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How Big Pharma distorts the costs of developing new drugs

A new study systematically dismantles the industry's claim that the research and development cost of bringing a new drug to market is $1.3 billion.

April 03, 2011|Michael Hiltzik

DiMasi assured me that his survey's drugs are representative of the industry as a whole in terms of the risk and expense of their R&D, and he pointed out that his findings were validated by a 2006 study using a separate, public drug database. But the authors of that study, who were researchers at the Federal Trade Commission, stated in their paper that they couldn't really be sure that their data were comparable. Of course, a study that doesn't reveal what it measured or provide a way for outsiders to reproduce its findings has an insurmountable flaw. That alone should render the Tufts study ineligible for use as the basis for any policymaking.

Another issue is that the cost figure produced by DiMasi and his team includes "opportunity costs" — that is, the potential income the drug companies might have made on other investments, such as equity securities, if they hadn't bothered to tie their money up for years developing drugs and getting them to market. The authors essentially doubled their calculations of out-of-pocket spending to accommodate these speculative lost profits. By financial alchemy, in other words, they made $403 million in tangible spending look like $802 million.

DiMasi contends that opportunity cost is relevant to his findings because "it shows what it costs to have sufficient incentive to develop a new drug." Light and Warburton, however, argue not only that the Tufts opportunity-cost multiplier is far too generous, but that it reflects a nonexistent choice: a company in the innovation business doesn't have the option of not investing in R&D. A drug company that leaves its money in a securities account isn't a drug company, it's a hedge fund.

What's especially questionable is treating these "foregone returns," as the Tufts researchers would call them, as the equivalent of out-of-pocket expenditures. When laymen hear that it costs $1 billion to develop a drug, they presume that the money is cold cash, possibly with an inflation factor thrown in — not that half of it is profits a firm might have earned by not investing in research at all.

In any case, the profit margins of major drug companies have been running as high as 49%, which suggests that the industry makes a lot more from developing and selling drugs than it could in the stock market. A Big Pharma CEO who earns even 10% on stocks and bonds while his rivals earn 49% by hawking painkillers and sedatives will become an ex-CEO faster than you can say "9 out of 10 doctors recommend."

Here too the fault lies not in the Tufts findings, but in their distortion by the drug industry. DiMasi's study proposed a reasonable standard for judging the potential yield of a long-term investment against a fixed return; it's the pharmaceutical lobby that, with staggering dishonesty, misrepresents this theoretical metric as if it's cold hard cash.

An important problem with the industry's citing a single figure to represent all drug R&D is that drug R&D isn't monolithic — the costs vary widely by the type of drug. The FTC study largely used DiMasi's methodology to conclude that average development costs ranged from $479 million for an AIDS drug to $936 million for an arthritis medicine. DiMasi himself published data in 2004 showing similar variations among therapeutic categories.

That said, the DiMasi team did produce a sophisticated study of the overall costs of pharmaceutical R&D. It's the industry's lobbyists who have caricatured it as a finding of the "average cost to develop one new drug." The lobbyists would have you believe that the cash cost of inventing and testing the contents of every one of those amber vials in your medicine cabinet is $1.3 billion, and consequently that any policy that cuts into drug company profits will mean less R&D and fewer lifesaving medicines.

Light and Warburton have done well to deconstruct how the drug industry contrived this all-important claim about R&D costs. Is anybody listening? When I asked Light if he's heard any reaction from policymakers since his paper was published in February, he replied, "I'm not getting the impression that members of Congress are paying attention."

Independent findings like his are easily overwhelmed by the tide of Big Pharma's dollars. "They rule the airwaves," he said.

Michael Hiltzik's column appears Sundays and Wednesdays. Reach him at, read past columns at, check out and follow @latimeshiltzik on Twitter.

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