Here’s Why Rx Drugs Cost So Damn Much

by Darwin on December 5, 2010

Pharmaceuticals are expensive, no doubt.  And for full disclosure, I work for a BioPharma.  I’m not a shill for the industry and I do concede to many of the arguments people make against the industry.  I agree industry practically creates new diseases, markets the heck out of them and then (incentivized) doctors are complicit in over-prescribing many medications when basic sleep, diet and exercise account for the vast majority of maladies (at least in America) people face.  That being said, there is great need for Rx medications nonetheless since most Americans simply don’t take care of themselves and they are very expensive – this is necessary to spur innovation. One big gripe is that drugs sell for different prices in different countries – with the most expensive being the US (Japan is up there too).  People seem to ignore that GM and Microsoft sell their products in other countries for less money as well while they blast the industry for selling drugs here for more money.  You think someone in China’s paying the same cost as an American for the same car?  But I digress.  Without focusing on cost spreads across countries, why do drugs cost so much in general?

This week was just another announcement out of dozens I’ve seen this year where large pharmas had to write off a failed drug to the tune of a Hundreds of Millions of dollars and in this case, I suspect it will exceed $1 Billion when the acquisition cost and the clinical trial and development costs are factored in.  That’s a heck of a lot of money even for a large pharma.  According to the latest dropped drug study, Glaxo had purchased Sirtris as well as its drug programs in the hopes of turning the franchise into a fountain of youth of sorts.  See, resveratrol is the “red wine” drug you may have heard something about which was supposed to have curing properties and extend life (as it does in mice).  I wrote about it in depth when Glaxo initially started working on it.  I also warned that the supplements you see on the shelves and on the internet are scams (resveratrol scams).  Only a large scale clinically controlled trial could actually show if it would work – and it didn’t.  So, while supplement companies can sell basically, crap, with no proof that what they’re selling is either SAFE or EFFECTIVE (ironically, while criticizing RX regulated medications), regulated pharmas have to actually prove their drugs work – as they should.  This comes at incredible cost though.

A Risky, Unpredictable Cycle

But going back to the business of failure, this is commonplace in industry, where a company spends upwards of $1 Billion trying to develop a new drug only to have it fail.  This happens several times per year for the large pharmas.  How do you think a company can sustain itself facing constant Billion dollar failures? It’s a very high risk business, so successful candidates have to make up the difference.  It’s quite simple really.  The simpletons that yell “drugs should be given away”, “drugs should be sold at cost” are really quite naive.  Who’s going to develop the drugs and who’s going to find the next one?  Some claim government and universities but they’ve never been able to efficiently commercialize and develop drugs any better.  And people only tend to point out the drugs that DID make it that were developed by government and universities, but not the thousands that failed.  As with virtually everything, it takes private investment (private risk) to optimize outcomes.

Profit Motive Drives Innovation

This is most basic, yet proven concept of life on earth.  People are driven by incentives.  So are businesses.  If a company is forced into a low margin business through regulation, market changes, litigation or whatever means, they will exit the business.  Because there is a profit motive in the biotech and pharma industry, new drugs continue to be pursued and commercialized.  Want the next cure for Alzheimer’s?  Hep C?  The common cold?  Without the potential to generate a profit, why would any company exert the resources and risk required to research and commercialize these entities? The government isn’t gonna do it and universities aren’t gonna do it – they don’t have the resources, the expertise or the risk capital to do it – only private industry does.  It’s the way things have always worked and as long as the ideologues don’t get their way, it’s the way they always will.

For those unfamiliar with the business, I hope this provides at least a little insight into why companies have to sell their SUCCESSFUL medicines at a hefty profit margin – to recoup the massive losses on their other attempts.   Should you believe political hype that the profits are outrageous and pharma are making a killing, the equity returns should pretty much say it all, right?  Pharma returns don’t differ much from the general market over virtually all timeframes in the past decade, so obviously the profits aren’t disconnected from reality – or the typical US stock.  Maybe we should get out the pitchforks and set price controls on Apple products and Chipotle’s Burritos, right?  I mean those stocks have more than tripled since March 2009.  My point is that like any business and any political message, take a look at what the markets are telling you and you can probably discern the truth rather quickly.

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{ 2 comments… read them below or add one }

Investor Junkie December 6, 2010 at 10:43 am

Couldn’t it be said that the FDA also causes drugs to be so expensive? Because of all of the legal red tape, requirements, and testing?

Why are some drugs sold in other countries cheaper than in the US?


Money Reasons December 6, 2010 at 7:23 pm

Yep, the cost of the drugs are a necessary evil! If the pharma companies can’t do R & D, we don’t get great new drugs!


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