In the US, drug prices for consumers are climbing. The average cost is up 11% from 2013 to 2014 — that’s a lot more than inflation. What’s really behind that sky-high pricetag?


First, a Few Numbers

Pharmaceutical companies cite the high costs of drug discovery as the reason for expensive medication, but it’s hard to fact-check whether their numbers are based on science or inflated to boost profits.


We do know that for some critical categories like Parkinson’s and asthma, the increase in drug costs over the past two years was as high as 30%. Some increases were even higher, and with no justification other than profit: This year, Valeant Pharmaceuticals bought the rights to two heart drugs that are already on the market and immediately raised the prices by 525% and 212%.

Pharma companies are notoriously secretive about the costs associated with developing new drugs. Estimates range anywhere from $2.6 billion to $55m on average per successful drug, depending on who you ask. That’s a huge chasm, leaving plenty of room for doubt and unanswered questions.

Here’s what we do know. According to the Food and Drug Administration, it takes an average of 8.5 years for a drug to go from “hmmm, this looks promising” to commercial approval. Other estimates, from the non-profit FasterCures (part of the Milken Institute) are as long as 15 years.

And that’s just for the drugs that make it to market. The pharmaceutical industry estimates that the overall success rate for getting new drug ideas from the lab to your medicine cabinet is a little under 12%. A recent study published in Nature Biotechnology pegged it at 15.3%. So, not great. In fact, chemist Derek Lowe, who runs a popular blog on drug discovery, writes that in 26 years in the industry he has never worked on a compound that made it to the FDA. The failure rate in the pharmaceutical industry is high enough that chemists have tried to calculate the chances of working on a compound that actually pans out during their entire career.


Why do so few drugs work out? And why can it take several years and multimillions of dollars to test a new compound? Let’s look at how the process works.

The Long Journey From Lab to Medicine Cabinet

First, a drug company decides what disease they want to work on — preferably something without a lot of good treatment options, so any drug they develop is not going into a crowded market. Then they try to identify a protein or pathway that causes that disease, which they will try to modify with a drug. Companies often relying on prior research from academia to identify this target.


Once researchers have identified a few promising compounds, they then test those compounds in animal models. Most compounds they test will not work; The statistic most often cited is that only 5 out of every 5,000 compounds studied will make it to the human testing stage. If the compound works well in an animal model, and doesn’t kill your rats or make them do anything weird, initial studies in humans can start, called phase I.

This whole pre-clinical research process — assuming an academic center has previously identified the pathways to target for a disease — takes about 4 years. The costs are relatively low at this stage; the real money kicks in when human subjects are involved. One estimate — from the pharmaceutical industry, which may be high as it is in their best interest to justify costs — is that on average it takes about $6.2 million to get a compound ready for phase I of testing.


Phase I studies test what happens when the drug is in a real live human body, using no more than 100 healthy volunteers. Is it absorbed okay? Does the body metabolize it? Is it making your hair fall out and little blue men appear out of nowhere? Can you excrete the drug okay or does it build up dangerously in your system? According to the pharmaceutical industry, the costs of this phase come to about $38,500 per patient, depending on the complexity of the disease, and about 67% of drugs pass this phase.

If the drug passes, and no blue men appear, it can move on to phase II, which is testing in patients that have been diagnosed with the disease the compound is suppose to treat. Phase II studies are similarly small, maybe a few hundred patients for a reasonably common illness. These trials are what most people associate with a drug study, where the patients are randomized to the drug and given either an existing treatment or a placebo.


At this stage, researchers are testing if the drug is actually helping treat the disease it was designed to treat in an actual sick person, if there are any adverse effects in patients, and what dosage works best. This phase of research is more involved and lasts longer, anywhere from a few months to two years, and is estimated to cost around $40,000 per patient.

Around 39% of drugs make it to phase III — the big money spender. This is when the company thinks they really have something and conduct a large scale trial in order to get FDA approval to make and sell the drug. Phase III research can involve thousands of patients taking the drug at multiple centers, generally in different parts of the country and the world, and can take years to complete. The pharmaceutical industry estimates that this stage costs around $42,000 per patient.


This phase accounts from about two-thirds of the total drug development cost. It’s so expensive in fact, smaller drug companies have to partner with one of the mega pharmaceutical companies — or sell to them — in order to fund the research.

This leaves big pharma responsible for a very large portion of drug discovery costs in the U.S.




Justifying High Drug Costs

The prevailing logic goes, drug discovery is difficult and expensive and that is why, for example, a company can charge $1,000 per pill for an effective treatment for Hepatitis C. But pharmaceuticals is a for-profit industry that also serves what is arguably a basic human right: the right to health care. That conflict of interest has led patient, doctors, hospitals, and government agencies to start to push back on the industry for rising drug prices — with little success. Patient groups have started Change.org campaigns. Doctors and hospitals have written collective critiques and op-eds pointing out how rising prices limit patient access to drugs. Various bills and ideas have been introduced by the government in an effort to curb rising drug costs, including by current presidential candidates.




But drug discovery costs may not be the whole story when it comes to pricing. It may not even be any part of the story. Pricing is usually based not on some calculus of drug development costs but on whatever a company thinks it can charge. “We all look at each other and keep pace with each other. Honestly, there is no science to it,” a drug developer recently told The New York Times, when asked how prices are set.

At the end of the day, a drug company is looking to make a healthy profit, and if it is a publicly traded company, it has to show some kind of revenue growth from quarter to quarter to appease shareholders. Charging more for its drugs — those it just got approved and those that are already on the market — is the way to do it.


The estimates of how much it costs to get a drug from an idea to a reality — that gaping range of $55 million to $2.6 billion per successful drug — depends on who you ask to calculate costs, the industry itself or a third party.

But regardless of who does the calculations, without full disclosure from pharmaceutical companies on what they spend for each specific drug it is hard to get any kind of real figure. Drug companies only disclose their entire R&D budget overall, not spending on each individual drug. There have been calls by the senate to get that information in order to create some sort of justifiable model for drug pricing, or at least answer the question of how much it costs to bring a new drug to market in a scientific manner that does not involve just taking the word of the pharmaceutical industry. So far those bills calling for more transparency have not made much progress getting past big pharma’s powerful lobbyists.


The most well-publicized drug discovery figure is $2.6 billion per drug, and it comes from Tufts Center for the Study of Drug Development, funded in large part by pharmaceutical companies. Many people to question the accuracy of that number.

Criticisms of the study claim it cherry-picked drugs that happen to have been developed in-house from the start, and not from promising leads from academic centers, which generate most ideas. The drug companies that participated in the Tufts study were also not randomly selected but instead chose to participate in the study and self disclosed their information. Tax breaks for research were not subtracted from the price and around $1.2 billion of it is money the study assumes the companies would have made if they invested their funds instead of spending them on drug development.


The estimate on the low end of the spectrum — $55 million per drug — comes from a study that basically called out the flaws in the assumptions in the Tufts study and attempted to correct them with publicly available information, without having any access to the pharmaceutical companies themselves.

A third study, from 2010, evaluated 13 studies that each try to estimate the cost of developing a drug. The analysis found that the cost of development for a drug ranged from a low of $161 million to a high of $1.8 billion, still a significant gap that does little to clear up the confusion.


How Can We Improve Things?

There are many of ideas out there about how to make the drug discovery process cheaper and more efficient, whether they can be put into practice is another matter. A lot of the ideas would either involve sharing data, which would be difficult if not impossible in an industry that depends on patents and a model of guarded proprietary research or would involve generously funding other institutions to carry out drug research, which in a time of diminishing NIH budgets seems unlikely.


One idea is to make all data open and free to everyone so anyone with a great idea can work on it, and all the knowledge that companies acquire can be shared for the greater advancement of science. Think of the open-source software model. But since the pharmaceutical industry currently relies in patents and proprietary information to make its money the chances of that happening are pretty slim.

Another idea is a prize model, similar to what Netflix did when it needed new complicated code and offered to pay $1m to anyone who could write it. Instead of spending so much time and money trying to find and validate compounds, the industry could offer sizable rewards to anyone who can bring them vetted ideas, raising the rate of compounds making it all the way through the research process and to the FDA. It may take an academic researcher many years to find the right compound that is ready for phase I research, time the pharmaceutical company does not have to spend. And it brings fresh eyes and ideas to a problem.


One obvious solution is to increase funding to the NIH and other organizations that conduct the basic research the pharmaceutical industry relies on for its initial ideas. More basic research could mean much better targets identified for a disease or the development of a better animal model of the disease, resulting in less failures upstream. It also means a better understanding of the complex diseases like Alzheimer’s that we still don’t know much about — diseases that drug companies are increasingly trying to target without really understanding exactly how they work. Unfortunately, getting the government to agree to prioritize NIH funding has always been difficult.

Drug prices — and price increases — are not sustainable, and the backlash is becoming more evident. Just this month, a pharmaceutical company run by a former hedge fund executive bought the rights to a drug that treats a complication of AIDS and raised the price by 5,000%, prompting public outrage and intense media coverage. Valeant Pharmaceutical’s huge increase in price for those two heart drugs has now been met with a subpoena from lawmakers demanding to know what justification the company has for the price hike.


Pharmaceutical companies have a right to make a profit, but patients should also have a right to affordable treatments. Drug companies set the prices they think the market will bear. It’s time for them to rethink just how much the market can stand.

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