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The Costs of Developing Prescription Medications

By August 8, 2017Commentary

It is health economics week, as I catch up on a variety of research in this area.  Today’s study covers what it really costs to develop a new medication.   (JHE Article)   Drug development follows a series of phases, from basic research into diseases and potential treatments that lead to discovery of therapeutic compounds, their pre-clinical evaluation, including animal studies, and finally, extensive human testing.  It is generally and lengthy and risky path.  The primary data for this study was gathered from ten multinational drug firms.  From these companies they compiled data on 1442 potential medications.  7% have been approved for marketing, 1% still have active regulatory submissions, 1% submitted a regulatory filing that has since been abandoned, 576 drugs, or 39%, were abandoned in phase 1 development, 1.3% are still active in phase 1, 34% were abandoned in phase II, 6% are still active in phase II, 5.4% were abandoned in phase III, and 4.6% are still active in phase III.  Obviously, a large number of compounds are abandoned in human testing, which is the most expensive part of the process.

In calculating average cost to get a drug to market, failures are included along with successes, and the time value of expenditures is also included.  The current success rate is estimated at around 12%, substantially lower than the 21.5% rate these researchers found in an earlier study.  A decline in success rate obviously raises development costs, all other things held constant.  But firms were also “failing faster” in regard to drugs in development, which lowers spending.  And the total time to approval for successful compounds has increased, which tends to raise spending.  Phase III costs were a notable area of increased spending in comparison to the earlier studies.  Adding an 11% real, after-tax, average weighted cost of capital is questionable in my mind; it is more relevant to see the actual cash outlays, held constant by an inflation measure.

The final estimate for new drug clinical development cost was $965 million out-of-pocket and $1460 million capitalized and for the pre-human phases was $430 million out-of-pocket and $1098 million capitalized.  So the total is $1395 million out-of-pocket and $2558 million capitalized.  In addition, firms may expend money on post-approval research activities, some mandated to monitor safety, some for new indications, some to create marketing differentiation.  This amount was estimated to be around 312 million or $466 million, depending on the method used.  The total cost is about 166% higher than in the prior study in 2003, in constant dollars.  To the extent that this is due to the higher failure rate, you have to wonder about the quality of work related to selection of compounds to move ahead in the development process.  Or perhaps this higher failure rate simply reflects the reality that getting a drug to the market in the US typically means phenomenal returns, so why not take a chance on more compounds.   Pricing for many new drugs would generate enough revenue and profit to fully cover development costs in a year or two.  Just another example of how excessive drug pricing behavior has become.

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