Joseph A' DiMasi, Ph'D'

1
The Economics of Pharmaceutical Innovation
Costs, Risks, and Returns

• Joseph A. DiMasi, Ph.D.
• Director of Economic Analysis
• Tufts Center for the Study of Drug Development
• BioStrategy Seminar Series
• MIT Sloan School of Management, December 4, 2003

2
Productivity Declines in the Drug Industry

• In 1960 the trade press of the U.S. drug
  industry began to refer to the last few years as
  constituting a research gap, commenting that
  the flow of important new drug discoveries has
  for some inexplicable reason diminished.

Source U.S. Senate, Report of the Subcommittee
on Antitrust and Monopoly, 87th Congress, 1st
Session, Study of Administered Prices in the
Drug Industry, June 27, 1961, p.136
3
Presentation Topics

• The length of the new drug development process
• Risks in new drug development
• RD costs per approved new drug
• Rates of return to new drug development
• Impact on cost from improvements in the
  development process

4
Mean Time from Synthesis to NDA Approval,
1963-1999
14.1
14.2
11.6
8.1
Source DiMasi, Clin Pharmacol Ther,
200169(5)286-96
5
Mean Development and Approval Timesby
Therapeutic Category, 1990-1999
16.2
14.3
14.3
14.2
13.7
12.3
Source DiMasi, Clin Pharmacol Ther,
200169(5)286-96
6
Biopharmaceuticals vs. Drugs Mean Clinical
Development and Approval Time
Years
Source Tufts CSDD, 2002
7
Phase Transition Probabilities for
Investigational Drugs
Source DiMasi et al., J Health Economics
200322(2)151-185
8
Reasons for Terminating Clinical Development by
IND Filing Period
Source DiMasi, Clin Pharmacol Ther,
200169(5)297-307
9
U.S. Pharmaceutical Industry Inflation-Adjusted
RD Expenditures and NCE Approvals, 1963-2002
Source Tufts CSDD Approved NCE Database PhRMA
10
Opportunity Cost for Investments

• Consider two investment projects, A and B
• Both projects require the same out-of-pocket
  expenditure (say, 400 million)
• However, returns to A are realized immediately,
  but investors must wait 10 years before returns
  to B are realized
• Rational investors would conclude that B is
  effectively much costlier than A

11
Out-of-Pocket and Capitalized Costsper Approved
Drug
Source DiMasi et al., J Health Economics
200322(2)151-185
12
Pre-approval and Post-approvalRD Costs per
Approved Drug
Source DiMasi et al., J Health Economics
200322(2)151-185
Tufts University
13
Trends in Fully Allocated Capitalized Cost per
Approved Drug
Source DiMasi et al., J Health Economics
200322(2)151-185
14
Compound Annual Growth Ratesfor Out-of-Pocket
RD Costs
Source DiMasi et al., J Health Economics
200322(2)151-185
15
Compound Annual Growth Ratesfor Capitalized RD
Costs
Source DiMasi et al., J Health Economics
200322(2)151-185
16
Mean Number of Subjects in NDAs for NMEs
Sources Boston Consulting Group, 1993 Peck,
Food and Drug Law J, 1997 PAREXEL, 2002
17
Clinical Trial Complexity Index (Phases I-III)
Source DataEdge, 2002
18
Summary for RD Costs

• RD costs have grown substantially, even in
  inflation-adjusted terms
• The growth rate for discovery and preclinical
  development costs has decreased substantially
• Conversely, clinical costs have grown at a much
  more rapid rate
• New discovery and development technologies (e.g.,
  genomics) hold the promise of lower costs in the
  long-run (but perhaps higher costs in the
  short-run)

19
Summary for RD Costs (cont.)

• Evidence and conjectures regarding factors
  affecting growth in clinical costs
• More clinical trial subjects
• Increased complexity more procedures per patient
• Patient recruitment and retention
• Treatments associated with chronic and
  degenerative diseases
• Testing against comparator drugs

20
Measuring Profitability in the Pharmaceutical
Industry

• Biases in accounting rates of return
• Sales over the product life-cycle
• Variability in returns
• Economic rates of return

21
Profits as a Percentage of Assets, 2002Top 7 of
Fortune 500 Industries
Source Fortune Magazine, April 14, 2003
22
Absolute and Relative Bias in Accounting Rates of
Return

• Accountants must follow GAAP and expense, rather
  than depreciate, most intangible capital
• Reported assets will therefore not include
  intangible capital like RD and promotion
• Both numerator and denominator will be
  understated, but under plausible assumptions
  about RD growth rates the profit ratio will be
  biased upward
• An industry like the drug industry will appear
  relatively more profitable than it really is
• We need to examine true economic rates of return

23
Mean World-Wide Sales Over the ProductLife Cycle
for New Drug Cohorts
Source Grabowski et al., PharmacoEconomics 2002
20(Suppl 3)11-29
24
Present Values of Net Sales and RD Costfor New
Drugs by Sales Decile (millions of 2000 )
Source Grabowski et al., PharmacoEconomics 2002
20(Suppl 3)11-29
25
Mean Industry Returns and Cost-of-Capital for New
Drug Development
Source Grabowski et al., PharmacoEconomics 2002
20(Suppl 3)11-29
26
Technical Productivity by Companyfor
Investigational NCEs
INDs first filed 1980-1989
Source DiMasi, Drug Information Journal 2000
34(4)1169-94
27
Technical and Commercial Productivity by Company
for Investigational NCEs
INDs first filed 1980-1989
Source DiMasi, Drug Information Journal 2000
34(4)1169-94
28
Cost Reductions from Higher Clinical Success Rates
Source DiMasi, PharmacoEconomics 2002 20(Suppl
3)1-10
29
Cost Reductions from Simultaneous Percentage
Decreases in All Phase Lengths
Source DiMasi, PharmacoEconomics 2002 20(Suppl
3)1-10
30
Constant Dollar Reductions in Total Cost per New
Drug
Source DiMasi, PharmacoEconomics 2002 20(Suppl
3)1-10
31
Conclusions

• Drug development has been and still is costly,
  risky, and lengthy
• RD costs have increased, but so have the returns
  to successful projects
• Pharmaceutical innovation is a highly uncertain
  process, even for highly diversified large firms
• The payoffs for improvements in the process are
  significant