A Difficult Time
My Journey in Medicine	by Jerry Sobieraj, MD © 2001
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Chapter 8: Drug Companies

The cost of bringing a drug to market has often been quoted as $500 million. The $500 million figure came from a 1991 study by Joseph DiMasi of the Tufts Center for the Study of Drug Development which included every conceivable cost that could be attached to drug development. This skewed the figure upward, because much of the research and development (R&D) done by drug companies was not expensive, per se. In addition, the $500 million figure was inflated by including lost income. This was income the drug companies claimed they would have earned had their R&D money been invested in Wall Street instead. Even when the drug companies did R&D, their cost for a winner (i.e. a drug that lead to enormous profits) could be a down right bargain. On July 23, 2001, the $500 million figure was challenged in a detailed and well documented analysis by Public Citizen. Their analysis supported a cost of $110 million for a drug company to bring a new drug to market.

An example of an inexpensive, but potentially financially rewarding drug development scheme involves the common phenomenon of making a copycat drug (referred to as a "me-too" drug in the Public Citizen report). When a successful drug had been brought to market for a novel indication (e.g. a drug to treat adult onset diabetes by making a patient’s own insulin work better), the company who manufactured and supplied this drug would strike it rich. Since this type of drug therapy didn't previously exist, the new drug would have this niche all to itself. If it generated a lot of revenue, other drug companies would begin to focus their development on making a copycat drug. This copycat drug would be of similar structure and would work by the same mechanism as the original drug. Thus, this would be a relatively easy task, since the new drug’s structure had already been published (in the medical literature and/or the patent application). An experienced organic chemist could study the structure of the original drug, and have a good idea how to modify it so that another drug like it would be sufficiently different to be patented, but still work in a manner similar to the original, novel drug. This process which netted significant revenue for all the major drug companies couldn't cost $500 million per drug; not even close.

In addition, modern molecular biology has simplified the screening and development of new drugs. At least once a month, I would read in Science magazine, a study published by a drug company which presented a new way to devise and/or screen for a new drug with a novel and likely very beneficial mechanism of action. Generally, I would read the details as to how they achieved their success, so I could get an idea of the cost involved. Using these state of the art techniques, I rarely could project even $1 million in development costs. Such studies were preliminary, and the cost of getting a novel drug through clinical trials would cost millions. Yet, we would be talking about tens of millions to get there, not hundreds.

Finally, using modern day computing power and structural analysis of cellular receptors, drug companies could make excellent guesses about which chemical structures would be most likely to be successful. During the 1980s, when the cost data was generated to support the $500 million drug development figure, drug companies still used methods similar to those devised at the turn of the 19th century by German alchemists. Today, a drug company can get the published genetic sequence of a receptor and use a program to predict its structure, or even better, get an actual study showing the molecular structure of the receptor (often paid for with federal research funds). From this information, they could then guess which chemical groups would likely interact with this receptor, and do virtual testing on a computer before they would synthesize a single compound. They would still ultimately have to do bench top research to make the product, but substantially less research. As a result, the process has become less expensive, not more expensive.

You might ask yourself, why then are drugs so expensive? I have maintained that it is due to a need by drug companies to maintain stock value, and thus, sustain a particular level of return for the shareholder. Since all drug companies are in the same boat, they haven’t undercut each other in price. As a result, the minor differences in price that competing drug companies charged had failed to lower appreciably the costs of medications. These practices sustain the revenues generated by those same drugs for the major pharmaceutical companies, and thereby, maintain their stock value. It might be easier to understand these factors, by looking at a specific example.

A new drug developed by drug company X would have a novel indication. Drug company X would enjoy no competition in the market for a year or two, until the first copycat drug came out by company Y. If drug company X needed to charge a patient $140 a month for their novel drug in order to cover costs, why did drug company Y need to charge $135? After all, the actual cost to company Y of making their copycat drug would have been substantially less than that of drug company X. In addition, drug company Y would want to get a significant market share with their new drug. This would not be any easy task, as once doctors became familiar with the novel drug of company X, they would be loathe to try the newer one due to the need to learn a new dosing schedule, potentially new side effects, etc. To counteract this barrier, why wouldn’t drug company Y charge $70 (i.e. substantially undercut the competitor)? Drug company Y could still have made a handsome profit, developed a large market share, and would have had soaring sales, as it was likely all insurance companies would require doctors to prescribe the cheaper copycat drug. The insurance companies would assume the copy cat drug worked as well as the original product from drug company X, but cost them significantly less.

Competitive pricing has occurred in most other industries. During the Christmas season in 2000, I saw many copycats of the Razor® scooter. They weren't 5% cheaper than a Razor®, they were 50% cheaper. The drug example above used a 3% difference, which in my experience, was typical in the drug industry, not the 50% decrease, which was the type of behavior taught in business school.

In fact, I have never seen such discount pricing occur in the pharmaceutical industry during my 20 years in Medicine, and I would be surprised to see data to the contrary. In addition, I could generate countless examples of drug pricing similar to the one above. I would argue that drug company Y didn't undercut the drug price of company X because company X would have retaliated by lowering the cost of a drug of another class that competed with a company Y drug. This would have resulted in real price wars, and thus, the revenues of all drug companies would have plummeted. As revenues fell, stock prices would fall, and who would benefit then? Well, just about everyone who used a prescription medication. Who benefited by the current pricing system? Only the drug companies and their share holders did (look at major drug company stock prices in the 1990s). The anti-competitive pricing practices of pharmaceutical companies were unlike anything I had ever seen in any other industry. Airline companies were constantly having to defend against price fixing complaints. Yet their pricing practices were on a scale that paled in comparison with that done by drug companies.

We have permitted the pharmaceutical industry to hide behind third party payers, as most people who use expensive medications don’t directly pay for them. In addition, when I served on the Pharmacy Committee of the academic medical center where I worked, I learned about rebates that the health insurance companies received from drug companies. The rebates were given in exchange for inclusion in an insurance company’s drug formulary. A formulary refers to a specified listing of medications used by an institution (e.g. hospital, clinic or insurance company) to limit the choices of medication available from a particular class of medication (e.g. having only two of nine cholesterol lowering medications available). Formularies were first used for valid reasons by hospitals, who would make reasoned attempts to use cost effective and safe drugs. Insurance companies attempted to do the same, but the process has become so distorted by rebates, that it often made no sense to a physician why the insurance company selected a particular drug as their preferred agent for a specific condition. I often read reviews of new medications in the "Medical Letter" (a newsletter about medications, new and old, which includes their uses and costs). The "Medical Letter" generally lists the average wholesale price (AWP) of a 30 day supply of a common dosage of a drug they review. However, these prices were meaningless when I tried to decide what was cost effective for my patients. My patients’ insurance company defined their formulary selections based on their cost, which could be substantially altered by rebates (some insurance companies would receive rebates totaling tens of millions of dollars per year from pharmaceutical companies). Even if the wholesale price of a drug I prescribed was less than the insurance company’s formulary choice, my patient might incur a higher copay because I was prescribing a non-formulary medication.

Thus, the drug formularies of insurance companies only complicated the practice of Medicine. In addition, they effectively took prescribing decisions out of the hands of physicians. Every year I would get a new formulary from each insurance company for which I was a provider (about a dozen). They each sent me a letter telling me how important it was that I read the formulary and prescribed according to it. Frankly, I didn't have time to indulge their corrupt practices. I prescribed what worked for my patients, taking into account efficacy, side effects and other drugs they were taking. The only practical way to define a drug as cost effective was to use the AWP. I didn't have time to memorize the choices made by each insurer, nor did I have time to match each patient’s insurance to the associated formulary book. When a health insurance company considered my prescription for a non-formulary drug sufficient to warrant a letter, I would answer them. Yet, to follow their formulary guide as though it were a bible, when it changed from year to year depending on whether the rebate they were offered from a drug company was sufficient to have their products listed on the insurance's formulary made no sense to me. A drug which the insurance company considered taboo one year could be in vogue the subsequent year.

A recent example of this phenomenon has occurred with the cholesterol lowering medication class referred to as statins. In 1997, Zocor was clearly the most effective agent. I felt it was arrogantly priced by Merck as the most expensive in its class, despite its newness to the market (generally the new drug on the block is priced slightly less to try and gain market share). When Lipitor came out in 1998, Merck dropped the price of Zocor just below that of Lipitor. They then rebated their way on to most insurance company formularies. Despite a newer more effective agent being available (Lipitor), I was required to prescribe Zocor for many of my patients. This year (2001) it has all changed. Now, many of these same insurance companies have been asking me to change my patients taking Zocor to Lipitor. Didn’t they think I had anything better to do than play their formulary games?

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