Crisis in Pharma R&D: It Costs $2.6 Billion to Develop a New Medicine; 2.5 Times More Than in 2003

A similar version of this Health Alert appeared at Forbes.

The rate of growth of health spending remains moderate. But one area where prices appear to be increasing faster than they have in the past few years is brand-name prescription drugs. By 2012, blockbusters had lost their patents, and many looked forward to a future where we could all get a month-long supply of generic drugs for $4. Well, it did not quite work out that way.

Specialized drugs for smaller patient populations were introduced with high nominal prices. In September, EvaluatePharma confirmed that the increasing cost of prescription drugs was concentrated in more specialized drugs. Of the 100 top-selling drugs in the United States:

  • The median revenue per patient of the top 100 drugs has increased from $1,260 in 2010 to $9,400 in 2014, representing a seven-fold increase;
  • The median patient population size served by a top 100 drug in 2014 is 146,000, down from 690,000 in 2010; and
  • There are now seven treatments priced in excess of $100,000 per patient per year in 2014, versus four in 2010.

Given these facts, it may be understandable that the health insurance industry is campaigning against the high prices of specialty drugs. For its part, the brand name pharmaceutical industry emphasizes that health insurers (especially in Obamacare exchanges) often put these specialty drugs on the most expensive tier of their formularies. This requires patients to pay high out-of-pocket costs. While this is an accurate description of the situation, a government policy simply forcing insurers to cover a higher share of the price of a specialty drug does not reduce the price. It just moves it from patients’ direct payments to their premiums.

Reducing prices of specialty drugs requires improving the productivity of R&D. On that front, the news is sobering. Last December, Deloitte and Thomson Reuters examined newly introduced drugs from the twelve pharmaceutical companies with the largest research and development (R&D) budgets. It cost $1.3 billion to bring a newly discovered compound to market. However, the average forecast for peak sales of an asset declined by 43 percent, dropping from $816 million in 2010 to $466 million in 2013.

The high nominal prices of new drugs do not compensate for the smaller patient populations that they target. Deloitte and Thompson Reuters estimate that the IRR (internal rate of return) of R&D spending has dropped in half since 2010, from 10.5 percent to 4.8 percent. Sales of new drugs are not overcoming the loss of patents, weak pricing power for older drugs or reduced productivity of R&D.

The crisis of R&D is highlighted in a new report by the Tufts Center for the Study of Drug Development. Back in 2003, the Tufts team estimated that the cost to research and develop a new drug was $802 million (in 2000 dollars). In 2013 dollars, that would be $1,044 million.

This month, the team updated its estimate, using drugs first tested on humans from 1995 through 2007: It now costs $2,558 million to develop a new medicine, almost two and a half times more than the (inflation-adjusted) 2003 estimate. It appears that the Tufts group’s estimate is much larger than the one from Deloitte and Thomson Reuters because the Tufts group looks at costs from the first step of research, before discovery.

This means that the cost of abandoned projects is allocated to successful ones. And an astonishing 8 in 10 were abandoned. Because some of the drugs in the Tufts study are still under development, even more will be abandoned. My Forbes colleague Bruce Booth confirms that an 8 percent success rate is the consensus of other estimates.

Why such little success? The authors note that “[c]linical approval success rates have declined significantly” since their earlier study.

For those who advocate that the research-based pharmaceutical industry should be subject to government audit and regulation of its R&D budgets for each new compound, the Tufts report confirms my own conclusion that this would be an impossible task: “The drug discovery and development process typically involves high fixed costs, meaning that substantial expenditures incurred prior to clinical testing cannot be directly linked to work on specific compounds.”

The Tufts report also estimates an average real cost of capital of 10.5 percent over the period. In 2010, it was 9.4 percent. I estimate that the real interest rate at that time (as measured by U.S. Treasury Inflation-Protected Securities) was about 2.8 percent. This implies a real risk premium of about 6.6 percent. If the nominal IRR (as estimated by Deloitte and Thomson Reuters) is only 4.8 percent, the pharmaceutical industry as a whole is clearly not achieving its hurdle rate.

The Tufts report is controversial, which I will address in a future Health Alert. Nevertheless, the body of evidence indicates a productivity crisis in R&D that demands attention. In the U.S. Congress, Rep. Fred Upton, Chair of the House Energy & Commerce Committee, has launched a bipartisan initiative for “21st Century Cures” that is examining the entire regulatory process governing the research enterprise. It is a necessary and welcome step in the right direction.

Comments (7)

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  1. Devon Herrick says:

    A few years ago I met a drug researcher who worked for a major drug company. She reported that the drug industry is so concerned about getting sued that they were discouraged from using email for internal communications. It seems email is archived and could easily be obtained during legal discovery. Imagine a productivity tool as common as email being unavailable?

  2. Stu B. says:

    The trade publication, Drug Topics published an interview where a consultant discussed common mistakes small pharmacies often made. Not pricing certain drugs high enough was cited as a common mistake. I think this is something that large pharmaceutical manufacturers have also figured out. Essentially there is few limits to what a drug can be priced at if there are few significant competitors. Specialty drugs are an example. Initially, fear of bad publicity held back extreme pricing. Once the dam broke, other firms jumped on board. Patent expiry may have prompted some of this but undoubtedly not all. Once this strategy is shown to be successful, there is no going back. Very costly drugs that treat small targets are the future of drug development.

  3. Devon Herrick says:

    Actually drug makers are encouraged to pursue new molecules rather than create me-too copies of existing drugs. The FDA made it clear that with each new drug application in a given class, the bar for approval would be higher than the last. Competition among existing drugs within a drug class lowers prices. Being the only purveyor of a novel drug for a small segment of patients is generally subject to price competition.

  4. Charlie Bond says:

    Good morning, John:

    Excellent post. Once again, you note: “The drug discovery and development process typically involves high fixed costs, meaning that substantial expenditures incurred prior to clinical testing cannot be directly linked to work on specific compounds.”

    Hmm. Sounds like a problem with cost-based pricing.

    What is not addressed is why the American people are expected to pick up more than their fair share of R&D? And why did the pharmaceutical industry seek and obtain the protection of a federal law prohibiting federal and state governments from using their purchasing power to negotiate the price of the drugs they buy? And of course, we have the current drug shortages . . . .

    To be clear, in every talk I give I point out that we are dealing with a crisis of abundance. We have longer lifespans and greater treatment options than could have been imagined even 25 years ago. We are extraordinarily fortunate to be here and to have the pharmaceuticals we have.

    In the re-invention of health care now underway, the pharmaceutical industry–like physicians and hospitals–must steward their resources to see that distribution is compassionate and effective. Like other sectors of the health care economy (doctors, hospitals, ancillaries, etc.), pharmaceutical companies should earn reasonable profits for their shareholders when they successfully discover, manufacture and deliver valuable products to market. Indeed, the lives of millions of people depend on their stewardship.

    With the American health care economy just about equalling the economy of China, I believe we have adequate resources that can be allocated to both the manufacture and creation of pharmaceuticals.

    Just as doctors and hospitals will have to bid adieu to fee-for-service reimbursement in favor of “accountable care”, our good friends in the pharmaceutical industry will have to propose (or have imposed on them) their own version of accountability.

    With the advent of genomics and new techniques testing and approval can enter the 21st century. When it does, we will all benefit from faster development times, lower costs and better designed drugs.

    In the meantime, all participants in the health care economy–including pharmaceutical companies–must be prepared to innovate their way out of the current cost crisis. They can do so.

    For example, the pharmaceutical industry can and should underwrite incentives for patients to follow doctors’ orders–not give patients specific kickbacks on specific meds, but contribute to a larger pool that is distributed to those patients who fill prescriptions and take them as directed. Over 30% of Rx’s in the U.S. go unfilled. Presumably the drugs were prescribed for a purpose and the patients’ outcomes would improve and net costs reduced if people simply obtained and took their meds.

    The technology exists to track the prescription from the doctor’s office to the pharmacy and from there to track whether the patient ever picks up the prescription. Other technology exists to telemonitor whether the patient takes the medication in compliance with the doctor’s prescription regimen. Using this technology, we have developed “PharmaAlarmer” as a part of CareChange(TM). CareChange is a larger incentive program to encourage patients to take care of themselves, including following their medication regimen.

    Anyone interested in this project should feel free to contact me at We are particularly interested in attracting the participation of pharmaceutical companies in this innovation. It would improve patient care and improve outcomes, and even though it would increase pharmaceutical sales, studies show the net costs of patient care would be reduced by the improved outcomes. If interested, please be in touch.

    Have a great day!
    Charlie Bond

    • John R. Graham says:

      Thank you for this comment. I have never head anyone advocate that the federal government negotiate the price of everyone’s car, or house, or groceries. Nobody would take it seriously.

      Yet, we take it seriously for prescription drugs.

  5. Wanda J. Jones says:

    John and All–

    A thoughtful research team should tease out the various causes of high drug costs; that is one way to see where interventions could go to reduce those costs.

    Thre is one to consider: when the Human Genome Project was successfully completed, its leaders indicated that it would soon be possible to “dry fire” potential drugs in containers of genetic material standing in for actual humans. There were glad cries. But the FDA’s trial guidelines have not seemed to permit that.

    The main reason why the patients’ costs are enormous is that they are not cured of it, so have to take it only a few weeks or months, they are never well, so take it until they die. Example: HIV.

    Another pet peeve: Doctors are paid enormous sums to flack their pet drugs. Not to mention the enormous sums spent on TV advertising, each instances of which seems to focus on side effects.

    The FDA seems not to prioritize true cure; palliation is enough.


    Wanda Jones
    San Francisco.

    • John R. Graham says:

      Thank you. Let me disagree about TV ads. They all have regulated voice-overs and scrawls that disclose side effects as per the label.

      It is not realistic to expect the manufacturer to tout the side effects on par with the benefits. There is a lot of anti-pharma promotion out there, by unregulated sources exercising their free speech.