Drug Prices - Part I
Before you read this, I must confess that I have a relative who works for a major pharmaceutical company and is involved in new drug development. Nonetheless, like most people who buy prescription drugs, I too have wondered why they cost so much. As it turns out, the answer is complex.
First, the process of developing a new drug is lengthy, risky, and expensive. It takes 10 to 15 years to develop a new drug from the early stages of discovery through marketing approval. If, after years of preclinical (laboratory and animal) and clinical (human) evaluations, a new drug is shown to be safe and effective in the disease for which it is intended, the company will apply to the Food and Drug Administration (FDA) for a license to manufacture and sell the drug in the U.S. The FDA closely regulates the testing of new drugs and has set rigorous standards for their approval. In fact, for every 5,000 to 10,000 compounds tested, only one will ever receive FDA approval and reach the market. This means the pharmaceutical business is much riskier than most industries because the vast majority of compounds tested are never approved for sale.
Drug companies make huge investments in research and development (R&D). The average cost to develop a single new drug is over $800 million.1 This money is spent before the FDA ever approves the new product and the company loses their investment if the drug is not approved. Drug companies must generate profits or they will go bankrupt and will no longer be able to develop the new medications we all hope will improve our lives. So the development costs of drugs that never receive FDA approval have to be covered by income generated by compounds that are successfully approved and marketed. Importantly, most drugs that reach pharmacy shelves never make a profit. Only 1 in 3 approved drugs ever recoup their development costs.
Patent protection is also a big factor. In the U.S., patents give researchers and inventors the exclusive right to sell their invention for 20 years before others can copy and sell it. It provides an incentive for companies to invest the time and resources to develop new products. Developing a highly successful new drug can generate significant sales and help cure, or reduce symptoms for, millions of patients. But the 10 to 15 years of development time eats up a significant portion of the patent term before the drug ever enters the market. The effective patent life for brand name medicines averages only 11.5 years. The net result is that drug companies have a limited time to recover their investment and make a profit before generic competition comes to market and drives down prices. In fact, pharmaceutical companies can expect a sales drop for a branded drug of up to 80% by the time a second or third generation generic reaches the market.
My second blog on drug prices I will discuss generics and our government's role in greater detail.
--------------1The $800 million estimate to develop a new drug includes the cost of failures, including research on compounds abandoned during development as well as opportunity costs including R&D expenditures before earning any returns.