What does a new drug cost? Part II: The productivity problem

A few weeks ago I reviewed Ben Goldacre’s new book, Bad Pharma, an examination of the pharmaceutical industry, and more broadly, of the way new drugs are discovered, developed and brought to market. As I have noted before, despite the very different health systems that exist around the world, we all rely on private, for-profit, pharmaceutical companies to supply drug products and also to bring newer, better therapies to market. It’s great when there are lots of new drugs appearing, and they’re affordable for consumers and health systems. But that doesn’t seem to be the case. Pipelines seem to be drying up, and the cost of new drugs is climbing. Manufacturers refer to the costs of drug development when explaining high drug prices: New drugs are expensive, we’re told, because developing drugs is a risky, costly, time consuming endeavor. The high prices for new treatments are the price of innovative new treatments, both now and in the future. Research and development (R&D) costs are used to argue against strategies that could reduce company profitability (and presumably, future R&D), be it hospitals refusing to pay high drug costs, or changing patent laws that will determine when a generic drug will be marketed.

The overall costs of R&D are not the focus in Goldacre’s book, receiving only a short mention in the afterword, where he refers to the estimate of £500 million to bring a drug to market as “mythical and overstated.” He’s not alone in his skepticism. There’s a fair number of papers and analyses that have attempted to come up with a “true” estimate, and some authors argue the industry does not describe the true costs accurately or transparently enough to allow for objective evaluations. Some develop models independently, based on publicly available data. All models, however, must incorporate a range of assumptions that can influence the output. Over a year ago I reviewed at a study by Light and Warburton, entitled Demythologizing the high costs of pharmaceutical research, which estimated R&D costs at a tiny $43.4 million per drug – not £500 million, or the $1 billion you may see quoted.  Their estimates, however, were based on a sequence of highly implausible assumptions, meaning the “average” drug development costs are almost certainly higher in the real world. But how much higher isn’t clear. There have been at least eleven different studies published that estimate costs. Methods used range from direct data collection to aggregate industry estimates. Given the higher costs of new drugs, having an understanding of the drivers of development costs can help us understand just how efficiently this industry is performing. There are good reasons to be critical of the pharmaceutical industry. Are R&D costs one of them?

Is the low-hanging fruit gone?

A growing concern with the pharmaceutical industry is its overall productivity in delivering new drugs. There’s a relationship assumed between what what’s spent (R&D) and the number of new drugs that get approved. Ignoring the fact that quantity is a poor guide to quality, let’s look at the crude values: It does appear that the number of new drugs approved is dropping. Here’s a European snapshot [PDF]:

And FDA approvals show the same downward trend:



At the same time, the amount spent on R&D, both in Europe and the US, has steadily climbed during most of this period:

Here’s another view with a even longer timeframe, from a paper on R&D efficiency published in March 2012 in Nature Reviews Drug Discovery:

From: Diagnosing the decline in pharmaceutical R&D efficiency by Scannell et al.

The number of new drugs approved FDA per billion US dollars has halved about every 9 years. Remember Moore’s law, suggesting the number of transistors on integrated circuts doubles every 18 months? The authors of this paper introduce Eroom’s law – Moore spelled backwards:

Eroom’s Law indicates that powerful forces have outweighed scientific, technical and managerial improvements over the past 60 years, and/or that some of the improvements have been less ‘improving’ than commonly thought. The more positive anyone is about the past several decades of progress, the more negative they should be about the strength of countervailing forces. If someone is optimistic about the prospects for R&D today, they presumably believe the countervailing forces — whatever they are — are starting to abate, or that there has been a sudden and unprecedented acceleration in scientific, technological or managerial progress that will soon become visible in new drug approvals.

Spending is up, productivity down. The data suggest the decline is real, which may mean claims drugs are becoming more expensive to develop are real. Matthew Herper did some rough calculations earlier this year in Forbes using publicly available data. He pulled R&D spending for companies over 15 years, and divided that by the number of new drugs developed per company during that time. He estimated the costs per drug per company ranged from $4 billion to $11 billion. A crude estimate, yes, and one that doesn’t account for the time lag in developments. But as a rough yardstick, it suggests that the costs per approved drug are more likely to be measured in billions and not millions.

Let the finger pointing begin. Here’s where you’ll see the blame split – some say it’s a regulatory issue and a consequence of of FDA stringency, while others point to industry as engineering its own misfortune. Setting aside blame (for now), let’s look at the drivers and the productivity issue. There’s also a new R&D estimate out from the Office of Health Economics, a UK-based consultancy and research group. The paper, entitled The R&D Cost of a New Medicine, is the latest academic attempt to quantify the “average” cost of developing a new drug.. I’ll first note that this analysis was “partially funded by an unrestricted research grant” from AstraZeneca. Keeping that potential bias in mind, let’s start with their bottom line:

Published estimates of the mean (average) cost of researching and developing a successful new medicine suggest an increased over the last decade—from the estimate of US$802m by DiMasi et al (2003) at 2000 prices (US$1,031m at 2011 prices) to the estimate by Paul et al (2010) of US$1,867m at 2011 prices. In this study, we present a new estimate, US$1,506m (at 2011 prices), which lies within this range. Our analysis explores how these costs have been evolving and for what reasons.

First, a review. Drug development isn’t a sequential process. It only looks that way in hindsight when you have a successful drug. R&D  may be better thought of as maze, with countless dead ends. And in some cases, no solution at all. Given we can’t accurately forecast the future, drug development becomes a series of decisions under uncertainty: Looking at the evidence collected to date, estimating probabilities, and factoring in costs. Every potential new drug passes through countless “go/no go” decisions – first identifying molecules and biological pathways of interest, then developing potential compounds, and possibly testing them in increasingly rigorous studies that start in test tubes, proceed to animals, and ultimately may end up in human trials. This diagram shows the steps:

This complicated diagram illustrates the attrition risk, and the approximate time involved at each step. Importantly, what’s called “basic research” and then “discovery research” component is the “research” part of the R&D. What follows, through trials is actually considered the “development” component. The authors argue that there are four key variables that influence overall R&D cost estimates:

1. Out-of-Pocket Costs

These are the direct costs spent on trials, recognizing that not all trials make it all the way through all three phases. The most recent estimates suggest that mean costs now likely exceed $200 million for all three phases, and these costs have been increasing over time, up 600% since the 1970’s. The factors that can influence OOP costs include:

  • The cost of each patient (recruitment, treatment, etc.)
  • The number of patients in the trial.
  • The complexity of the trial, including its duration. Complexity could be driven by regulatory demands for better evidence, or simply treatment of more challenging conditions. For example, studying a treatment for urinary track infections, is quite a bit simpler than studying a drug that treats Alzheimer’s disease.
  • Where the trial is done. Outsourcing the trial to Asia is much cheaper than conducting studies in North America. As other costs rise, companies have been shifting

2. Success Rates

The first goal is finding a possible drug. This is an area where there’s a vast difference of opinion between those that work on drug development, and those that criticize it. (If you’re interested in the development perspective, Derek Lowe’s blog can’t be beat.) Assuming we’ve identified a potential drug (which can take years and years), we’ll move into clinical trials. Throughout the development process, cold calculations are applied to the results: Should development continue? The chance of proceeding past each phase was estimated based on literature that looked at different samples of drugs:

Passing Phase I: 49% to 75% of drug candidates move forward

Passing Phase II: 30% to 48% of remaining drug candidates move forward

Passing Phase III: 50% to 71% of remaining drug candidates will go on to

The authors refer to different estimates and conclude that rates have increased over time. Whether this is due to more stringent standards established by risk averse regulators, or because finding effective drugs is getting harder is difficult to say. Failure rates could also reflect more effective scrutiny by industry, killing off weaker drug candidates, earlier. As the costs of new drugs continues to be scrutinized, research termination could also include economic reasons. When we consider this trend in the context of missing or unpublished data, it would suggest that these may be overestimates of what the true success rates should be.  Based on this analysis, the authors estimate it takes between 4 and 14 drugs to enter phase I trial for a single drug to make it through to final registration.

3. Development Times

Based on estimates taken from other papers on development, the authors noted the time from phase I to phase III has been fairly consistent – about 6.5 years.  So if trials are getting more complicated, and the regulatory review is more intense, this hasn’t shown up in the past.  This is a positive sign, as longer development times delay potentially useful drugs but also eat into overall profits, given a fixed patent expiry date.

4. The Cost of Capital

The cost of capital enrages pharmaceutical industry critics, who don’t seem to understand that it’s a real cost. The cost of capital is the rate of return a company is expected to generate for its owners.  That is, if investors are making bets (and that’s essentially what this is) on the future payoff of a potential drugs, they need to factor in the revenue they could generate by investing elsewhere in a project of similar risk. It’s true that the cost of capital doesn’t reflect a cash outlay. It’s also true that R&D costs receive preferential tax treatment. However this only changes who ultimately covers the cost. Taking risks like the pharmaceutical industry does means massive bets, with payoffs that might stretch decades in the future, or might disappear suddenly if a safety or efficacy problem is identified in the future. These authors use a cost of capital of 11%, which sounds excessive considering what your bank account may be paying in interest, but may represent a fair estimate for pharma given investing in drug development looks riskier and riskier.

The Critics

As I’ve pointed out before, there are considerable criticisms of R&D estimates that have appeared in the literature. One outspoken critic is Marcia Angell, former editor of the New England Journal of Medicine who has argued that R&D costs are only a fraction of published estimates. Specific criticisms include the confidential nature of the data analyzed – the transparency issue again. Selection bias is also cited, suggesting that companies that have shared data may have only included more expensive drugs, and not drugs that represent slight variations of existing drugs (“me-toos”) which presumably are significantly less expensive to develop. She has also criticized using the cost of capital in these estimates. Other critics, like Merrill Goozner have argued that much of the development costs are borne by the public sector (i.e., NIH). He also points to the competitive nature of drug development which creates waste through duplicative effort at different companies. Other criticisms in the literature include the complexity of estimating the costs of drugs that are discovered by small companies, and then licensed to larger companies to complete the registration process. There are fair points in many of these criticisms. However, none do an adequate job of explaining the current state: fewer drugs approved, and higher costs incurred.

The New Estimate

For this new analysis the authors gathered data on costs from 97 development products provided by confidential surveys of pharmaceutical companies. They aggregated costs and then averaged costs for each component of research and development, estimating the overall probability of success of any single drug at 7%. The authors noted the average overall development timelines were 11.5 years. On balance, the estimated out-of-pocket costs were estimated at $899 million (2011 values). Factoring in time and cost of capital, this becomes an estimate of $1.5 billion. It’s a number within the range of other published estimates, and again, it suffers from a lack of transparency in some of the estimates it uses. Set against the industry-wide trends I noted above, this number fits into that range.


Criticism of the pharmaceutical industry is justified when it’s done for the right reasons. Being skeptical of R&D estimates is wise. Data on individual drugs is not transparent, and estimates must incorporate a number of assumptions which have the potential to bias the conclusions.  This lack of transparency fuel suspicion of the process. But we should also be equally skeptical of arguments that dismiss or diminish the growing problems with R&D. There is good evidence to suggest that drug development is a risky, expensive endeavor, and that this work is getting harder. There’s also good evidence to suggest that the productivity of this process is declining. As consumers, this may mean fewer new drugs, and higher per-drug costs. Finally, average drugs costs are just that – averages. They’re good for talking points, but don’t diagnose the problem. Is it possible to fix the productivity decline in the pharmaceutical industry? I’ll save that discussion for  a future post.

Posted in: Clinical Trials, Pharmaceuticals, Politics and Regulation

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20 thoughts on “What does a new drug cost? Part II: The productivity problem

  1. Janet says:

    Some of the newer drugs seem to be no more than serendipitous discoveries of beneficial side-effects. I was recently prescribed such a drug (eye drops) for dryness that only works for about a third of people. My insurance declined coverage and I can’t really say I disagree with them, although I would like to have tried it to see if I was one of the “lucky” users. I thought of paying myself, but the cost would be hundreds of dollars per month–for eyedrops that were found to help some people only because of reported side effects (at least that is what the ophthalmologist told me).

    I found, on balance, that I could manage with the OTC products. But if my insurance had paid, I would have been oblivious to the cost of this drug. I shudder to think what such ignorance does to medical costs. For the first time I have some sympathy for insurance companies (but not much). I realize there were costs involved in the development of the original drug, and that the drug company is trying to recoup some of that money, but still…

  2. windriven says:

    This is an interesting problem and likely to become increasingly vexing as time goes on. The high cost of developing and bringing a new drug to market incentivizes companies to spend most of their resources pursuing and promoting drugs that have the potential to be blockbusters. The other side of this coin is that absent the promise of substantial payoff, development of a drug is likely to be terminated early in the process. This does not bode well for the treatment of diseases that are neither true orphans nor widespread maladies.

  3. Jan Willem Nienhuys says:

    I find the figures confusing. For example

    For this new analysis the authors gathered data on costs from 97 development products … . On balance, the estimated out-of-pocket costs were estimated at $899 million (2011 values). Factoring in time and cost of capital, this becomes an estimate of $1.5 billion.

    What one wants to know is how much is spent on total R&D divided by the number of drugs that made it all the way through to approval. For each product that reaches Phase I in the picture hundreds or more probably thousands of compounds have been examined and tried out in vitro. Are the costs of that also included? And is the final estimate the sum total of all thas was spent on these 97 products together (8.4 million per product, which seems rather low), or is it the average cost, making total expenditure on getting these 97 products on the market equal to 87.2 billion (2011 values)?

    1. Scott Gavura says:

      @Jan: Here is a more detailed explanation from the paper:

      Given the time required to take one molecule through the entire R&D process, it has not been practical to follow a cohort of molecules from start to finish. Hence, the R&D process has been broken down into sequential intervals in order to analyse the data on projects active in each interval. A project with resource data for a successful completion of one interval may have been terminated in a subsequent interval.

      There was a decreasing number of observations in each interval, as would be expected. For each interval, they calculated the mean, median, max, min and Sdev for all drugs they had data on. They multiplied the mean cost in each interval times the number of compounds that historically had to make it into that interval in order for a single drug to make it to market. (ref: pg 34+)

  4. Jan Willem Nienhuys says:

    Oops, something went wrong with blockquote.

  5. cervantes says:

    It seems to me the most likely explanation for at least part of the decline in productivity is that the easy targets have already been hit. We learned a huge amount about biochemistry and cell biology and hormone and cytokine regulation, genetics, in the latter half of the 20th Century, and we’ve reaped benefits. But now we’re getting into much more complicated territory where discoveries are narrower and the complexity of systems makes intervention more perilous. No telling whether the trend will reverse — maybe some line of inquiry will open up a new cornucopia — but at least it appears to me that new molecular entities will have narrower targets.

    Look at cancer. We used to talk about “curing cancer” but now we know it’s a thousand different phenomena of genetic abnormalities. We’re finding effective new drugs, but they only work for a small number of people.

  6. windriven says:


    ” it appears to me that new molecular entities will have narrower targets. ”

    And this, I think, is part of the rub. Costs of development are high and getting higher. But the burgeoning cost of health care is bringing resistance to high priced therapies. When those factors collide with a small potential patient population a drug company is unlikely to make the investment.

  7. daedalus2u says:

    Don’t forget that because the drug industry is profit driven and has large upfront costs, it can’t work without monopoly power to prevent copying. If a potential drug cannot be patented and competition prevented, and monopoly pricing assured, then a drug cannot be a good investment.

    Because drug producers only make profit when they sell the drug, there is a large disincentive to restricting sales. This is why the largest use of antibiotics is in animal feed. Once an antibiotic becomes generic and anyone can produce and sell it, there is no incentive to not induce bacterial resistance to it.

    If the drug producer has higher priced non-generic drugs that are effective, the continued effectiveness of a generic competitor hurts sales and profits. When an antibiotic goes off patent, the plant that produces it has already been paid for and can produce it very cheaply. Because it is now generic it will never produce high blockbuster profits. It makes good business sense to “kill” the now generic drug by having widespread resistance so that different higher priced (and higher profit) antibiotics must be used instead.

    Don’t blame the pharmaceutical companies that do this, they are only acting rationally given the incentives that the laws and the marketplace produce.

  8. Scott says:

    Lots of problems, definitely. But no really evident way to make it any better. If I might bastardize some Churchill, “Big Pharma is the worst way to produce new medications, except all the others which have been tried.”

  9. Harriet Hall says:

    An e-mail correspondent said the medical system is flawed and tarnished by greed. Yes, it is. But the diet supplement industry and CAM in general are even more flawed and tarnished. Why reject a flawed system only to replace it with one that is even more flawed?

  10. windriven says:

    “An e-mail correspondent said the medical system is flawed and tarnished by greed.”

    As opposed to the financial services industry. Or, for that matter, politics. Neither whining about the tawdry greed nor minimizing it by comparison with the even tawdrier resolves the problem.

    Picking up on Daedalus':”Don’t blame the pharmaceutical companies that do this, they are only acting rationally given the incentives that the laws and the marketplace produce,” one is forced to wonder whether the purely capitalist model* is the best model for pharmaceuticals.

    In 2010 prescription drugs accounted for 10% of total US health care spending** and was growing at a much slower rate than any other category. Hospital care accounted for 31% of spending and physician services for a bit under 20%.

    *Suggesting that pharmaceuticals currently follow a purely capitalist model is probably misleading. A good deal of research is funded with federal dollars. Further, pharmaceuticals operate in a highly regulated environment that further distorts normal marketplace relationships.


  11. @Dr. Hall: Someone made the same argument to me on Facebook. But if we are going to talk about medicine and CAMs in terms of profit motive, that is to say in the rhetoric of free market economics, then CAMs are just as suspect and capitalistic as medicine (my interlocutors were discussing medicine in the context of capitalism). Even without taking science into consideration, I would much rather side with medicine (done well) than with CAMs. Medicine is heavily regulated. Those regulations tend to be consistent in developed countries. And medicine is also governed by a consistent code of deontology. CAMs are not.

    Okay, I feel I keep repeating the same things over and over again…

  12. Angora Rabbit says:

    I worked for Upjohn in R&D for awhile. There I learned that over a third of drug candidates die early in the pipeline due to cardiac effects, as tested in myocyte cell lines. If exposure produces changes in contractility or other issues, then further development is terminated. The potential risk of taking such a drug into humans, even if it turns out to be an artifact, is something that companies simply don’t wish to risk, for good or bad. I do think that risk-aversion is huge in the industry, and this drives up costs simply because of the number of leads that fall by the wayside.

    For awhile we had “targeted drug design” and the idea that advances in protein structure analysis would accelerate drug discovery. A strategy now known as “methyl, ethyl, butyl, futile.”

    It’s a real problem. I’m so glad I took the permanent job in academia instead of pharmaceuticals. It was easier to get tenure than to stay employed in pharma. Saw too many leads get canned, along with the teams who developed them. Upon reflection, perhaps this is another problem with the field – lack of long-term investment in the scientists who develop the drugs.

  13. daedalus2u says:

    The classic way to deal with monopoly power is through regulation. Drug manufacturers need to have monopoly power to justify investment in R&D, that monopoly power needs to be more effectively regulated on both ends.

    Electric utilities are regulated monopolies. There isn’t any new technology (essentially) in bulk power generation that utilities develop. Equipment suppliers may develop new technology and new equipment, but utilities themselves don’t.

    I think the problem is mainly a US problem. The US is something like 40% of the world market for drugs. A lot of the reason for that is the extremely expensive US health care system where Medicare doesn’t negotiate reduced prices for drugs (by law). The big drug companies tolerate the byzantine FDA regulations because they are an effective barrier to entry.

    I think it is similar to US military procurement. The US spends about half the worlds total military budget. You could use the same type of system for drug discovery and production. The advantage of a government owned and controlled drug discovery and development system is that once drugs are found that work, there wouldn’t be the incentive to over sell them and then make them obsolete. The problem with government sponsored and controlled R&D is that congress will want to micromanage it based on what lobbyists tell them and who their donors are. That is the problem that NASA has. They are micromanaged by Congress, and then the NASA managers micromanage people down the food chain.

    The way to deal with that is with competition, but raw competition allows for gaming the system. Not following FDA regulations is an example of gaming the system. Billion dollar fines are not enough to prevent pharma companies from gaming the system. People have to go to jail, otherwise it is just a cost of doing business.

    Pass laws that if FDA regulations are not followed, and people are harmed, the senior management of the company gets charged with criminal violations, assault, manslaughter, wrongful death. But then, management one step below where criminal liability stops will game the system.

  14. windriven says:

    Daedalus said, “Pass laws that if FDA regulations are not followed, and people are harmed, the senior management of the company gets charged with criminal violations…”

    I enthusiastically agree. But it seems unlikely that Congress will.

    The financial services industry drove the world economy to the brink of collapse yet there have been essentially zero successful criminal prosecutions. Even Jon Corzine who presided over the recent collapse of MF Global and the loss of billions in supposedly sequestered investor funds is contemplating a return to political office rather than a long stretch in a federal penitentiary. This says far more about the power of Wall Street to shape legislation that fits its desires than the lack of culpability of the ‘lords of the universe’.

    A Congress that is scientifically illiterate and easily swayed by any group with a fat checkbook and a table at the Old Ebbitt Grill is unlikely to pen legislation that will jail their benefactors.

    But continuing with Daedalus’ argument favoring a public hand in pharmaceuticals, it wouldn’t be too difficult to set up a not-for-profit manufacturing operation (or even a GSE) for drugs that are off patent, then expand that to include new drug discoveries coming out of government-funded research.

  15. shawmutt says:

    I also ponder Jan’s question. Are the costs being averaged out or are they talking about a single product?

    I work in biotech, and if I didn’t see the financials I’d have a hard time believing how much money we burn through for R&D and then manufacturing any approved projects. For example, the amount and cost of water to make biotech products is inconceivable to the average Joe. I’m not sure there are many businesses that can survive burning through so much money. If our profit wasn’t so high we wouldn’t even be able to produce the products that are approved. Most biotechs in this area fold–it’s rare to find that flagship drug that finances all future endeavors.

    My company has many products in the pipeline, but many of those products won’t make it past clinical. We might get one or two products out of hundreds. However, for a drug to get to market, we still need to manufacture the products for clinical trials with all the cost that entails. Nothing sucks more than to get a drug all the way to phase 3 and have an issue with the product. That’s many many hours of work literally down the drain.

  16. Tom S says:

    It is so, so easy to confuse the question “How much does it cost to develop a drug?” with the similar question “how much did it cost to devlop THIS drug?” The latter is fairly easy to answer–it is the total that was spent to get THIS drug to market. It even might be used to justify the cost of THIS drug to the patient.

    The first question invites folks to include the costs of failures, etc. That cost can be a bottomless pit, and is very poorly defined. It is tempting just to put the R&D budget in there. That might give you the cost to develop an “average” drug (whatever that is), but its relevance is not immediately apparent.

  17. Jan Willem Nienhuys says:

    a more detailed explanation from the paper

    But what does the 899 million dollar stand for? Estimated average total R&D costs (including those of all dead ends) per marketed product?

    The phrase

    On balance, the estimated out-of-pocket costs were estimated at $899 million (2011 values).

    is simply not clear enough to me, even though in the two previous sentences the words ‘single drug’ and ‘average ‘ occur.

    Assuming this figure to be indeed per marketed product, one can imagine the annoyance of a pharmaceutical company when someone comes along and blames them for the high price of a product that can be easily synthesized.

    I don’t quite understand how 0.9 billion becomes 1.5 billion. I seems to rely on roughly the following argument: A pharmaceutical company A spends 0.9 billion cash with as result just 1 marketed product. The management wants to know how much money they (i.e. the management) would have had if they hadn’t spent it on their own research. Of course they wouldn’t have put all the cash in some kind of vault, but they would have invested it, for example in buying stocks of pharmaceutical company B* (which is spending money in actual research). So the 1.5 billion represents a share of the company’s value based on how the public (the stock buying public) perceives the future earning capacity of the company based on their track record, or maybe of an average pharma company. This future earning capacity is partly based on the prices the company can ask for their new products. Actually the amount spent on PR is probably much more, and all this spending on PR is ultimately paid for by the consumers.

    Somehow it doesn’t seem fair to mark this extra 0.6 billion as R&D costs. The 1.5 billion is the amount by which a company’s total value on the stockmarket increases (annual dividends included) which can be assigned to their R&D effort if you use a proportional** method of assignment. Spend 0.9 billion to increase your value to 1.5 billion. If it’s true then medicines are overpriced. A hefty amount of each new drug’s price is (A) for the cost of getting the patient to use it and (B) for satisfying the monetary desires of the shareholders.

    I don’t claim any originality for the above. It is just my rendering of a part of Ben Goldacre’s Bad Pharma.

    * Maybe the management thinks about investing in some other lucrative business such as Enron or subprime mortgages, but let’s not assume that.

    ** But why should you? If a company spends 1 billion in R&D and 2 billion in PR, and 3 billion in other costs why should the increase in a company’s worth be allotted in a ratio of 1:2:3 to each of these? Why do any allotting at all?

  18. fledarmus1 says:

    @Jan Willem Nienhuys and the cost of money:

    I think you are looking at two different questions when you are comparing 0.9 billion to 1.5 billion for research costs. It is rather like looking at housing – are you asking the question “how much does a house cost”, or the question “how much does a family have to pay for housing if they buy a house?” The first question you can answer simply by looking at the real estate section of the local newspaper; the second question requires you to consider the cost of a mortgage with interest and upfront costs, upkeep on the house, insurance, taxes, requirements to comply with housing codes or any homeowner associations, and so on. The question of how much the homeowner gets when he sells the house is also pretty much fixed at the selling price. How much profit he makes from buying to selling the house, however, depends very much on how you calculate how much he paid for the house – do you include just the buying cost, or do you include all the maney that was put into the house, while trying to subtract the money he would have spent on housing if he didn’t own a house? And which costs get included?

    Likewise, it is fairly easy to calculate how much money a company makes from selling a drug; just look at prices and volumes. Trying to decide which costs should be included when you are trying to calculate how much the company spent to make the drug is much more difficult. The money that gets spent upfront to develop a product is not cheap, especially when it has to be spent so many years before the success of the project will become obvious.

  19. Jan Willem Nienhuys says:


    My remarks also apply to the following:

    That is, if investors are making bets (and that’s essentially what this is) on the future payoff of a potential drugs, they need to factor in the revenue they could generate by investing elsewhere in a project of similar risk. …. These authors use a cost of capital of 11%, which sounds excessive considering what your bank account may be paying in interest, but may represent a fair estimate for pharma given investing in drug development looks riskier and riskier.

    (my emphasis)

    The 11% interest sounds plausible, because when the expenditures for a single drug are increasing (a full scale Phase III trial is more expensive than lab tests) then the overall result of investing the same amounts in the given 11.5 year may yield a final amount that is 65% higher than the total of the cash invested. I maintain that this a strange way of computing, because instead of investing elsewhere in drug development they could also invest in themselves, namely by paying for their own research – which is what they actually do – and then the investment’s yield is a function of the money earned by one’s own research. The money earned is payed as dividend to the shareholders, and together with the current interest rate and the prospects of the company this in its turn determines the market value of the shares.

    I am not an economist, but counting the revenue of what you invest in your own business as expenses seems seriously wrong. The comparison with a house and a mortgage is faulty. A house is not a means of production, and pharmaceutical companies don’t have to borrow money for their research. They pay for their research (and their PR and their production facilities) with the money they earn from those activities.

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