to merely want are the 'marginal' ones? Can you back that up?
Further, this is _exactly_ the same sort of argument that claims that increasing taxes will always 'shrink the economy', as I think one not too articulate individual once put it, the notion being that marginal operations will go under, so ipso facto, the economy has shrunk.
Wrong. As any macro text will quickly tell you. No, there is no reason why a frivolity like viagra can't be capped while other, more medically beneficial drugs aren't.
Just as increased taxes collected for various improvements can have the effect of increasing the size of the economy while still causing marginal players to lose out.
Really, this is all quite standard.
And your arguments, as I have already noted, are standard libertarian dogma; you might just as well come out and say this is a philosophical rather than a debating point.
SoV,
In fact, reduce the price (of Viagra) so far that genuinely innovative drugs would have a higher ROI, thus redirecting investment dollars into better avenues of health research
That statement just shows how ridiculous your positions are here. Viagra was a blood pressure medication all the way up until it no longer showed promise in human trials for that or angina. The erectile dysfunction help was a side-effect. At that point tons of money had been sunk in its development for a purpose you wouldn't be capping, and when it failed at that you would rather they stopped?
Also, as you can see here http://en.wikipedia.org/wiki/Viagra there are other things besides ED that Viagra works for, so how should discriminate what we charge for the lifesaving uses and for non? Also, who should maintain the list of "medical conditions and the associated profit margins allowed." That seems like an impossible task rife with corruption.
And since you clearly think ED meds are not real medication, shouldn't those be the ones we don't cap? They, in theory, would subsidize the more innovative ones.
Skullberg
No, there is no reason why a frivolity like viagra can't be capped while other, more medically beneficial drugs aren't.
The problem lies in the smooth gradation between "frivolous" and "medically beneficial."
Is risperidone "frivolous" or "medically beneficial?"
How about escitalopram? If you like, I can titrate you down through a series of less and less "medically beneficial" drugs, in the sense of delaying mortality. Is a mood-enhancing drug "medically beneficial?" How about if given to a suicidal patient?
Bottom line: just like on the street, drugs are worth what those buying them think they're worth, not what you think they should be worth. Welcome to capitalism - the market decides value.
SoV:
Without the numbers attached, we simply don't know if the market is already saturated, or crying out for new entries.
That the market isn't saturated is implicit in your claim that the pharmaceutical industry is consistently more profitable than other industries. A saturated market is one in which profits are below average due to an abundance of competition.
The big companies, spending $100 million a shot? You better believe that they wouldn't be spending that money unless they had some reasonable calculation that suggested the expected value of the play was positive, and highly positive at that.
No one's disputing that. What I'm disputing is your claim that this consistently averages out to extraordinarily high expected profits for no good reason. If this were really the case, more companies would enter the industry until the market approached saturation. So the question remains: Why has competition not driven expected profits down to normal levels? Or has it?
And again, a look at the fortune 500 companies suggests that for some companies at least, the payoff is quite handsome.
I'm not sure that return on equity means what you think it means. It may. I need to think about it some more.
There's a lot about the "me-too drug" narrative that rings false to me, or at least suggests a different takeaway lesson than the one you want us to get.
First, what exactly is a "me-too" drug? Is it something which cures a disease already treated by another drug, but using a completely different mechanism? If so, it may not be useless. Many drugs don't work in all people.
Or is it a drug which is changed just enough from another to be patentable, but offers nothing new? If so, this is a good argument for granting broader patents to the developers of the original drugs (in order to discourage wasteful gaming of the system), but it's not a good argument for price controls (which also discourages the development of the original drugs).
There's also the question of why people would buy "me-too" drugs. By the time a drug reaches market, it may have only ten years or so of patent life left, so a company bringing a "me-too" drug to market will soon find itself competing against generics. If it really adds no value, then why would anyone be willing to pay the premium?
Consumers don't care, because their insurance insulates them from marginal costs. But why don't insurers care? Proponents of socialized health care are fond of telling stories about insurers denying necessary coverage at every opportunity--so why would they waste money on patented drugs when generic equivalents exist?
None of this makes any sense (which usually means that government is involved somehow). This may be a good argument for investigating and addressing whatever is causing this odd behavior among drug consumers, but it's not a good argument for price controls.
Regarding price caps on Viagra specifically:
1. If it's frivolous, why do you care that it's expensive? If people don't need it, why does it matter whether they can afford it?
2. Do you really think it's frivolous? Would you feel the same if you developed ED? It's easy to make jokes, but I suspect that impotence is a serious quality-of-life issue for those who suffer from it.
You're making the assumption that the marginal drugs are the 'good ones'. Is that what you really want to maintain? That statistically speaking the drugs that most people really need as opposed to merely want are the 'marginal' ones? Can you back that up?
Do you know that they aren't? Are you willing to put price controls on drugs and then wait and find out? I'm really not worried about drug companies stopping research on a cure for cancer... they'll do that under any scheme as it would be obscenely profitable. I'm more worried about life saving drugs that treat diseases that are not so common. Those are the drugs that are being neglected. There are plenty of problems out there that only affect a small number of people but that cause those people great difficulty (pain, inability to work, death...). Those are the drugs that would most likely be impacted first by a reduction in drug company profits. They have a smaller potential market so are less likely to make loads of money.
Further, this is _exactly_ the same sort of argument that claims that increasing taxes will always 'shrink the economy', as I think one not too articulate individual once put it, the notion being that marginal operations will go under, so ipso facto, the economy has shrunk.
Except in one case you're talking about taking a portion of income from individuals and letting the government spend it and speculating on how that affects the economy while in the other case you're talking about how a market driving companyy responds to price controls in allocating research funds... the differences vastly outweigh the semantic similarities.
Wrong. As any macro text will quickly tell you. No, there is no reason why a frivolity like viagra can't be capped while other, more medically beneficial drugs aren't.
Who cares how much viagra costs... if we're going to mandate the price of viagra, we should raise it to raise more money for research into important drugs like cures for cancer, etc...
Of course, there is the problem of who is deciding what drugs are "frivolous" and what drugs are really important. And who is setting the prices? And how long before the drug companies gain influence with this committee through campaign donations, or whatever?
And your arguments, as I have already noted, are standard libertarian dogma; you might just as well come out and say this is a philosophical rather than a debating point.
Maybe you are projecting, but I'm arguing from the basis of my knowledge and logic and experience. I tend to believe that markets allocate resources better than the government or any other agent, but I'm not a fanatic or religious about it. There are plenty of examples of how markets can fail.
I'm sure there's a nifty latin name for the logical fallacy of arguing by virtue of comparing your opponent's argument to some groups dogma and then writing it off as reflexive rather than thoughtful.
I still can't understand what SOV is arguing for (or against). I think there's a strawman somewhere who's being thrashed to within an inch of it's life, but I don't quite know what it is.
That said, the thought of introducing an ED surcharge that's used to subsidize economically marginal but medically useful research strikes me as being potentially an interesting concept.
Reference, that is an _excellent_ suggestion!
I still don't see the evidence for the root thesis here -- that innovation will maintain if we start capping all or portions of the pharma markets.
This is exactly backwards - evidence has to be presented for the so-called root thesis that innovation won't be maintained if we start capping some or all portions of the pharma market.
That _is_ the objection to the original proposal to cap prices, is it not?
This is exactly backwards - evidence has to be presented for the so-called root thesis that innovation won't be maintained if we start capping some or all portions of the pharma market.
No, the burden of proof is on the person proposing the change. That's you, kemosabe.
That statement just shows how ridiculous your positions are here. Viagra was a blood pressure medication all the way up until it no longer showed promise in human trials for that or angina. The erectile dysfunction help was a side-effect. At that point tons of money had been sunk in its development for a purpose you wouldn't be capping, and when it failed at that you would rather they stopped?
Sigh. First, I will note _again_ the nastiness here, something I most certainly did not start. I'd say the myth of SoV rabidly attacking those noble, logical, prudent defenders of the faith has not just been exploded, it
We'd love to see numbers or references. Most pharma firms have histories that go back to the early 20th century. Mergers and Acquisitions happen, but the companies that combine have been around a long time. There aren't many new players.
And the amount they spend on advertising is an indication of profitable most of them are. We can do fuzzy math and number crunching, and take Pfizer's recent problems into account. But overall, you will see that big pharma is big for a reason.
Posted by Dhalgren | January 31, 2008 8:46 AM