Why Do Medications Cost So Much?
This is not a simple answer, according to a recent Forbes article it may cost anywhere from $4-$12 billion to develop a drug. This accounts for all costs from pre-clinical, through phase 1-4, and finally FDA approval.
In a recent interview with Darshan Kulkarni we discussed five reasons why drugs cost approximately $1 million a day by conservative estimates, to create.
1.) Research and Development Costs. It costs $750,000 to $2.5 million a day over the span of 20 years for a drug to make it to approval. Imagine going to Vegas and constantly betting $1 million every day for 20 years blindly, without knowing whether you will ever win. This is what drug companies do every single day. Many of the costs accrue during the clinical trial process which encompasses phase 1-4 studies. I have discussed this at length in previous articles, but the main culprit for study delays are slow patient enrollment in about 90% of trials. Every single day that a clinical trial is delayed costs on average an extra $1 million to the drug company. 90% of clinical trials experience delays that last anywhere from 3 to 12 months in addition to what the projected trial lengths originally were. This translates into an extra $90 million-$365 million per trial per year that the drug companies need to absorb, and of course, pass on to the consumers.
2.) Lack of competition. In the video interview Darshan and I discuss patent rights and exclusivity. Patent rights are handled by the United States patent office and are good for 20 years. Exclusivity is issued by the FDA and lasts for six months to seven years depending on the type of drug that is being researched: is it a novel drug, a "me too" drug, or a drug for an orphan disease? All of these factor in to the FDA's exclusivity granting. Due to a lack of competition from the generic companies during this exclusivity period, drug companies can and need to recoup their losses and therefore increase prices while they are able to. The average rate of return on any drug is 4 to 15% per year. This may not sound like much but when a drug company is spending $4 billion, 4-15% is significant. During this exclusive window that the drug companies have to sell their drugs competition free, they need to make sure that they charge enough for their drugs to make just a 4 to 15% return
3.) Hedge fund pricing. Here we discuss the recent hedge fund pricing model where Wall Street hedge funds will acquire small market drugmakers that provide treatments to rare diseases and other underserved markets. Since these markets are so small there really is no incentive for competitors to enter these markets therefore many monopolies occur on specific medical conditions and the drugs that treat them. In the interview Darshan and I discuss Martin Shkreli and the criticism that he is currently facing for doing just this very thing after acquiring a generic drug company for a rare disease and raising the price of a pill from $11-$750. There is nothing illegal about this hedge fund pricing model, and there is quite a bit of an arbitrage opportunity available for any venture backed "drug company".
4.) Medicare. Medicare does not negotiate drug prices, private insurance companies do. There is however a stop clause with Medicare which states that they will pay the least amount that any private insurance company pays. Nevertheless 80% of all healthcare costs in the United States are funded by Medicare. This drives away competitive bidding and leads to higher drug costs.
5.) Drug shortage. In this video I did with Darshan back in 2012 we discussed the ramifications of the FDA's heightened manufacturing standards which essentially cost drug companies more money to improve their manufacturing facilities. Because of this, many drug companies either stopped making as many drugs (which led to an increase in price following simple supply and demand dynamics), or passed on these cost to the consumer by charging more for each pill.
It remains to be seen what the Trump administration will mean for drug prices going forward, and we will certainly keep abreast of the situation. Here is the interview with Darshan Kulkarni in it's entirety.