One estimate of the rate of return on pharma

…return on investment in pharma R&D is already below the cost of capital, and projected to hit zero within just 2 or 3 years. And this despite all efforts by the industry to fix R&D and reverse the trend.

That is from Kelvin Stott.  Keep in mind this is during a time when global demand has been growing, which suggests the supply side is all the more constipated.


That doesn't surprise me. Derek Lowe of In The Pipeline at Science made a similar point a couple years ago, about how the Return on Investment for Pharma was pretty unremarkable.

A couple of thoughts - in economic terms, doesn't this indicate a strong level of market competition (ie, industries with high levels of competition ROI tends towards cost of capital, whereas fields with high barriers to entry/poor competition see better rates of return).

Barriers to entry in pharma are getting lower (patents help but cost of research is falling, and adoption of genetic 'cures' like CRISPR-based treatments will drive even lower).

I think the challenge to pharma is that 'good' treatments - ie, cures, vaccines, gene therapy - are typically 'single shot and done' which leads to a low rate of return but a high externality value to the recipient. In my opinion, this is a good argument to eventually lead to 'public sector' pharma - strong health outcomes are a public good, and true cures have a low rate of internal return but high value to the patient.

It also indicates that biology is very hard, now that much of the low hanging fruit has been picked (a point Derek Lowe has also made).

Congratulations to Michael Argast for (1) mentioning the word "PATENTS" which the original article did not do (nor any other comment here to date), and (2) understanding that in perfect competition you have zero incentive to patent anything (e.g., commodities are not patented, and profits are zero, with each firm seeing MR = price = flat curve). In short, the world with perfect competition is the Malthusian world of hand-to-mouth.

The solution to Great Stagnation is more and better societal incentives (patents, government R&D, prizes, etc).

The article does mention patents.

There is a flip side related to patents and IP. If there are areas of research which, while yielding health benefits, are not patentable, who will research them?

I recall that a random trial was only recently done on whether saline solution was better for cleaning wounds than commonly used soap and water. It turned out saline was better. Sorry about the last hundred years, eh?

@dan1111 - yes, he mentions patents in passing, for some reason I missed it the first time, for his model of IRR having an investment period of around the term of a patent. A rather trivial mention but at least it was a mention, and the article was largely a polemic about the law of diminishing returns, along the lines of Jevons' coal question lament. All in all the article was bogus, but had nice graphics.

@Anonymous - they used to say that's why penicillin was not commercialized (Fleming did not patent it) and later government R&D had to step in to commercialize it. Actually a book was written on this theme a decade or more ago, how government R&D was necessary to make production quality penicillin (which is found naturally in mold found on oranges, and, strictly speaking, you cannot technically patent something under US patent law that is already found in nature, per se).

Graveyards are full of people who have made linear interpolations.

btw the cost of capital of big pharma is much lower than 6%

I’m going to live forever because I’ve never made a linear interpolation.

No one can know that they are going to live forever, because forever never comes. However they just may be able to live indefinitely by the benefits of future technology.

Yep. The article makes the bizarre assumption that innovation is a limited resource similar to oil and fossil fuels. And claims that the slowdown is happening because we're running out of new innovations to find. Even Ehrlich and the Club of Rome at their silliest and most pessimistic wouldn't go that far in assuming fixed and limited resources.

The article makes a mistake that is becoming increasingly common in these days of machine learning and AI being used to analyze data: it puts too much emphasis on the data and not enough on theory and common sense. Glorified curve-fitting, a downward trend, and a post hoc story to explain why the downward trend allegedly makes sense and will continue.

Increased knowledge generally gives us not decreased but increased abilities to make further improvements in technology, e.g. the Wright Brothers couldn't have invented the airplane without the invention of lightweight powerful engines. I remember Martin Weitzman even modeled increasing returns to technology in a paper maybe 15 years ago.

Which is not to say that I have an explanation for the recent downward trend in returns. I do expect that the most recent data will show that it has reversed, though for political and regulatory reasons rather than technological ones: someone who works in the pharmaceutical industry told me that Trump's election resulted in a very fast relaxation of many FDA approval processes. As in, companies that were anticipating spending many years and millions of dollars getting approval for a new use for a drug were told don't bother, they didn't need to get approval.

Nah bruv, your friend is sadly mistaken. The entrenched scientists and staff at FDA do not care about Trump. Getting a new indication is still a slog with the agency. You'd still be insane to move forward without an approval as the next FDA commissioner, current/future DOJ, current/future FTC, and all 50 states attorneys general would rake you over the coals for a host violations related to off-label marketing, misbranded products, adulterated products, deceptive and fraudulent business practices. The civil fines alone would be in the billions.

The red dotted line is silly, bit still uh-oh. Hopefully the shift toward biologics can turn this around.

Kids: don't go into Biology or Chemistry unless you really love those subjects. Career-wise you're probably better off with a degree in Psychology, honestly.

Maybe you are trying to hog
all the sweet Chemistry money.

I would like to see the corresponding graph for marketing expenditures. The pharma industry has always been a balancing act of R&D and Marketing (detailing, specifically).

A good argument for public funding, based on a goal of public cost reduction, rather than high return (and thus higher public expense).

In other words dropping a couple billion on a $1 cancer pill makes sense for public health, even if not private ROI.

Public funding? You mean like Concorde? How is all that money thrown down the pit of fusion working out? Still looking at a thirty year wait for it to work?

As far as public health goes, the last thing you would want to do is cure cancer. Cancer mainly kills old people after they have stopped working. And if they don't die of that or a heart attack, they die slowly of some form of dementia. That is expensive. If you wanted to make a public health cost-benefit analysis you would encourage everyone to smoke.

The problem here is that suing and regulations have made the discovery of new drugs for otherwise health adults impossibly risky and expensive. The bureaucrats have killed the goose that laid the golden egg. Nothing will change that except the government deciding it is exempt from tort law.

As always, nothing is more ridiculous than complaining about public research funding ... on the Internet.

Have you heard of opportunity costs? What if the money taken from tax payers to fund that last few decades of science had been left with them, who knows how muncher higher gdp would have been.

Yes. Opportunity cost is an incantation people use when they have no actual data to support their position.

To be a bit kinder, you may calculate return on investment for various types of government research, and I would take those numbers seriously.

The government is great for early stage R&D. The internet being a great example. The NIH is still responsible for a great deal of early bench science on discovery of new chemical entities and mechanisms of action.

The government, however, does not have as great a track record of completing the commercialization of projects within reasonable metrics of cost or time. See: any DoD weapons program. Can you imagine if the government had been responsible for building out the full infrastructure of the internet? Nightmare.

Similarly, the cost of NIH or CDC to complete research or clinical trials is astronomical compared to private companies. In the abstract folks might not care because they think the drugs would come out the other side free for use, but if pharmaceutical R&D was 'nationalized' (for lack of a better term) the total costs to the taxpayer would exceed the current drug costs for consumers.

We spend maybe $510m per year on trying to figure out fusion. In contrast I see a headline that says Netflix says it plans to spend $16B on content.

In 20 years is Jessica Jones season 15 going to make us sit back and think it was all worth it?

Of course it's easy to cherry pick R&D that didn't pan out. The Concorde doesn't seem like a huge insult to mankind to me. The Internet, of course, paid off. So did the Interstate Highway System and zillions of other things too numerous to mention (including some funding Spain gave an Italian sailor a few centuries ago).

It is also easy to cherry pick government R&D that did pan out. As it turned out the Great Pyramids in Egypt were really good investments even though they may not have looked like it to the peasants who were whipped to put them up. That is not really the issue. The issue is how efficient government research money is.

I would think the answer to that is not very. Private research is likely to be much better. For one thing all government funded research is likely to come under pressure to be politically correct. The grossest example of this is the disproportionate funding HIV gets. ACT-UP is a very powerful group of bullies no one wants to stand up to. But breast cancer gets vastly more funding than prostate cancer.

Specifically on health, the National Institutes of Health is responsible for research and development of many life-saving vaccines, including hepatitis A and B vaccines, the flu shot, and the HPV vaccine.

Do we worry that not enough money is made on vaccines? Or do we celebrate that falling costs have made them available to the world's poorest children?

Vaccines aren't cancer cures. If your best example of publicly funded cures are vaccines you've got a long way to go.

They are even better, really. At low cost they protect the young. We could put the polio vaccine and the March of Dimes in the same category. Public effort for great public benefit.

"The CDC estimates that vaccinations will prevent more than 21 million hospitalizations and 732,000 deaths among children born in the last 20 years"

Well actually the HPV vaccine does prevent many forms of cervical cancer and there are cancer vaccines in the pipeline that are intended to actually cure certain types of cancer (this is a bit different from our usual experience with vaccines which are usually given to prevent the illness, not fight it once it is present).

I'm not sure what your nitpicking comment is intended to accomplish. A vaccine to fight an infectious disease versus 'curing cancer' is a bit like the difference between a mission to put a man in Earth orbit and return him home versus a mission to have a man orbit Pluto and return home. It sounds like just going to another place in space but the reality is a totally different magnitude in scale.

Exactly. "Wouldn't you rather just spend oublic money doing X? Look at all the Y it's generated!" is a very weak argument.

Wait. You guys think a line about low cost per treatment was a promise for a new cure for cancer?

That is a way to avoid a message by inventing goalposts, I guess.

If you want to get back on track, the argument is about agency issues and who would work for lower cost treatment, in general.

The for-profit, where the boardroom pitch is "look boss, we can make less money?"

So you're saying your tangential point unrelated to the actual post and article makes no sense when people who read the post and article comment based on the assumption you were stcking to topic?

Sure. Granted.

I wonder if the same can be said of military (weapons) research.
Pharmaceutical companies are often framed as organisations who win a license to blackmail dying patients with extortionate pricing for their products, citing research costs.
Yet there doesn't seem to be a parallel with military research organisations and companies. If ill health could be regarded by governments in the same way as hostile foreign governments, ie an enemy to be fought at all costs, then a better method of funding pharmaceutical research could be developed.

So Pharma's ROI was 25% in the early 1990's and I should care about the fat cats?

Sooooo, you're saying that the F-35 is too cheap?

I am writing that military research has a funding model that works. Why not apply the same model to fighting disease.

Maybe because you don't want to duplicate the incredible waste?

I am a stupendous cuckold!

"you don't want to duplicate the incredible waste?"

Exactly. Military funding is as it is because there is one buyer, the government. You cannot sell that equipment to anyone else.

In the UK there is a National Health Service. Therefore for prescription only medicines there is one main buyer, the government, and its NICE, the National Institute for Care Excellence. (There are a few remaining private doctors.)

And ... patients die of thirst because NHS nurses are too lazy to bring them a glass of water.

Britain used to lead the world in medical innovation. Starving the beast of money has consequences.

with regards to "patients die of thirst because NHS nurses are too lazy to bring them a glass of water."

I would suggest substituting "busy filling in paperwork" for "lazy". It is wrong to castigate NHS staff in general when it is the operating system of the service that is flawed. Records have to be kept, but devise an automated way of doing it that doesn't impinge on actually doing the job.

John de Rivaz - May 4, 2018 at 5:55 am 31

I am writing that military research has a funding model that works. Why not apply the same model to fighting disease.

I hope I am replying to the right indentation - but why do you think that military research funding works? What is the evidence that it works? If you throw a lot of money at a lot of things, some of it will stick. Perhaps even to talented people.

But talented people tend not to like bureaucracy and jumping through hoops. They will move to places where they do not have to do that. Which is why great minds were willing to work on the Manhattan Project but almost immediately the most talented went back to academia and left bomb design to the B students.

NASA is worse. NASA got a lot of talent together to put a man on the Moon. But then around 1973 they decided that Political Correctness and Affirmative Action were more important than science. They have done little of any interest ever since. Get kill school teachers.

Military research has given the world massive cost-over-runs and the promise that one day the entire Air Force budget will buy one plane.

Does Military R&D funding 'work'? We have had zero wars in the modern age of serious powers against serious powers (in fact, we barely have serious powers at the moment. A war between the US and Russia and/or China would pit the world's largest military R&D's against each other and assuming you could keep it from going total nuclear you are still testing one giant against two mid-weights at best).

So how do we know military R&D is a success? Because we had amazing breakthrus? Ok but how much did each breakthrough cost us? Did we really care if we were doing military R&D efficiently or did we not because contractors were making $$$ and since no actual hot war was going on no one was dying because of poor R&D results.

If US military research/technology is so successful, why are we in a 17-yr war in Afghanistan and a 15-yr war in Iraq that’s bled over into Syria and Yemen?

Because all wars since WW2 ended by diplomacy, not by force. Nuclear weapons would not end these wars.

I suspect Cowen is presenting a pop quiz to dear readers: The vertical axis is the internal rate of return. With IRR you calculate the actual return provided by the project’s cash flows, then compare that rate of return with the company’s hurdle rate (how much it mandates that investments return). If the IRR is higher, it’s a worthwhile investment. IRR doesn’t give you real dollars. Similarly, it doesn’t address the issues of scale. For example, an IRR of 20% doesn’t tell you anything about the amount of money you’ll get. Is it 20% of $1 million dollars? Or of $1? A company may prefer a larger project with a lower IRR to a much smaller project with a higher IRR because of the higher cash flows generated by the larger project. Indeed, an IRR close to zero may be the ideal IRR for a company.

But how is the rate of return on pharma reps?

Plus, I just ran across this company - maybe they are hurting pharma's bottom line? 'Express Scripts Holding Company is an American Fortune 100 company. As of 2017, the company is the 22nd-largest in the United States as well as the largest pharmacy benefit management (PBM) organization in the United States.[2] Express Scripts had 2016 revenues of $100.752 billion.'

As noted in the Post article which mentioned this company - 'In most other wealthy countries, the government puts a lot more limits on prices along the supply chain, said Anna Kaltenboeck, program director of the Center for Health Policy and Outcomes at Memorial Sloan Kettering Cancer Center.

“I don’t see Express Scripts operating in Germany, for example,” said Kaltenboeck, referring to the country’s largest PBM.' I have to agree - what sort of idiot would want such a middleman wasting health care money in a rational health care system?

While you're having governments rationalize industries, why stop at pharma? Why not ban factory reps, salespeople, distribution companies, etc across the board in all industries? I mean, why have all those useless folks and all those middlemen wasting so much of the money we spend on all kinds of products and services? And when we're done fixing that, maybe we can look at finally eliminating harmful competition? Why allow multiple companies in the same industry, with all that duplication of effort? So wasteful! Why not just have the government license one company in every industry and set prices all along the supply chain just as enlightened Europeans do? If it works for pharmaceuticals, why not automobiles?

So why are you paying all the middlemen instead of buying directly from suppliers and producing your own pharmaceuticals (at least where patents aren't at issue)? And if you're making an economically rational choice, isn't it possible that they are too?

PBMs are the biggest actual customer for drugs, and as they merge with insurers, increasingly control the formulary. The pharma companies talk about this in their quarterly earnings calls. Its a routine topic for Teva, the largest generic pharma.

The big 3 PBMs have the majority of the market.

Cigna (insurance) announced a $52 billion deal in March 2018 to buy PBM Express Scripts.

CVS (retail drugs, clinics, and PBM Caremark) is (Dec 2017) merging with Aetna.

United Health bought PBM Cataman for $13 billion in 2015, expanding its existing in-house PBM.

My guess is we end up with 3-4 highly integrated national firms, with retail pharmacy / first line clinic / PBM / insurance.

I rhink the time has come to fullscale nationalization of pharma research and patents and railroads.

Think again. Didn't you learn anything from Brazil's already failed and abandoned nationalization of their railroads?

We never had that much railroads anyway (we have ships and trucks and airplanes). Those we have either the government built or the English capital built in exchange for government-garanteed profits. Capitalism works for many things (food, toys, electronics, automobiles, etc.), but not for everything (I would exchange all my ties and T-shirts for guayaberas and Mao Suits if I could). Wholesale nationalization of banks and railroads is the best way to go ahead. Let private capital do what it does well.

OK but how does that square with the article? At the end of the day whether or not the R&D is done by private companies or gov't or both you still have diminishing returns setting in as low hang fruit is discovered and the bar for what qualifies as a useful discovery keeps getting raised.

A nationalized industry would be able to use today's patented drugs revenue to fund research. There is no reason to keep paying shareholders. They did not invented anything. Most were not even born when the drugs were invented. Public money to cure public ills.

Doesn't really change the dynamics from the article. Drugs would be expensive because they have patents on them. The gov't would collect the money from those higher prices and presumably fund R&D.

Today the article points out while companies with existing patents reap revenue, these are just transitory states. A successful drug that commands a high price will eventually go off patent. In order for that revenue stream to be maintained some new drug has to be invented before that happens. But the new drug has an even higher bar to jump since it must work better than the current drug, otherwise people will just use the cheaper generic drug in the future. Hence more and more R&D funds are needed yet the improvements get harder and harder to find.

If the private initiative can not get the job done, the government must step in and act.

It's remarkable that they kept up a decent IRR for so long after the Golden Age of Medicine had finished.

Maybe a better solution will be provided by "right to try" coupled with a large database of results good or bad.
The downside of established research procedures is the long drawn out statistical double blind trials. These may have been the best that could have been offered in the past, but now with so many more IT tools available they may no longer be the best.

Also, one size fits all statistical medicine will be replaced by patient based genomic medicine.

A problem I see is 'right to try' works best when you have a very strong, clear signal that a treatment works in a superior way. But this sometimes happens in clinical trials, you will hear that a trial was halted partway through and all patients switched over to the medication because the results were so positive. In those rare cases approval doesn't take long at all.

That, though, doesn't address cases where the impact is more subtle. For example, say a drug improves survival for those with cancer by a median of 5 months. For many this is a very marginal gain but for some it often means much more than 5 months. Yet collecting anecdotes seems like a very hard way to really tease out that fact and establish the drug has some benefit.

I suppose a very rigorous data collection system could let you do 'virtual trials' where you match people who try a drug with others who don't. As i recall IBM Watson was supposed to do something like that reading through thousands of articles and patient charts to pick up on patterns and come up with great treatment recipes but so far jaw dropping results have yet to materialize.

Economist talking about pharma R+D is like biochemists talking about economy ...

Very interesting. Thanks for sharing.

I agree with Michael Argast, even if the return is marginal at best, the practical solutions created is still a good sign for the overall population.

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