The Pharmaceutical Games

For decades the pharmaceutical companies have answered complaints and investigations about outrageous drug pricing by responding with the old axiom, “We have to have money for Research and Development.”   First of all, they make more money than other industries and secondly, their R & D expense is much lower than what they claim. Actually, those two statements add up to the same thing.

Recently there have been headlines proclaiming new high R & D costs of anywhere from $2.6 billion to $11 billion per new drug. One set of figures is generated by Joseph DiMasi at the Tufts Center of Drug Development.  This Center is financially supported by the drug industry. More recently Forbes published the $4 billion to $11 billion claims of Matthew Herper and Scott DeCarlo . What’s this all about? It’s about stacking the deck in order to plead high R & D costs as a justification for the astronomical prices the drug companies are charging for both new and old drugs. They also use this ruse to gain government protection from price competition by extending patent terms and data exclusivity.

Back in 2003, when Tufts guesstimated the average cost of each new pharmaceutical discovery, they doubled their initial figure of $401 million to $802 million. This was on the basis of “opportunity cost” or what the company could have earned if invested elsewhere. In defending this accounting ploy they later wrote “These are real, not ‘theoretical’, costs. They are especially relevant for investments in pharmaceutical R&D since the development cycles are so lengthy…”  Many comments have been written about this non-intuitive concept. But DiMasi et al aren’t through. Now they have come out with their latest figure, $2.6 billion, which includes $1.2 billion for opportunity costs. As we will see with the Forbes estimate, the authors take all of their R & D claimed costs and apply them to a small (and secret) list of self-originated new drugs. Numerous unverifiable assumptions and complex weightings are used in their calculations. One gets the impression that they worked very hard to come up with results which would satisfy the industry.

One problem is that commentators (and policy makers) have allowed Tufts to pervert the sense of the term “investment”. Once the perversion is accepted it’s clear sailing for this new example of Hollywood bookkeeping.  R & D is not an investment.  R &D is not an investment. Do we need to say it again? It’s the cost of doing business. The “investment” goal for the company is not to have R & D but to produce a marketable and profitable product. The “investment” goal of the stockholders is to make money. One doesn’t invest in R & D anymore than they invest in executive salaries or invest in advertising and promotion. These are all costs of doing business. Calling it investment doesn’t make it an investment anymore than going out and buying the most expensive coat you can find and calling it an investment makes it one .  One doesn’t invest in coats (or family groceries). One doesn’t invest in R & D.  It’s still just the cost of living. This is recognized by the IRS and affirmed by the companies when the R & D expenses are taxed as ordinary business expenses and not amortized over a 10-20 year period as would be a long term capital investment. Let’s see now. If I bought the coat for $300 then the real cost was $600 because I lost an additional $300 that I could have invested somewhere else.

Just when we thought we had seen the prime example of bookkeeping chicanery the writers at Forbes (Matthew Herper and Scott DeCarlo) came up with those figures of at least $4 billion and up to $11 billion for each new drug. Their genius was to take the industry claimed total R & D costs and, for each company, divide that number by the number of new drug approvals. It looks like they meant new chemical  entities. Let’s see now. If we take the number of oranges and divide by the number of drug bad apples we will get the cost per barrel. Of course that R & D figure includes the doubling effect (the phantom dollar) of opportunity loss. But it also contains all of the costs for the development of me-too drugs, new dosages, new forms of administration (intra-nasal, different propellants, slow release, etc.). The me-to-drugs are the big profit makers. They are the main reason drug companies spend at least twice as much on promotion and advertising as they do on R & D. Also, as Light and Warburton note, “R & D has been known to include all the costs of their contracting related to R&D, for example with biotech companies, contract research organizations and other organizations; the cost of land and buildings used substantially but not exclusively for research or development; and general administrative overhead and major equipment. Other costs mentioned in the R&D literature that some companies may include in their total R&D costs are large legal expenses for developing patents and other IP protections and legal defense against challenges; large fees paid to doctors to participate in clinical trials and become key opinion leaders, to promote new drugs; the costs of ghost managing and authoring research results, as well as support for medical journals publishing them; executive costs in finding and negotiating with other firms for new products; lectures and courses to inform physicians about current research; or company-wide technical upgrades, like software or computers.” For good reading, still applicable, is the Public Citizen report, Rx R&D Myths: The Case Against the Drug Industry’s R & D “Scare Card”

Without getting into the multiple assumptions and manipulation of data in the diMasi calculations there are some points worth consideration:

1) The Tufts Center is Pharma supported.  If they don’t come up with the results desired by Pharma they won’t get any more “contracts”, i.e., money.

2) The data used by Tufts is furnished to them by the drug companies and is not available for peer review or the public. If the industry wanted us to know the real costs of R & D they would release the data for public perusal. They never have. In fact they have spent a lot of money on legal and lobbying fees to fight efforts for transparency  (Appendix D) . At present the only effective way to force the industry to reveal its data is through the subpoena power of congressional committees.

3) There is no validation of what is included in Tuft’s company R & D figures.

4) Only 10 (unnamed) drug companies out of the top 50 firms provided figures. What is the selection bias?

5) Which drugs were used in the study? This has not been reported. What is the selection bias?

6) The whole rationale is just a smoke and mirrors show to divert attention from the fact that the top 10 Pharmas made $711.4 billion in the 10 years, 2003-2012 and that income is going up rapidly, partly with the help of U.S. taxpayers. Global drug sales are expected to top $1 trillion in 2014. If R & D costs are such a threat why are they making so much money?         

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7) Because the drug companies use supposedly high R & D costs to justify their high prices it s important to know how much of their costs are reimbursed by  government and non-profit organizations.

8)  It doesn’t include the tax savings from tax credits and the reduction in taxes achieved by classifying R & D as business expenses, thereby reducing the taxable income.

9) It doesn’t account for amount of research paid for by others. An internal National Institutes of Health (NIH) study obtained by Public Citizen shows that taxpayer-funded scientists and foreign universities conducted 85 percent of the published research studies, tests and trials leading to the discovery and development of five blockbuster drugs. That was back in 1995 and the ratio hasn’t changed much since then. The drug companies usually report applied research without acknowleding that the basic research (pre-applied) is dominated by government support.

10) It doesn’t include profits shifted overseas and immune from U.S. taxes. ($7.2 billion in taxes avoided in 2012). It doesn’t explain why U.S. drug prices area so much higher than in the rest of the world. It doesn’t explain why old, generic prices are skyrocketing. It doesn’t explain how you figure R & D on a drug developed by one company and that company then bought out by a larger company. (See Gileal’s purchase of Pharmasset and subsequent marketing of Solvadi at $1,000/pill).. Yet Pharmasset’s R & D costs for Solvadi were only $62.4 million. And, after the sale, one of the later clinical trials was run by the NIAID.

The pharmaceutical industry hides the data for R & D costs while claiming astronomical figures. They turn to calculations supplied by DiMasi, et al at the Tufts Center for the Study of Drug Development which receives funding from, and is a cover for, big Pharma. They garner huge profits with the American taxpayer supporting a large percentage of their sales. We need regulations which create true transparency of R & D costs, and we need regulations to reign in these runaway prices. Competition and important research needs to be encouraged and prices need to be controlled to provide only reasonable return on investments.

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