By Timothy Noah

Posted Thursday, March 3, 2011, at 9:19
PM ET

For years the government has sought to
make brand-name drugs cheaper and
more widely available to the public. It
has tried and failed to limit to a
reasonable time period various patent
and other "exclusivity" protections. Or
it's tried and failed to negotiate volume
discounts on the drugs that the feds
purchase through Medicare. Every time,
the pharmaceutical lobby has used its
considerable wealth and political clout to
block any government action that might
trim Big Pharma's profits, which typically
amount to between one-quarter and one-
half of company revenues. And just
about every time, Big Pharma has argued
that huge profit margins are vitally
necessary to the pharmaceutical industry
because drug research and development
costs are so high.

The statistic Big Pharma typically cites
(see, for instance, this PhRMA video on
how Mister Chemical Compound becomes
Mister Brand-Name Drug) is that the cost
of bringing a new drug to market is
about $1 billion. Now a new study
indicates the cost is more like, um, $55
million.

Big Pharma has been making its R&D
argument for half a century, but the
specific source of the $1 billion claim is a
2003 study published in the Journal of
Health Economics by economists Joseph
DiMasi of Tufts, Ronald W. Hansen of the
University of Rochester, and Henry
Grabowski of Duke. I will henceforth refer
to this team as the Tufts Center group,
because they were working out of the (
drug-company-funded) Tufts Center for
the Study of Drug Development. The
Tufts Center group "obtained from a
survey of 10 pharmaceutical firms" the
research and development costs of 68
randomly chosen new drugs and
calculated an average cost of $802
million in 2000 dollars. That comes to $1
billion in 2011 dollars based on the
general inflation rate since 2000 (28
percent). One billion dollars for every
little orange prescription bottle in your

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How drug companies exaggerate research costs to justify absurd profits.

medicine cabinet! And according to
PhRMA, even that is way too low! As of
2006, its calculation of the drug-
development average had already risen to
$1.32 billion. That means costs specific to
drug development increased by 64
percent between 2000 and 2006. Medical
inflation typically outpaces general
inflation, but PhRMA's calculation puts
its rate of cost increase at more than
twice the rate for medical inflation
during that period (26 percent). If
Pharma's alleged inflation rate hasn't
slackened since 2006, then the drug-
development average should be now
approaching $2 billion. But let's not go
there. We'll stick to Big Pharma's official
last-stated estimate of $1.32 billion.

The new study, by sociologist Donald W.
Light of the University of Medicine and
Dentistry of New Jersey and economist
Rebecca Warburton of the University of
Victoria, and published in the journal
BioSocieties, builds on some excellent
previous research by journalist and
health care blogger Merrill Goozner,
author of The $800 Million Pill, and the
consumer advocate Jamie Love. Light and
Warburton begin by pointing out that
drug companies submitted their R&D
data to the Tufts Center group on a
confidential basis and that these
numbers are therefore unverifiable. Light
and Warburton find it a little fishy that
only 10 of the 24 invited firms chose to

participate, given "the centrality of the
issue and the prominence of the Center"
within the industry. "The sample," they
suggest, "could be skewed" toward
companies or drugs "with higher R&D
costs." Light and Warburton also observe
that if the Tufts Center group made any
effort of its own to verify the information
it received from the drug companies, the
group makes no mention of it in the
study.

The first research phase involved in
developing a new drug is basic (as
opposed to applied) research. Very little
of this type of research is funded by drug
companies; 84 percent is funded by the
government, and private universities
provide additional, unspecified funding.
The Tufts Center group assumed that
drug companies spent, on average, $121
million on basic research to create a new
drug, but Light and Warburton find that
hard to square with their estimate that

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industry devotes only 1.2 percent of sales
to all their basic research. Add in a few
additional considerations and Big
Pharma would have us believe basic
research costs end up constituting more
than one-third of the Tufts Center's $802
million estimate. That's way too much,
Light and Warburton say.

Another problem Light and Warburton
have with the Tufts Center group is that
they didn't subtract from their R&D c
alculations pharmaceutical firms' tax
breaks. Research and development costs,
they point out, are not depreciated over
time like other investments; rather,
they're excluded entirely from taxable
profits. This tax break lowers net costs by
39 percent. Add in other tax breaks and
that cuts the Tufts Center group's R&D
estimate in half.

Now take that figure and cut it in half
again, Light and Warburton say, because
half the Tufts Center group's estimate
was the "cost of capital," i.e., revenue
foregone by not taking the money spent
on R&D and investing it in securities
instead. But R&D is a cost of doing
business, Light and Warburton point out;
if you don't want to spend money on it,
then you don't want to be a drug
company. And who says that investing in
securities always increases your capital?
Sometimes the market goes down. Many
of us learned that the hard way in 2008.

There are other problems. The Tufts
Center group's per-subject calculation of
how much clinical trials cost was six
times that of a National Institutes of
Health study. Its calculation of how
much time it takes to conduct clinical
trials and have them reviewed by the
Food and Drug Administration—7.5
years—is twice as long as Light and
Warburton's calculation, which is less
than four years. The Tufts Center group's
use of the average (mean) cost rather
than the median cost, Light and
Warburton argue, is also misleading,
because R&D costs for different drug
products vary widely, and a very few
expensive drugs will skew the mean. That
appears to have happened in this case,
because the Tuft Center group's median
was only 74 percent of the mean.

When Light and Warburton correct for all
these flaws—well, all the ones that can
be quantified—they end up with an

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average cost of bringing a drug to market
that's $59 million and a median cost
that's $43 million. In 2011 dollars, that's
a $75 million average and a $55 million
median.

So the drug companies' $1.32 billion
estimate was off, according to Light and
Warburton, by only $977 million. Let's
call it a rounding error.

Timothy Noah is a senior writer at Slate
He can be reached at thecustomer@slate.
com.

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