Pharmaceutical Research And Development Spending – Richard G. Frank and Richard G. Frank Director – Economic Studies, USC- Schaeffer Initiative for Health Policy, Senior Associate – Economic Studies Kathleen Hannick Kathleen Hannick Senior Research Assistant – USC- Schaeffer Initiative for Health Policy @katehannick
This analysis is part of the USC-Schaeffer Initiative for Health, which is a partnership between economic studies at the University of Southern California’s Schaeffer Center for Health Policy and Economics. The initiative aims to inform the national health care debate with detailed, evidence-based analysis that leads to practical recommendations through the collaborative strengths of USC and . We gratefully acknowledge functional support from Arnold Ventures.
Pharmaceutical Research And Development Spending
At the heart of the debate over plans to control prescription drug prices is concern that price cuts, which will reduce revenues for brand-name prescription drugs, will lead to fewer “new treatments.” The rationale behind this concern is this: higher prices lead to higher returns on investment which then bring more capital into the development of medicine, which is the lifeblood of innovation. Therefore, the logic goes, reducing prices will reduce returns, which will reduce invested capital and thus slow innovation. Various versions of this argument include the head of PhRMA, the main pharmaceutical industry association, threatening recent legislation aimed at manipulating drug prices, which H.R. 3, would cause the innovation of nuclear winter.
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To better understand the extent to which innovation and pricing are linked, here are five important things to know about pharmaceutical research and development (R&D) and its relationship to drug prices and revenues.
We gather existing information and evidence on each of these issues, as well as observations related to these issues.
While in theory it can be seen that high levels of R&D spending result in the production of new drugs, empirical experiments indicate that the relationship between R&D spending and new drugs is moderate. As seen in the chart below, annual R&D budgets for PhRMA members are on the rise, growing from $37.5 billion in 2000 to $83.0 billion in 2019. During the same period, the 5-year average for new drugs -approvals, however, dropped from 36.8. in 2000, then dropped for nearly a decade in 2009 with 22 new drugs, before the 5-year average gradually rose to 44 new drugs in 2019. Furthermore, the ratio of PhRMA’s R&D to the 5-year average for new drug approvals only moderately positive at 0.58.
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Beyond the levels of R&D spending by PhRMA members, it’s also worth noting that the sources of innovation vary, further implicating the relationship between R&D spending and the supply of new medicines. According to the IQVIA report “Biopharma’s Contribution to Emerging Innovation,” emerging biopharmaceutical companies are defined as companies that spend less than $200 million annually on R&D or have less than $500 million in global revenue. In 2018, EBP companies accounted for 80% of total pipeline projects from discovery to filing, while large pharmaceutical companies with global annual sales of more than $10 billion accounted for only 15% of pipeline projects. Moreover, EBP companies’ dominance in R&D activities has only grown over time. In 2003, EBP companies accounted for 52% of the newly developed R&D pipeline, while large pharmaceutical companies accounted for 36%. 15 years later in 2018, EBP companies took up 73% of late-stage research and big pharma fell by 19%. Additionally, by 2021, it is estimated that 53% of all new drug EBPs will be introduced and 76% will be launched. As shown, EBP companies engage in greater innovation with R&D ratios that are smaller than large pharmaceutical companies.
In addition, documents from the House Committee on Oversight and Reform and the FDA show that big pharmaceutical companies’ large R&D programs do not necessarily coincide with large numbers of new drugs. As part of its ongoing investigation into drug pricing, the Oversight Committee recently released the total R&D expenditures for the 14 largest pharmaceutical companies by market capitalization. ,  Together, these R&D companies spent $121 billion in 2019. , the FDA approved 50 new molecular medicine (NME) applications, of which only 10 (20%) came from five of these large pharmaceutical companies, while the other nine companies did not have NME approvals that year. From 2016-2020, these 14 companies spent a total of $521 billion on R&D. At that time, 236 new molecular drugs were approved by the FDA. Of the large pharmaceutical companies surveyed, 11 companies accounted for 48 (20%) of those approvals, while the other three companies had no new molecular entity approvals in the past 5 years.
Observation 2: It costs a lot to bring a new drug to market, but the actual amount varies widely.
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Clearly, estimating the cost of bringing new drugs to market has been a source of heated debate, despite the more dry technical issues involved in developing such estimates. The fever of the debate stems from the high R&D costs used to remove high prices of prescription drugs. Drug R&D cost studies have used complex types of drugs, different drug classes, different user choices of capital costs to make estimates of R&D capital costs, and used different models from manufacturers. Research uses a variety of methods which in turn produce a wide range of estimates; as a simple comparison of ratings can be misleading in judgments.
Cutting the data in many ways and building assumptions has led to a wide range of cost estimates for drug development. The most recent and comprehensive review of studies evaluating the costs of bringing a new drug to market in 2021 was presented by Schlander and colleagues. The series estimates the average capitalized cost of bringing a new drug to market from some as low as $161 million (in 2019 dollars) to $4.5 billion. The difference between the mean and median estimates was also large, taking into account the variation underlying the cost of bringing a new drug to market. There are also different estimates based on the perceived cost of drug development. The weight of evidence suggests that average capitalized R&D (which includes all levels of R&D) ranges from $1.3 to $2.5 billion. Median capitalized R&D is 5% to 13% lower than the average.
Some parameters are very different and underlie some of the observed variation. Among the main differences are the composition of the main flavoring agents, the development times and the capital costs of the applied user. Three parameters are particularly important: the sample of drug studies, the success rates for the R&D process, and the user’s capital costs. In one evaluation of best practices, DiMasi, Grabowski, and Hansen used data for costs and drug launches from a sample of so-called “big Pharma” products. The mean and median capitalized R&D costs per new drug reported were $2.6 billion and $1.9 billion, respectively, in 2013 dollars, a difference of 31%. If one applies weights to new drugs as seen in the population of FDA-approved new drugs instead of the sample used by DiMasi and colleagues, estimated R&D costs drop by half to an average of $1 .01 billion and a median of $762 million.  This finding is the result of the fact that the share of orphan drugs in DiMasi, Hansen and Grabowski’s sample is much smaller than the share of orphan drugs among all new drugs, and that fewer orphan drugs are brought to market.
Research And Development In The Pharmaceutical Industry
In addition, the human experience of success varies along many dimensions. The studies reviewed by Schlander and colleagues reported success rates that varied by a factor of more than four (9% to 39%). The success rate varies depending on factors such as the type of drug class being investigated and the organization of the development process (partnerships, joint ventures, licensing agreements, solo development). A combination of therapeutic sampling and therapeutic evaluation can therefore have a potentially powerful effect on evaluations. For example, the share of licensed and joint drug development arrangements has increased significantly over time. Recent research shows that these arrangements involve significantly higher success rates. Such development is projected to change rates, so that estimates of average development capitalized costs are expected to fall by 24%.
A third issue of salient parameters in this literature review relates to assumptions about the user’s cost of capital. The literature, as previously mentioned, uses a number of users with various assumptions about the cost of capital. The most commonly used user cost of capital parameters are 10.5% and 11%. However, some studies have used 7%, 8%, 9% and 11.5%. To illustrate the importance of these assumptions, most studies find that the time cost of capitalization accounts for between 35% and 51% of average capitalized R&D costs. While the lower cost of capital was 7%, the cost of capital accounted for about 21% of the total.
In summary, the models used for R&D study, the success rates applied to the models, and the box
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