Posted on May 21, 2007 by David Laidlaw
One way the pharmaceutical companies have adapted to slower discovery of new breakthrough medications and increasing research and development costs is to increase the prices for their drugs. In many cases, these price increases have been spectacular such that the high prices themselves might be a threat to the pharmaceutical industry.
On average, it costs about $800 million to $1 billion for a drug company to shepherd a new drug through clinical trials and the Food and Drug Administration’s (FDA) approval process. These costs are associated with proving that the drug is both safe and effective.
To provide incentive for companies to develop new treatments, the patent office issues patents that last for 20 years. The FDA also allows separate, but not additive, exclusive selling arrangements that run for 5 years for new chemicals and 7 years for “Orphan Drugs” (drugs for rare conditions). Since clinical testing and the FDA approval process averages about 10 years, the window during which a new compound is protected from competition is often 10 years or less. Therefore, there is intense pressure for pharmaceutical companies to recoup their investment and earn a profit on their efforts within a short period of tim e.
The pharmaceutical companies also face continued risks once a drug is approved. These risks are mainly associated with class action lawsuits if drugs are found less safe than advertised and patent challenges by generic drug manufacturers.
The prices that pharmaceutical companies are charging for new drugs, especially for cancers and rare conditions, keep rising. In 2004, ImClone began charging $10,000 per month for four month treatments with Erbitrux, its colorectal cancer drug. Genentech introduced Avastin, which treated the same disorder, for a total treatment cost of $47,000. Most recently, Alexion Pharmaceuticals set pricing at $389,000 per year for its drug that treats a rare blood disorder associated with clotting.
The Wall Street Journal reported that push-back on these pricing trends has begun in an article on March 15th. The article covered a Morgan Stanley analyst, Dr. Steven Harr, who first raised the issue with the pharmaceutical companies themselves that high prices alone would create their own resistance. Harr expressed his concerns that the pricing practices of the drug companies could lead to government price setting.
Congress has already begun addressing the pricing issue. On February 14th, Representative Henry Waxman, Chairman of the Committee on Government Oversight and Reform, and Senators Hillary Clinton and Charles Schumer, introduced legislation to allow for generic biopharmaceuticals. Biotech firms are now able to avoid generic competition for their products which are typically made from living cells rather than inert chemicals. The political press releases accompanying the proposed legislation all point to the high prices for biotech drugs and the need to make them more affordable. The politicians expect that generic competition for biotech drugs will make them more affordable once patent protection expires as it has with traditional medications. This legislation may be the tip of the iceberg as Representative Waxman held a committee meeting on March 26th “to examine the high cost of biotech medicines to our health care system.”
Aside from government regulation, there is also the question of whether or not the private sector is able to pay for very high-priced medications. We have not researched how the health maintenance organizations treat these drugs, but could imagine loopholes for not covering the expense. Also, the drugs are so expensive that the co-pays mandated by private policies would be unaffordable to all but the most affluent patients.
The investment considerations that stem from this pricing pressure seem apparent. Pharmaceutical and biotechnology companies will come under pressure where their future earnings es tim ates are based on inflated prices for their products. We believe that this is especially true for non-blockbuster drugs that treat small patient populations. Many of these companies are more attractive short candidates since their research and development expenses will continue to grow and their future earnings potential appears more limited than expected.