Just how much profit is there in a new drug?

It seems like the debate over the cost of patented drugs never ends: patients complain about the ever increasing prices and the drug companies complain about the high costs of R&D. However, one question you rarely see asked is how much does it really cost to make that one dose of a new drug? How much of the price is profit?

Now keep in mind when I say profit I really mean contribution margin. Contribution margin is price minus the variable cost of producing a single unit and ignores the fixed costs which in the case of a new drug includes the cost of R&D, marketing and the equipment used to manufacture the drug, just to name a few. It’s called a contribution margin because it’s the part of the revenue that contributes to paying for the fixed costs. A good example of a contribution margin comes from the entertainment industry: once you’ve shot a film, paid the actors, edited the film and put it on a DVD, what is the cost of producing another copy of the DVD compared to the price it’s sold for?

In the world of pharmaceutical manufacturing, the variable cost of producing a unit of drug can vary a great deal. Relatively simple drugs, like aspirin, can be very cheap to manufacture, while the complex biological drugs, like Herceptin, can be relatively expensive to manufacture. And the costs don’t stop there. What patients typically refer to as a “drug”, is known as a “drug product”, that is the tablet or injection that patients receive. Before a drug is made into a tablet or injection, it’s known as API (active pharmaceutical ingredient) and is typically a powder of some sort. Since you can’t just give a patient a bottle of powder to take, you need to turn into into a drug product first and that can be either inexpensive (making a tablet) or very expensive (making an inhaler for an asthma medication).

BG-12 (Dimethyl fumarate)

OK, so now that we have all of the industry jargon out of the way, let’s look at an actual example using (very) rough numbers. Biogen Idec has a new drug in clinical trial for multiple sclerosis known as BG-12. BG-12 is very unique in that it is an incredibly simple and inexpensive drug. BG-12 is dimethyl fumarate, a chemical that is manufactured on a huge scale in ton quantities. To give you an example, here is a Chinese chemical supplier who is offering dimethyl fumarate for sale for $1 – $50 per metric ton, but you have to buy at least 2 tonnes and if you need a lot, they can supply up to 2000 metric tons per year. Supply is obviously not an issue here.

If BG-12 is approved by the FDA, patients with multiple sclerosis would receive 240 mg of the drug 2 or 3 times a day (based on clinical trial data). Using rough approximations, let’s calculate how much it would cost to treat one MS patient for a year using BG-12.

Cost of dimethyl fumarate: $25/ton (let’s choose the average cost)

Dose of BG-12 per day: 750 mg (let’s go with the high dose)

Total dose of BG-12 per patient per year: 750 mg * 365 days = 274 g

Total cost of BG-12 per patient per year: $25 * (274g /1,000,000 g) = $0.007

Based on the commodity price of dimethyl fumarate, it would cost less than 1 cent to treat an MS patient with BG-12 for one year. Of course you need to turn the dimethyl fumarate into tablets and put them in a bottle, so let’s assume all those added costs are $0.05/tablet. I honestly have no idea how much it actually costs to make tablets on an industrial scale, but it can’t be much considering you can buy a bottle of 100 generic Tylenol tablets at Target for about $3 or $0.03/tablet all in. However, we’ll estimate on the high side and say $0.05/tablet. If we add in the cost of the dimethyl fumarate ($0.007/tablet) and round up, we get $0.06/tablet or $65.70 to treat an MS patient for a year with BG-12. Not very expensive!

Now we know the variable cost to produce a year’s treatment of BG-12, but how much will it sell for? Well, BG-12 looks like it will be a very effective drug without a lot of side-effects, so Biogen certainly isn’t going to price it less than treatments that are currently on the market. If we take a look at this article from Pharmalot, we can see that the annual cost to treat an MS patient with current drugs ranges from approximately $36,000 to $48,000 per year. Let’s assume that Biogen will match the highest price therapy (Gilenya).

Contribution margin = revenue – variable cost

= $48,000 – $67.50

= $47,932.50 or a 99.85% contribution margin

Now before you start screaming about greedy pharmaceutical companies, remember, this is just the contribution margin. Current estimates put the cost of developing a new drug somewhere between $500M and $2B dollars. Biogen will have to treat a large number of patients for many years to recoup their development costs and begin making a profit on BG-12 (for example: treating 1000 patients with BG-12 for 5 years would pay off $1B in development costs). This is why it’s estimated that only 1 in 3 drugs that hit the market actually make a profit for the company; you may have an incredible contribution margin on a drug, but if all of the margin goes into paying off the fixed costs that went into development, you may end up not making any profit at all.

The other lesson from this exercise is now you can see why the cost of generic drugs is so low. A generic pharmaceutical company incurs only a fraction of development costs that an R&D-based company does and thus can charge a much lower price (typically 80-90% lower), receive a much smaller contribution margin and still make a profit.

Update: After some delay, the FDA has promised to make a decision on BG-12 (brand name: Tecfidera) on March 28th, 2013.