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Friday, October 23, 2009

Innovation and Healthcare Reform

Earlier today I was part of a panel discussion on the topic of ‘Health-care Reform and its Effect on Innovation.’  I focused my talk on the effect on innovation in terms of pharmaceuticals (with a nod to medical devices).  It’s an interesting issue, one that I’ll flesh out a bit over a couple of posts.

Generally, the question of effect here is one of profitability:  whether the decrease in consumer costs, as a result of reform, will drive profitability down to such a level that pharmaceutical companies will be forced to devote less to innovation.  In terms of health-care reform, I view this as a quality of delivery issue:  How do we balance the need to reform a system that is quickly becoming untenable (if it’s not already) with the desire to maintain high standards in quality of health-care delivery (here, pharmaceuticals)?  

The answer must be multi-faceted, I believe.  There are a number of considerations; profit/cost, my focus in this post, is but one factor.  As I’ll discuss later, patent terms, barriers to generics entering the market, and potential changes to both regulatory processes and incentive schemes also warrant examination. 

The potential profit loss drug manufacturers face would stem from a reduction in price-per-unit as a result of health-care reform.  The concern is that that will not be compensated by the numbers of newly insured individuals, thus limiting the funds that can be directed to innovation and ultimately slowing the output of novel drugs.  This raises the question of the manner in which drug manufacturers direct their spending:  what is classified as ‘innovation,’ and how much capital is devoted to it?

As it happens, the development of truly innovative drugs—novel products that provide previously unavailable benefits—is perhaps less than we might wish.  Pharmaceutical companies have limited innovative productivity, instead focusing on profit-bearing ‘me-too’ drugs:  relatively easy ‘spin-offs’ that are highly similar in effect to preexisting treatments and provide a follow-up monopoly right once the patent terms of preexisting drugs expire (although these efforts are profitable, one questions the wisdom of creating a product that will compete with generics; a blockbuster drug, if focused upon, seems a better goal for post-patent expiration).   

Further, it’s not clear that the industry is spending nearly as much on R&D as one might imagine.  As a commentator in the NYT recently put it, ‘only naïve politicians and academics really believe that pharmaceutical companies are always greedy and egregious in pricing drugs far in excess of manufacturing costs.’  Certainly, innovation is expensive; industry studies estimate over $1.3 B for singular, novel drug development.  This number encompasses years of research, drug failures, and the high cost of a heavily encumbered regulatory approval process.  But the pharmaceutical industry also pours money into advertising (almost twice as much as spent on R&D, according to one study) and into lobbying efforts—the latter to the tune of over $600,000 a day in the first six months of 2009 .  The amount of monies sent to R&D?  According to a study published in the British Medical Journal (note: registration required), as of 2005 it was 1.3 cents per dollar of sales (accounting for research-based tax incentives). 

In terms of the profit/cost dilemma, how is the health-care reform/quality health-care delivery balance to be struck?  Keeping in mind that this is just one factor among several to be deliberated, the initial focus should be on the type of spending done by drug manufacturers—and what of that spending is going to be rewarded by government incentives to encourage R&D.  The industry needs incentives, to be sure, but there should be an accounting of what is actually being spent on developing novel advancements in treatment—and those efforts alone should be incentivized (thereby perhaps limiting inefficiency in drug development and perhaps curbing the ‘me-too’ practice).  

Posted by Nadine Farid on October 23, 2009 at 08:26 PM in Intellectual Property | Permalink


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With all due respect, you pose this as a question but present what appears to be an extremely pointed and cherry picked set of facts.

First, almost all studies show R&D in the pharmaceutical industry to be between 15 and 30%. This is much higher than the figure you cite and higher than almost any other industry (e.g., software, aerospace, etc).

Second, the presumption that spending twice as much on marketing and sales is bad is naive. Almost all industries that develop and sell innovative products need to spend large amounts on these efforts in order to generate revenues. Contrary to popular opinion, good products rarely sell themselves, even when there is much research to demonstrate its value (see statins). This is particularly true with medical technologies where the remaining useful patent life after approval are short and the industry has a short time to recoup their development costs. Consider what the costs of drugs would be if sales of each drug were 90% less without substantial sales and marketing efforts. You might reduce the percent of revenue spent on sales and marketing and you might increase the percent spent on R&D, but you would likely increase the cost per treatment and do it to such an extent that many would never get developed.

Furthermore, contrary to popular belief, a small percentage of this is spent on direct-to-consumer advertising. Most of it is going to providing free samples, educating and training physicians, convincing payors to reimburse, funding additional studies, and so on. A significant portion of these funds provide a critical benefit for society and would probably need to be spent under alternative regimes (i.e., government paying for it).

Third, it is disingenous to cite lobbying funds being spent today, when healthcare "reform" is afoot and the industry is potentially on the chopping block, as if it somehow represents the norm. It is certainly orders of magnitude larger today than the average over the past 10 years.

Fourth, your point on "me too" drugs is likely over-stated. Many of these are the results of parallel efforts that occur before long any outcome is known. Those those are true copy-cats have dramatically lower development costs and less risk. In other words, they are diverting fewer resources from other, perhaps more worthy, efforts than you might think and generally pay for themselves, i.e., it's not necessarily zero sum. Many of the so-called "me too" drugs are competing with the novel drugs developed by their competitors, thereby lowering costs and increasing choice (sometimes in clinically relevant ways).

Fifth, to the extent that consumers are using line extension drugs when equally good generics are available for much lower cost (which is not always clear), this is largely a by-product of the 3rd party payor system we have today, i.e., comphrensive insurance. If consumers had to pay for all or at least a substantial portion of the cost of their commonly consumed drugs, then they would likely at least try the lower cost generics. There are other models that would address these problems (e.g., castrophic insurance combined with generous (and sometimes subsidized) health savings accounts. A great case for this is the use of Nexium over Prilosec and its generic equivalents.

Finally, you fail to mention the critical relationship between risk and reward in the industry and timing of cash flows. These companies are spending a lot of money today that will not pay off for many years (10+ years to bring a drug to market) and has a very good chance of not paying off at all. In order to encourage continued development efforts, these companies need to be compensated for their risk and for the time-value of money. To pretend as if there is a simple non-market based formula to calculate the correct ratio of R&D today as a proportion of current revenues and to underestimate the importance of the need to spend money on sales and marketing demonstrates a profound and dangerous ignorance of the business.

Posted by: fall99 | Oct 25, 2009 11:08:33 AM

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