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It Costs More Than This

Here’s another paper on the cost to develop a new drug, a topic about which, I’m convinced, debate will never end. This one is designed as a response to the Tufts estimates on these costs, and I’m not going to help much, because I have some things to debate about this paper myself.

The authors have looked at oncology-focused companies that got their first drug approvals during the period 2006-2015. There are ten of them for which 10K filings are available, and the total of R&D spending from the company’s inception up to the approval is taken as the cost of developing a new drug. The raw spending numbers run from $157 million to $1.9 billion, so you can see that there’s a bit of spread right from the beginning. They average the figures out to $648 million, and that is presented in the abstract as the cost to develop a new drug – substantially less, the authors note, than the Tufts estimate (most recently $2.7 billion).

My first thought was that it’s at least better than Donald Light’s figure of $43 million, which is my natural look-on-the-bright-side disposition coming through. But several important factors come to mind that I didn’t think the $648 million figure were taking into account. Famously, among those who argue about such things, the Tufts figure includes opportunity cost / cost of capital estimates. This drives some critics into what I can only describe as a state of rage, and my usual response to them is that I will be glad to hold any sum of money they wish and give them the exact dollar amount back in ten years. No one has taken me up on this offer. If you feel that this deal would be a loss to you, but that it would not be a loss to a business like a drug company, you need to examine your views a bit more closely. And if you feel that it would be a loss, but that this should not be included in the cost of developing a drug, my question is where are we going to put it, then? Because it’s real. The timelines involved in the drug business make it quite real indeed.

This paper, though, does include an adjusted column of figures, noting the years each company took to develop its drug and assuming a 7%/year cost. That takes the range from $203 million to $2.6 billion (basically, the Tufts figure), for an average of $757 million. But there’s an even bigger consideration than the cost of capital: the cost of failure.

And that, to me, sinks this entire paper. We have in this business somewhere around a 90% failure rate in the clinic. Picking companies’ first approvals disproportionately selects for the fortunate ones who succeeded their first time out. In other words, this estimate ignores (as much as possible) the cost of clinical failure, and that cost is one of the central facts of the entire drug industry.

Let’s do a thought experiment. Looking at the list of companies, most of them have not had a drug approval since the ones under study here (as you’d figure). So instead of taking the numbers up to the date of that first approval, how about taking them up to right now? The amount spent per drug will be creeping ever higher, since they’re still spending R&D money and still have only one drug to show for it. When they do get a second approval, we can change the denominator to a “2” and bring it back down again, but the point is that several of these companies will likely never get a second approval. That’s the odds of the game. You can argue, I suppose, that this is an unfair comparison because now you’re including costs of Drug Number 2, but you can be sure that many of the companies on this new paper’s list were working on other projects at the same time that they were getting their first drug through.

So how do we account for the cost of these failures, which are as real as can be? Matthew Herper has already done this calculation for us, as of a few years ago. He looked at a list of 98 drug companies over a ten year period, added up the stated R&D costs, and divided by the number of drug approvals (exactly as in the preceding paragraph). This is not the most elegantly nuanced financial analysis, but there’s a lot to be said for it, because that’s real money going into the hopper every year. And what you find is that you don’t even get down to the level of the Tufts estimate (as it was at the time) until you get down to nearly company #40 on the list (!) Now, I realize that the “R&D costs” category varies from company to company, but after you’ve done 98 of them, you should be closing in on something meaningful.

I have one more objection: not all the drugs on that list of ten are equal, by any means. The cheapest of the lot is a new liposomal formulation of vincristine (from Talon), and that is just not the same as coming up with a truly new drug from scratch. The estimate for the second cheapest, pralatrexate from Allos, does not take into account that there were years of collaboration between NIH, SRI, and Sloan-Kettering that identified the drug candidate itself (which is in the well-traveled antifolate area) some years before Allos even came into existence. I’m not saying anything against these companies, far from it. They actually identified ways to get useful compounds onto the market for much less money than usual, and good for them. But holding them up as examples of how much it costs to “develop a new drug” is a bit off.

So while this paper is certainly not useless, it’s not as useful as it advertises itself to be, either. Some of the points I’ve raised here do come up in it, but I don’t find the arguments against them persuasive. In the end, the universe of one-drug/first-drug companies is just not anywhere near a representative sample. (In fact, Herper’s analysis found just that – the one-drug companies in his ten-year window had the lowest cost per drug, and the companies that had more than one approval during that time spent more and more per drug, up to many billions). As far as I’m concerned, this paper sets a lower bound, and that’s all.

 

Note: All opinions, choices of topic, etc. are strictly my own – I don’t in any way speak for my employer

66 comments on “It Costs More Than This”

  1. johnnyboy says:

    Yes, you cover everything I thought when I read this study, especially your last paragraph – some of these drugs should not have been included in this ‘analysis’. A liposome reformulation of a generic, really ? It’s almost like they included these to lower the overall average. And you haven’t mentioned about the figures for revenue for these drugs, which is what will rile everyone up – apparently when a company was sold, they include the cost of the acquisition in ‘revenue’ from that drug – so apparently 22 billions worth of Ibrutinib has already been sold – which might be a surprise to Abbvie’s management. Clearly another paper published not to enlighten anyone, but to push an agenda.

    1. Gilbert Pinfold says:

      Especially when you consider that Ibrutinib was acquired by Pharmacyclics as part of the Celera (read Axys) divestment of all their skall molecule assets, hundreds of leads sold fro a few million dollars baci in the day

      1. Gilbert Pinfold says:

        Never type before adequate coffee has been consumed. skall=small; fro=for; baci=back.

        1. DrOcto says:

          I don’t start working before my coffee does.

  2. Hap says:

    If you count how much to cost for individuals to win the lottery without counting the costs of the people who never won, you’re not going to get a very good estimate of the benefits (or not) of buying lottery tickets.

    1. tangent says:

      Amen. I wish I could say I can’t believe a paper was published with so damning a methodological error.

  3. Old Timer says:

    I am curious who reviews and accepts papers like this. As an academic chemist, I am outside the field and can still spot ridiculous methodological errors (as pointed out by Derek). I think medical reviewing must be far more political.

  4. SirWired says:

    I agree; as soon as I saw that it was the average of the first approved drug I was all… “Errr… that’s all well and good if have an infallible crystal ball, but it’s not real useful otherwise.”

    Medical care costs are a problem. There are real conversations that need to be had on drug development costs, drug pricing, etc., but garbage “studies” like this do nothing whatsoever to usefully advance the conversation.

    1. SP says:

      Why do people screen millions of compounds in HTS? It would be so much cheaper if they’d screen only the hits and not all the inactives.

    2. David says:

      The real question is why they’re only using these crystal balls once, or only using one…

      1. DrOcto says:

        And whether the exorbitant cost of a working crystal ball was included in the above study.

        1. John says:

          I have a discount crystal ball! Only 2 million. Pm me for details. Not all crystal balls are exorbitant!

  5. drsnowboard says:

    “all these companies were pursuing several drugs. Thus, our analysis includes the cost of pursuing a portfolio of candidate compounds to yield one drug (ie, considers the cost of development failure).”
    In their defence, they assert the above to include the cost of failures. You could argue that this only includes discovery, early development failures as they are picking the company for inclusion once it has passed the winning post with one drug.
    It does beg the question, should companies liquidate as soon as they get one successful development candidate?

    1. Derek Lowe says:

      Kind of like, as soon as you win a roulette bet you should scoop up the money and exit the casino?

      1. a. nonymaus says:

        If it’s roulette, you pick up your winnings or cut your losses as soon as the ball stops. One hopes that pharmaceutical development has a better payout ratio than roulette. If not, fold the company and head to a casino where you can lose your money with less effort.

        1. drsnowboard says:

          well VC’s invest in 10 companies, expect 5 to bomb, 3 to cover their costs or be sold on into other investments, 2 to be profitable and 1 of those to be a real winner.
          Red or Black?

  6. DevicesRus says:

    Well the big pharma way is one way to look at things. But from a VC point of view in starting a company whose goal is to get one/any drug to the marketplace then $750M is not a bad place to start when you are thinking of funding a startup. Still daunting though

  7. Healthy reader says:

    I knew it was a Vinay Prasad paper just reading the post’s first five lines. He makes some good points but a lot of his stuff is just anti-pharma propaganda.

    A rather inconvenient stat for pharma bashers is that prescription drugs only make 10-12% of healthcare costs in the US – and this share is increasing slowly if at all. How to blame drugs for the massive increase in health expenses, then? Well, quite a few of Prasad’s presentations (and maybe some of his papers – can’t read or remember all) include a chart “showing” how pharma makes a bigger profit, in absolute dollars, than hospitals/doctors. Huh… since the “profit” is about 5% of total healthcare costs, who cares? Indeed one could wipe out hospitals’ profits and health expenses would barely budge!

    1. Emjeff says:

      Healthy reader – everyone who does “research” in this space ignores this fact. Also ignored is the payout on the back end – how many lives are saved/extended by pharmaceuticals? A rigorous analysis would account for payers’ savings in (for example) decreased hospital stays and increased productivity.

      There is a difference between price and cost, and even economists don’t always understand it. If a treatment gives a patient a couple years of productive life, what is that worth? I don’t know, but it’s not zero, and that needs to be factored into the price to get the total cost of the therapy.

      1. johnnyboy says:

        I’d be curious to know Prasad’s salary as a hemato-oncologist. Physician salaries account for about 10% of US health care cost, pretty much same range as drugs. So I’ve drafted a quickie paper with rilly solid data showing that physicians are price-gouging parasites praying on the weak, who don’t need to make that much money, and who could provide the same service for much cheaper. Who wants to be a co-author ?

        1. Bagger Vance says:

          “You know they say a physician’s salary is $200,000 a year, but according to these figures, it should be closer to… $35,000 a year! Who’s with me?”

        2. tangent says:

          So all the doctors and all the drugs cost the same as the insurance companies’ administrative costs. A remarkable place.

          johnnyboy or anyone who can chime in, I was looking around for this type of cost breakdown data with any other nice features.
          — Cross-time or cross-country data
          — Breakdown by useful chunks of ICD space
          — Anything that gets at health results, to whatever extent possible: knowledge that the patient died would be one sad type of example, but a researcher with EMR history data might take a crack at breaking out “test for X is / is not followed by treatment for X.”

          What’s your favorite cost data?

      2. Some idiot says:

        Reminds me of the definition of an accountant: someone who knows the cost of everything and the value of nothing (this definition was given to me by an accountant… with a smile..!)

        1. Anonymous says:

          It’s from Oscar Wilde, “Lady Windermere’s Fan”.
          Cecil Graham: What is a cynic?
          Lord Darlington: A man who knows the price of everything, and the value of nothing.
          Cecil Graham: And a sentimentalist, my dear Darlington, is a man who sees an absurd value in everything and doesn’t know the market price of any single thing.

          1. Some idiot says:

            Thanks, I’ll remember that!!! 🙂

    2. DrugA says:

      Pharmaceutical costs are 16.7% of healthcare costs (including retail and non-retail drugs, taking into account all rebates and using an appropriate denominator that excludes things like the NIH and CDC budgets). And drug spending is rising faster than health costs overall. Not by much, but enough that it adds up when compounded year on year.

      1. ab says:

        Source?

        The CDC seems to think prescription drugs make up 10.1% of US healthcare spending.
        https://www.cdc.gov/nchs/fastats/health-expenditures.htm

  8. Biomaven says:

    There are serious factual and methodological problems with the paper aside from the “picking winners” argument which is exactly equivalent to quoting the drug response statistics from only responders to the drug and ignoring the failures and drop-outs.

    One glaring error can be seen by looking at Ponatinib – the paper claims it had revenues of $4.5 billion which is just flat-out wrong (actually only a couple of hundred million). The error comes because Ariad was acquired for that sum – but in actuality the crown jewel in the purchase was brigatinib, with ponatinib accounting for maybe 10% of the purchase price. (See proxy disclosures). Acquiring a company is not the same as acquiring a single drug.

    The other issue is looking only at stated R&D costs for these development-stage biotechs. These were all companies without any manufacturing, sales or selling expense. Thus *all* their expenditures are related to drug discovery (very unlike big pharma). Yes their CFO’s aren’t in the lab (I hope) but without a CFO you don’t have a public company and have no way to support your R&D. Ariad had an accumulated deficit of some $1.5 billion (over more than 20 years) before they got an approval – and you get to add some more for the few hundred million Merck threw in for the failed mTOR ridaforolimus and also for the license fees they got from Incyte for European rights to ponatinib.

  9. Drug Developer says:

    A general reminder to muddy things further: Companies spend piles of money on 2nd, 3rd, and 4th indications for approved drugs — remember, Phase 3 is the expensive part, and you’re largely repeating it. Just dividing total R&D spend by # of NCE’s approved loses this.

  10. flem says:

    If you are trying to inform healthcare policy by quantifying R&D cost per approval you must also include the risk involved.
    It’s one thing to say it costs say $X m to get to an approved drug, its another to mention that the probability succeeding is say 5%. That means, at these odds, you would expect to make at least $10b-$20b profit to break-even on a $500mm bet (leaving NPVs out of equation).

  11. anon says:

    I like how people defending the big pharma while they are laying off people, killing research programs etc. These companies making billions in profit each year. And the profits keep going up. Literally the only way they can look less evil is by bringing up the cost of a drug. Don’t fall for it.

    1. Bryan Lanning says:

      Exactly. Thank you. Pharma is total crap. Pfizer literally stole my PhD project from me and got me fired from my subsequent job(s?). Ian Reed, you are a moron. This is not tongue in cheek, this is not a drill, Pharma is stupid/evil, purely. If I were a US senator, I would go after that godforsaken industry ASAP.

  12. Pharma fed numbers are pile of whatever. Parma discovery, development are inefficient and there is no need or desire to be cost efficient. Manufacturing stone age. Quality by repeated analysis paralysis. Marketing padded up and every pocket along the line padded. Poor patient she/he die do why worry.

    1. Some idiot says:

      From what you say it sounds so simple. If you know a better way, then why aren’t you doing it and making a killing? Just curious…

    2. ab says:

      Totally! Which is why all those academics, nonprofits, and government labs have managed to produce efficacious drugs so much more efficiently!

  13. QuestionAsker says:

    If only a question or two could be asked about said subject. Regards.

  14. m says:

    Derek – you nailed every point perfectly.

  15. M. Welinder says:

    Opportunity costs, while real enough, are tricky. Including them in drug development costs seems like an invitation to skew comparisons since such costs aren’t traditionally included in, say, expected returns from investing in an index mutual fund.

    Also, pinning down rate for opportunity costs often involves “investment by hindsight”, i.e., looking at past returns for something. If you knew the exact future return of your alternate investment, you could make a lot more money!

    In other words, opportunity costs is one more free parameter in your spreadsheet. Great for getting the result you want.

  16. Steve says:

    You could include opportunity costs in anything. The money spent to make a sweater could have been better spent investing in Google pre-IPO. The money spent to make a Corvette could better have been spent buying pork belly futures. Who knows? It’s a rather silly argument to make and just invites making up crap to suit your hypothesis (or inflate your numbers). The question about what are the costs to make a drug is also nonsense from the outset – as you rightly point out, the costs vary greatly from drug to drug. Why don’t we just say that it costs a lot and leave it at that?

    1. Hap says:

      No, it isn’t – if you have money to invest you try to make as much as you can consistent with your level of risk tolerance. If your level of risk tolerance is near zero, you can still make money investing (bonds, for example, or a bank account)- the amount of money you risk when you invest in something else. Hence, Dr. Lowe’s argument that if opportunity costs for investment are bogus, you should give him a bunch of money and he’ll give it back to you in ten years.

      Most people that have the money to invest in drug companies (or any individual enterprise) are likely thinking in such terms – they want to make more money than they could investing in something less risky. If they can’t make more money than less risky investment, then they won’t invest their money in those businesses, and what those businesses would do won’t get done.

      1. steve says:

        Nonsense. I can tell you that it costs $1 million dollars to make a sweater because I could have gotten a much better return on my money investing in a Silicon Valley startup with my money which just sat there the whole time it took for the sheep to be born, to graze, to have its wool sheared, to have it shipped, to have the wool made into yarn and to have someone in Indonesia knit it before it’s sent to Saks Fifth and sold. You can dream up a similar scenario for anything you want and say – “Oh yeah – well I must be right because no one will give me a million dollars and let me sit on it from the time the sheep is pregnant to the time Saks Fifth sells the sweater”. It’s absurd and simply a way to manipulate pricing by making the “opportunity cost” as high as you’d like.

        1. Hap says:

          The problem isn’t what you can dream up, it’s what you can get. You can get a whole lot more than zero for your money, particularly if you have the cash someone thinking of opting in to a pharma can invest. The comparison isn’t between the profit from farming unicorns and from investing in pharma, but between the yield of 10 year T-bills, say, and the yields of pharma. Since T-Bills aren’t paying zero, the original point stands.

  17. anon_finance says:

    If I understand correctly, there was a study that used 7% rate for opportunity cost. That sounds very rich. In valuing financial assets, the opportunity cost is risk free rate of return i.e. usually 10-year treasury rate or some similar government note/bond return. Currently, 10-year US treasuries are about 2.16%. The risk free instrument used should have similar duration (time to redemption) to whatever is being valued otherwise you are exposed to market price changes. Of course, there are formulas to derive (theoretical) risk free rate for duration where there is no exact match in duration.

    The risk free rate is the rate of return you can get without assuming any risk. Note that equity market returns are not risk free.

    1. steve says:

      If that’s the standard to be used then investing in a 10-year pharmaceutical project is many times more lucrative than letting it sit in a 10-year treasury note at 2.16%. You could buy 100 notes or you could invest in 100 projects and have one blockbuster that still would outperform all the treasury notes (if that weren’t true then there would be no large pharma). So the opportunity costs by that definition are basically zero.

      1. ab says:

        It is fair to question the value used for the cost of capital. I read the Tufts analysis on how they arrived at their cost of capital, which I believe was somewhere around 10%. It was really complicated and I got bored. But I did glean that the value they opted to use was specific for the pharmaceutical industry. So the cost of capital for a different industry would be expected to be different. I’m sure if you’re an economist there’s a good reason this is so, and if I had a better attention span I’d see the light, but it didn’t sit quite right with me. Personally, I think values of, say 2% (what any of us could unquestionably earn right now) or perhaps 7% (inflation adjusted rate of return on the S&P 500 over the last century) are reasonable. The right value is worth debating.

        What is not reasonable is to not include cost of capital, for exactly the reason Derek points out. Over a 10 year investment time frame, opportunity cost is real. And for that matter, whether you use 2% or 7% or 10%, the bottom line is the same – drugs are really, truly expensive to invent and develop.

        1. steve says:

          It is as absurd to say that a drug actually costs more to develop because the money could have been better spent doing something else as to say all our salaries should be much higher because they’re not including the opportunity costs of what we’d be making if we were CEOs of Fortune 500 companies. You could say a high school student is actually worth $2.7M because instead of spending the money on teacher and administrative salaries, school buildings and buses, etc. for 12 years you could have spent it on building Bugatti Chirons. Where does that type of rationale end?

          1. tangent says:

            Nobody is interested in using rates that would come from lucky guesses. “Where does it end” is a question that has actual answers, if you’d stop talking long enough to think.

            Your ridiculous scenarios are only proving “if I say a dumb thing, look, it sounds really dumb!”

  18. Sue Denim says:

    As somebody who worked for one of the companies listed on the paper and as a named inventor on the patent that first contained the drug listed, I can tell you that some of this data is flawed. For example, I know for a fact that we first synthesized the drug in question a full 6 months before the date listed as the R&D start date. This was obviously long before we knew that was going to be “the drug,” but once we knew I went back and documented everything including the date that it was first registered in the database. If their data is this flawed, I don’t see how one can value the conclusions they draw about costs, time, etc.

  19. LBL says:

    How does something like this get published? Deciding to use successful compounds as the basis for their analysis was a huge red flag, and something which so many other commentators across the internet have also noticed. So how does that not get picked up during review? It just makes it seem so political. Of course there are problems but muddying the debate with bad science is not a good way to start fixing them.

  20. steve says:

    Tangent – My point is, anything that can be manipulated so easily with any assumption you want is too fungible to be taken seriously. Guess that’s why they call economics the dismal science and why it’s failed so miserably so often.

  21. steve says:

    Here’s a good article about the Tuft’s estimates. This is the relevant quote for opportunity costs followed by another relevant criticism. Beware of claims that are just too patly convenient for the people paying for them especially when they contain fungible numbers.
    https://www.ncbi.nlm.nih.gov/pmc/articles/PMC2630351/

    “Another criticism of studies that produce numbers in the billion-dollar range is that large portions of those estimates aren’t out-of-pocket expenses. About half of the 10-figure price tag is an estimate of the profits a drug company might have made, over the course of bringing a product to market, if it had instead invested its capital elsewhere. Calculating forgone profits is, according to Light, a reasonable way for a company to determine if it should go ahead with a project. “What is not reasonable,” he says, “is to then take that estimate, which is a calculation of investment, and claim it as a cost against society.”

    The cost estimate of successful drug development also includes the cost of research that fails to net new products. Again, this is a common practice. But critics claim the pharmaceutical industry misleads the public by claiming it costs more than a billion dollars to overcome the 1-in-5000 odds of a new chemical compound making it to market. About two-thirds of true research and development costs, Light says, are incurred in phase III trials, where the odds of success are about 3 in 5. Earlier trials are relatively inexpensive, and most compounds don’t even make it to the trial stage.”

    1. Hap says:

      Except if that cost isn’t paid – if people can’t make sufficient money to be worth it to invest in something – then society doesn’t get the benefit because people invest their money elsewhere and those things don’t get done. People who make food, or houses, or clothing, or electronics make the same calculations when they decide what to do with their money – whether to build new plants or buy farms or make new products. The costs of developing those things (and the profit they needed to make it make sense) are going to get wrapped up in the costs somewhere, particularly if large (and/or fixed) investments are required to make it happen).

      Since Light’s analysis is more or less nuts (the results do not fit observable reality), I’m not sure how applicable the logic he used to help generate that analysis is going to be to get an actual good estimate of drug development costs.

      1. Hap says:

        I guess if I were counting what I made from an investment, I wouldn’t count the opportunity cost as a cost – I’d count how much I put in. If I had lots of money, though, and invested it, I would be using opportunity cost to tell me whether I should keep investing there or do something else with the money. If opportunity cost is not a cost, it might as well be, because if it doesn’t get made up somewhere, then the things that don’t pay it off don’t happen.

        Also, with lots of fixed costs (some R+D outlays end up in multiple areas), it may be hard to distinguish costs for a specific drug – lots of things may be like fixed costs in building physical or intellectual infrastructure to do other things.

        1. steve says:

          Sorry, Light is correct – it still doesn’t make sense. If I decide to invest in GSK stock and hold it for 10 years that doesn’t mean that GSK stock actually costs more because I could have put that money into a savings account. The relative opportunity cost of tying up my money for 10 years might affect my decision but in no way affects the actual cost of the stock any more than it should affect the actual cost of a drug. Both are affected by market forces, not the initial decision of where to invest you money. The GSK stock decision is probably a dumb one for a number of reasons but that doesn’t give them the right to charge more per share because of “opportunity costs”.

          1. Derek Lowe says:

            Steve, I know what you’re trying to say, but you’re getting a couple of things turned around.

            Buying a stock is actually a pretty poor example to use as a comparison. For one thing, we wouldn’t be talking about you buying some and parking it – it would be adding more and more of it every year, since that’s how the spending on a drug project works. But the big difference is that a stock is an item with an externally agreed-on value, constantly marked to market by the activities of zillions of other trades that you have nothing to do with. You can choose to hold it, or choose to sell it, and its price is set by just that activity in aggregate. The market does not know, nor care, how long you yourself have held it or how long you intend to hold it, and thus the price is totally insensitive to your situation and your intentions.

            Spending on an internal project is, of course, a very different thing. There is no value set on said project in the way that there is a value of a share of stock, nor does it fluctuate according to market conditions. There is no market. The value is what you think it might be. Now, it’s true that projects and portfolios do get sold off sometimes, but the figures involved are fuzzy, and mostly the deal tend to involve payments if the project progresses or (especially) royalties if it gets something to market.

            There’s a key: you are not holding GSK stock in the anticipation that someday, if you keep pouring money and effort into it, it might turn into something of value. Nor are you hoping against hope that it’s not going to turn out like the last several times you bought GSK stock and just become worthless. But that’s just how an internal project works. The uncertainty is huge. The alternatives (just park your money somewhere (safest), or use it to buy back your own company’s stock instead, or use it to to go buy some other company (increasing amounts of risk, although not as high in most cases as your internal work), etc., etc.) are always there to be argued against If you’re looking for a securities analogy, a long-term option or warrant might be a better fit, although that one still breaks down pretty easily, since there’s some sort of market for those, too.

            We’re just not used to computing opportunity costs and adding them in, but that doesn’t mean that they’re not legit:

            http://www.investopedia.com/terms/o/opportunitycost.asp

  22. Not an economist says:

    Opportunity costs confuse me. I understand that it represents the benefit a company could have received, but gave up, to take another course of action. My confusion comes from considering what else a pharmaceutical company would invest in. Is the idea that they regularly choose between investing in drug discovery projects or mutual funds? Or that if they think they can get a better return elsewhere they’ll stop doing drug discovery and start making widgits? They are pharmaceutical companies because their business is to invest in drug discovery. So an opportunity cost seems like it would need to be the cost of investing in one target vs another. If that is so, and since nobody knows which projects are going to be successful, I see no way to put a price on it. Can anybody with greater knowledge of economics help me?

    1. steve says:

      I’m afraid greater ecomomics will just further confuse you as your analysis is already spot on.

    2. Derek Lowe says:

      You can start to get an idea by asking how much someone would charge to loan you money to do this sort of work. That’s something drug companies can (and do) use as an alternative – provide capital for someone else.

    3. Duane Schulthess says:

      Not an economist
      “So an opportunity cost seems like it would need to be the cost of investing in one target vs another. If that is so, and since nobody knows which projects are going to be successful, I see no way to put a price on it. Can anybody with greater knowledge of economics help me?”

      This is pretty good, Not an economist . The ‘opportunity’ for a pharma company won’t be a choice between developing a new indication or investing in a Broadway show. It will be the best return option for their money, given their sector. Opportunity costs are also usually zero sum, i.e., mutually exclusive – if you do one, you can’t do the other. Increasingly, this has often been a choice in pharma between investing in internal R&D or instead acquiring external IP that has already had some proof of concept. Budgets increasingly don’t allow you to do both, which is why, according to Jack Scannell, there are now 150k less employees in pharma then there were 10 years ago.

      It can also be a choice of selling the company, or buying a competitor.

      The concept of opportunity cost, at its heart, just means that you need to maximize the return on your money, and take the best, most efficient decision that you’ve got available when the liquidity is there. Sitting on a cash pile is inefficient, money looses value over time (inflation, devaluation, etc). Sometimes, that may even be minimizing losses if every option is a looser (i.e. shutting down a loss making biotech company rather than continue investing in a bad portfolio). Opportunity cost was developed out of Bastiat’s theories on the ‘broken window fallacy’ (I wish some contemporary Keynesians would read this) that economic activity is not good for its own sake, investments should be in something that improves productivity. The opportunity cost is, basically, the cost of not taking the best option available to you.

  23. steve says:

    Derek – My point is that all that goes into a business decision but it should not affect the estimated cost of the product. If you don’t like the stock comparison then use any other industry you want. Is there any one that you can point to other than the drug industry that will tell you that 50% of the cost of their product is due to the fact that they could have spent the money they used to develop it more wisely elsewhere?

    1. Derek Lowe says:

      Oh, none of this should have much of anything to do with the estimated cost of a single product. That’s not based on development cost of any one drug. You should read Jack Scannell on this subject: http://blogs.sciencemag.org/pipeline/archives/2015/10/14/jack-scannell-talks-loads-of-sense-on-drug-pricing

      1. steve says:

        The point of the Tufts analysis is to show how expensive it is to bring a drug to market. Their pricing has escalated by leaps and bounds until they now claim it’s $2.6B. There’s simply no doubt that the number is widely used by large pharma to justify its pricing. That’s why they’ve received so much criticism and that’s the basis for the objection.
        If you read any standard text, opportunity costs are used in decision making but are not included in the costs of doing business. For example: “Opportunity costs are fundamental costs in economics, and are used in computing cost benefit analysis of a project. Such costs, however, are not recorded in the account books but are recognized in decision making by computing the cash outlays and their resulting profit or loss.” http://www.businessdictionary.com/definition/opportunity-cost.html
        So it’s really misleading to say that’s responsible for 50% of the costs to bring a drug to market and then imply that the costs should be higher as a result.

        1. steve says:

          Sorry, last line should have read: So it’s really misleading to say that’s responsible for 50% of the costs to bring a drug to market and then imply that the pricing should be higher as a result.

          1. ab says:

            Who knew it could be so complicated?! [\sarcasm]

            I remember 15 years ago when PhRMA started pushing the narrative that drugs cost a lot because they’re expensive to invent and develop. Both statements are true, but they’re unrelated. The ‘because’ should be an ‘and.’ I think pushing this ‘because’ narrative was a mistake. For the past 10 or more years, the narrative has changed to, Drugs are expensive because that’s what the market will fetch. At least that’s the verbiage on the inside of the industry. There’s an emerging narrative that says drugs are expensive because that’s how much value they add. This is the right way to think about it, but it’s more complex than any of the other measures. How much is life worth? What about quality of life? What about just a slight increase in quality of life? What about a slight increase in quantity but also a slight decrease in quality? It gets sticky fast. But these are the calculations that should be done, I think. This is logic that people (me, at least) can get behind.

            I’d still argue that most of this churn is misplaced since prescription drug spending makes up only a small fraction of overall healthcare spending. I have yet to hear a convincing argument for why we spend so much time arguing about prescription drug prices and so little time arguing about the other 90% of healthcare spending.

  24. Passerby says:

    Anyone who questions the validity of the Tufts study because Big Pharma uses it to support its costs is committing an elementary logical fallacy.

  25. Tim says:

    So the really interesting question is at what point does drug discovery just become too expensive an endeavor and we as a society should just stop investing in it as it doesn’t meet a cost-benefit analysis. Perhaps instead we should redirect funding to more fundamental research until we have the tools to discover drugs more cheaply using predictive methods. This may not yet currently be the case. But there is no reason why it will not one day be the case. Unless advances in fundamental science arrive in time.

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