Big Pharma Needs to Get Busy in the Lab
By Gary Pisano,
Mr. Pisano, a professor of business administration at Harvard Business School, is the author of “Science Business: The Promise, the Reality, and the Future of Biotech” (Harvard Business School Press, 2006).
The average cost of developing a single new drug has reached $2.6 billion, according to a 2014 study by the Tufts Center for the Study of Drug Development. Is this figure accurate? It depends who you ask: Critics of the drug industry say companies use the expense numbers to justify high prices. But drug companies defend the estimates.
A March 4 event offered a new data point. The biotech firm Pharmacyclics agreed to be purchased by drug maker AbbVie for $21 billion after a heated bidding process. Pharmacyclics has one drug approved by the Food and Drug Administration—Imbruvica—for various blood cancers. Its other drugs are in the early stages of development, so AbbVie in essence paid $21 billion for Imbruvica. No one really knows whether this price is too high. That will depend on how much AbbVie can expand the market for Imbruvica.
As expensive as the Pharmacyclics deal may be, it reflects a broader trend of pharmaceutical companies acquiring drugs instead of developing them. In the past few years, pharmaceutical companies desperate to refill thinning pipelines have forked over several hundred billion dollars on acquisitions—many times more than what they spent on their own research and development. In December, for instance, Merck acquired antibiotic company Cubist Pharmaceuticals for $8.4 billion. These acquisitions are not accounted for as “R&D” on the income statement, but economically they amount to R&D expenditures.
This raises the question: Are pharmaceutical companies paying more for R&D by acquiring companies than by carrying out the R&D themselves? The acquisitions would suggest they are.
Consultants, Wall Street analysts and pundits have long urged pharmaceutical companies to cut back on internal research and buy drugs from small biotech companies instead. Invoking various theories about economies of specialization and the efficiency of small firms, they’ve argued that it is cheaper and less risky to buy from the outside than to develop on the inside. This argument has been repeated so often and for so long—I first heard it in 1985—that it has almost become beyond dispute.
There’s just one problem: It’s wrong. In my own research, I compared the costs over a 20-year period of drug development at large pharmaceutical companies and biotech firms. I found no meaningful difference on average between what large pharmaceutical companies and biotech companies spent to successfully develop a drug. The blanket generalizations about biotech firms being more efficient are unfounded.
Beyond that, the cost of buying a company that owns a desirable drug depends on supply and demand of drug assets. Those urging pharmaceutical companies to scale back on drug discovery have assumed that the supply of available new-drug candidates would be high enough to keep prices low. The price of the Pharmacyclics acquisition, however, suggests that this assumption was badly off base. The supply of high-quality assets like Imbruvica is actually quite scarce, while a surging demand for blockbusters is coming from pharmaceutical companies with few of their own discoveries in stock.
Pharmaceutical companies thus increasingly find themselves in bidding wars to acquire the most prized external assets, a process that will inevitably increase what they must pay to acquire these drugs. And who ultimately pays the price for these higher costs? Under the current system, they are passed along to patients in the form of higher prices.
Clearly, patients, society and pharmaceutical companies would all be better off if there were more investment in drug research; government can do its part by reversing funding cuts for basic biomedical research and streamlining regulatory processes. Pharmaceutical companies can do their part. While they still need to collaborate with partners like biotech firms and universities, no pharmaceutical company will survive without strong internal science and research. Those with such capabilities will not only benefit their bottom line over the long term but make a much greater—and much needed—contribution to society.
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