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Well, GlaxoSmithKline (GSK) CEO Andrew Witty has made things interesting. Here he is at a recent conference in London when the topic of drug pricing came up:

Witty said the $1 billion price tag was "one of the great myths of the industry", since it was an average figure that includes money spent on drugs that ultimately fail. In the case of GSK, a major revamp in the way research is conducted means the rate of return on R&D investment has increased by about 30 percent in the past three or four years because fewer drugs have flopped in late-stage testing, he said."If you stop failing so often you massively reduce the cost of drug development ... it's why we are beginning to be able to price lower," Witty said. "It's entirely achievable that we can improve the efficiency of the industry and pass that forward in terms of reduced prices."

I have a feeling that I'm going to be hearing "great myths of the industry" in my email for some time, thanks to this speech, so I'd like to thank Andrew Witty for that. But here's what he's trying to get across: if you start research on for a new drug, name a clinical candidate, take it to human trials and are lucky enough to have it work, then get it approved by the FDA, you will not have spent one billion dollars to get there. That, though, is the figure for a single run-through when everything works. If, on the other hand, you are actually running a drug company, with many compounds in development, and after a decade or so you total up all the money you've spent, versus the number of drugs you got onto the market, well, then you may well average a billion dollars per drug. That's because so many of them wipe out in the clinic; the money gets spent and you get no return at all.

That's the analysis that Matthew Herper did here (blogged about here), and that same Reuters article makes reference to a similar study done by Deloitte (and Thomson Reuters!) that found that the average cost of a new drug is indeed about $1.1 billion when you have to pay for the failures.

And believe me, we have to pay for them. A lottery ticket may only cost a dollar, but by the time you've won a million dollars playing the lottery, you will have bought a lot of losing tickets. In fact, you'll have bought far more than a million dollar's worth, or no state would run a lottery, but that's a negative-expectations game, while drug research (like any business) is supposed to be positive-expectations. Is it? Just barely, according to that same Deloitte study:

In effect, the industry is treading water in the fight to deliver better returns on the billions of dollars ploughed into the hunt for new drugs each year.

With an average internal rate of return (IRR) from R&D in 2012 of 7.2 percent - against 7.7 percent and 10.5 percent in the two preceding years - Big Pharma is barely covering its average cost of capital, estimated at around 7 percent.

Keep that in mind next time you hear about how wonderfully profitable the drug business is. And those are still better numbers than Morgan Stanley had a couple of years before, when they estimated that our internal returns probably weren't keeping up with our cost of capital at all. (Mind you, it seems that their analysis may have been a bit off, since they used their figures to recommend an "Overweight" on AstraZeneca shares, a decision that looked smart for a few months, but one that a person by now would have regretted deeply).

But back to Andrew Witty. What he's trying to say is that it doesn't have to cost a billion dollars per drug, if you don't fail so often, and he's claiming that GSK is starting to fail less often. True, or not? The people I know at the company aren't exactly breaking out the party hats, for what that's worth, and it looks like the company's might have to add the entire Sirtris investment to the "sunk cost" pile. Overall, I think it's too soon to call any corners as having been turned, even if GSK does turn out to have been doing better. Companies can have runs of good fortune and bad, and the history of the industry is absolutely littered with the press releases of companies who say that they've Turned A New Page of Success and will now be cranking out the wonder drugs like nobody's business. If they keep it up, GSK will have plenty of chances to tell us all about it.

Now, one last topic. What about Witty's statement that this new trend to success will allow drug prices themselves to come down? That's worth thinking about all by itself, on several levels - here are my thoughts, in no particular order:

(1) To a first approximation, that's true. If you're selling widgets, your costs go down, you can cut prices, and you can presumably sell more widgets. But as mentioned above, I'm not yet convinced that GSK's costs are truly coming down yet. And see point three below, because GSK and the rest of us in this business are not, in fact, selling widgets.

(2) Even if costs are coming down, counterbalancing that are several other long-term trends, such as the low-hanging fruit problem. As we move into harder and harder sorts of targets and disease areas, I would assume that the success rate of drugs in the clinic will be hard pressed to improve. This is partly a portfolio management problem, and can be ameliorated and hedged against to some degree, but it is, I think, a long-term concern, unless we start to make some intellectual headway on these topics, and speed the day. On the other side of this balance are the various efforts to rationalize clinical trials and so on.

(3) A larger factor is that the market for innovative drugs is not very sensitive to price. This is a vast topic, covered at vast length in many places, but it comes down to there being (relatively) few entrants in any new therapeutic space, and to people, and governments, and insurance companies, being willing to spend relatively high amounts of money for human health. (The addition of governments into that list means also that various price-fixing schemes distort the market in all kinds of interesting ways as well). At any rate, price mechanisms don't work like classical econ-textbook widgets in the drug business.

So I'm not sure, really, how this will play out. GSK has only modest incentives to lower the prices of its drugs. Such a move won't, in many markets, allow them to sell more drugs to make up the difference on volume. And actually, the company will probably be able to offset some of the loss via the political capital that comes from talking about any such price changes. We might be seeing just that effect with Witty's speech.

Disclosure: None.

Source: GlaxoSmithKline's CEO On The Price Of New Drugs