(OPCW, CC BY-NC 2.0)
It’s hardly worth describing in detail how ordinary people view pharmaceutical companies. There is a widespread belief that the pharmaceutical industry does not care about the treatment of diseases. On the contrary — it attempts to stifle the development of new and effective drugs. Because how would it make money on a disease that has been cured?
The stories about “Big Pharma” may be somewhat exaggerated and may contain some misrepresentations, but one thing is true: today it almost isn’t worth it to invest in new drugs. It is estimated that while just three decades ago the rate of return from investment in the development of new drugs was approximately 25 to 30 per cent, today it only amounts to approximately 3 to 5 per cent and continues to decrease. What will happen if these profits completely disappear?
The coronavirus pandemic provides an opportunity to get a fresh look at the problems of the pharmaceutical industry. It makes them more visible, as it interferes with the “traditional” business model based on selling the same product in new packaging. The decrease in the number of new, genuinely original drugs was described by Joshua Krieger, Danielle Li and Dimitris Papanikolaou in 2019 in the article “Missing Novelty in Drug Development”. The authors analysed 64,000 different medications and came to the conclusion that drugs advertised as new products are often just new variants of medications already available on the market. Scientists call them “me-too drugs”, when we are dealing with a simple copy, and “me-better drugs”, when we are talking about a new version with minor improvements. It turns out that one in six medications currently in development has a chemical structure that is 80 per cent identical to that of other drugs. Let’s take a look at one example: in 1987 Mevacor, a drug for metabolic disorders, resembled its predecessors in 25 per cent. In October 1991, a new drug for the same disease appeared on the market — Pravachol. It was similar to what has been already available on the market in 61 per cent. Two months later the drug Zocor was released. Its similarity to previously available drugs was 82 per cent.
How can companies convince people to buy medicine A, when B and C are basically the same thing? Well, this depends on the individual country. In the United States and in New Zealand advertisements of prescription drugs can be targeted directly to consumers. As a result, companies invest in such marketing, based on the assumption that if there are no real differences, then it is necessary to invent them. This costs a lot of money. In the paper entitled “Medical Marketing in the US”, Lisa Schwartz and Steven Woloshin state that the overall advertising expenditures of pharmaceutical companies in the United States increased from USD17.7bn in 1997 to USD30bn in 2016.
The rest of the world limits or prohibits the advertising of prescription medications. As a result, the pharmaceutical companies have to find other ways to promote their products, since the patients are not fully sovereign as consumers. This gave rise to the widespread practice of providing benefits to physicians in order to ensure that they prescribe the given drugs to their patients.
Fear of novelty
But why are pharmaceutical companies investing in generics and not in new drugs? There are several reasons but fear is a major one. The far of novelty. This tendency may seem irrational. Why would Big Pharma be afraid to invest in new drugs (referred to as “first-in-class” drugs) if they bring 15 to 35 per cent more profits than “me-too” and “me-better” drugs? This is partly due to the fact that the higher returns only apply to drugs that are ultimately introduced to the market, and the risk that this will not happen is enormous. It is estimated that only a per cent of medications pass the phase of (preclinical) laboratory testing, which can last up to four years. Then there are three phases of clinical trials, depending on procedures determined by regulatory bodies. The first phase is supposed to confirm the effectiveness of the drug. The second phase is used to determine the dosage. It is only in the third phase that drugs are tested on any significant number of people in order to examine their effect on the health of a larger population. It’s not hard to guess that the newer the chemical structure of the drug, the more difficult it is to successfully pass all these phases. For example, 70 per cent of innovative medicines are rejected in the second phase of clinical trials, which lasts up to two years. An investment in an original drug is associated with costs of at least USD1bn, and possibly more than ten years of testing. The authors of “Missing Novelty in Drug Development” note that the high risk associated with investment in new drugs generates uncertainty about the future cash flows in the pharmaceutical companies. It is impossible to accurately estimate the cost of such an investment ex ante, and to exclude the possibility that it will force the company to pursue external financing. While investments in “me-too” drugs are not cheap either, they are much more predictable, both in terms of duration and the likelihood that the drugs ultimately make it to the market. They do not generate extraordinary costs.
Managers responsible for research on, for example, oncology drugs is typically assigned a specific budget by the company’s management. If they take on a risky project that does not work out, they will have to seek additional funding in order to secure the continued operation of their department. Aware of this risk, the managers usually choose safer projects in order to avoid a situation where they have to explain their failure to the management board. According to the researchers, the managers may therefore choose the maximization of their utility to the company over the maximization of the value for the shareholders.
The impact of the pandemic on the revenues, production and profitability in the pharmaceutical industry is not clear, though. On the one hand, it certainly has a negative effect on the supply chains. For example, in China the production of active ingredients, which are the key component of drugs, has decreased by 10 to 20 per cent. Since the production is reduced, their exports are also decreasing, and this disrupts the production of the final medicines. One of the main recipients of the active ingredients from China is India, which in turn meets up to 50 per cent of the demand for generic drugs in the United States. The production of generic drugs is falling, causing shortages of medications in the United States. Meanwhile, aggressive price increases, which could save the pharma companies’ revenues, are a move that is particularly risky in the times of the pandemic, for a variety of reasons, including political considerations.
On the other hand, during a time when the issue of health has become the main concern of eight billion people living on Earth, we could expect an increase in demand for various medications. The supply chains may be broken, the distribution may be disrupted, but the companies that are able to overcome these difficulties will reap enormous benefits. And many companies are doing that. The financial results of the largest pharmaceutical companies were pretty good in the Q1’20. The annual sales growth amounted to 7 per cent for the Swiss giant Roche, 3 per cent for Johnson&Johnson, 11 per cent in the case of Novartis, 19 per cent for GlaxoSmithKline, and 16 per cent for AstraZeneca. Of course, these increases in turnover are accompanied by growing profits.
The pandemic — at least in its initial phase when panicked consumers and governments were purchasing drugs just in case — had a positive effect on the revenues of many companies. Although these additional earnings are not derived from the sales of new, breakthrough medications, they could possibly contribute to their development. Joshua Krieger, Danielle Li and Dimitris Papanikolaou write that positive shocks, which boost the turnover of the pharmaceutical industry, translate into increased risk-taking in the research on new drugs. And this is not limited to the areas in which these shocks occur.
For example, if the shock relates to medicines for the elderly, the companies will also invest more in new drugs for younger people. Of course, a short, one-off shock is not enough for that phenomenon to become permanent. The companies also need to have a strong financial position in the future. And it seems that they will be able to secure it. The governments are announcing subsequent rounds of funding for research on medicines and vaccines for COVID-19. Any company that invents an effective medication can expect to find plenty of customers from all over the world. There are also proposals of government-sponsored prizes for the most innovative companies. In the article “Running ahead of Pandemics: Achieving In-Advance Antiviral Drugs”, the physician and epidemics expert Jaspreet Pannu writes that sufficiently high (reaching millions of dollars) prizes could encourage companies to develop medicines even for diseases that don’t yet exist, that is, for future pandemics. This is because pharmaceutical experts are able to invent broad-spectrum drugs that target not just a single virus, but entire viral families with pandemic potential. Such drugs created “just in case” require financial incentives. Without them no one will invest in a product for which the demand may never materialize. Meanwhile, according to Mr. Pannu, prizes awarded at the early phases of clinical trials are perfectly suited for this purpose.
Patents and procedures
The belief that the level of innovation of companies increases when they are certain of stable incomes seems counter-intuitive. After all, if we are sure that our business will prosper without any special efforts on our part, why would we even put in any effort at all? This counter-intuitive logic is not accidental, though. In many ways, the pharmaceutical industry is not like the many traditional businesses that elevate their profits by offering increasingly better and newer products.
This is due to two words starting with the letter “P”. Procedures and patents. I have already mentioned the time-consuming nature of the procedures associated with drug approval. This is to a large extent justified — it is better to thoroughly test a given drug than to allow the sale of a toxic pill. However, caution justified by scientific considerations is different than bureaucratic caution. The former tells us to reduce risk, with the knowledge that it is impossible to eliminate it completely. Therefore, this approach allows for an acceptable margin of risk — this is why the description of any medication has a number of entries in the “side effects” section.
Meanwhile, the nature of bureaucratic caution is absolute — its objective is to completely eliminate risk. Is it inspired by genuine concern for people’s health? No, it is based on the public officials’ fear of losing their jobs. The line of reasoning adopted (often unconsciously) by officials is as follows: “There is a 0.0001 per cent risk that drug A would turn out to be harmful, and if this is the case, I may be blamed for approving its introduction to the market. Therefore, it’s better to be safe than sorry.” The economist Milton Friedman in 1973 described the bureaucratic mechanisms of extreme cautiousness in relation to matters of public health in his articles, such as “Barking Cats.
The agencies that approve drugs for marketing are by definition bureaucratic in nature, even though they would like to be seen as scientific institutions. Scientifically justified caution is strengthened by the cautious attitudes of the bureaucrats. As a result, drug testing procedures are constantly tightened, which increases the investment costs and reduces the competition in the industry (as the smaller companies simply cannot afford such costs). One consequence of that is that life-saving drugs enter the market later than they could. The effects are devastating — a two-year delay in the approval of a thrombolytic therapy (i.e. treatment of blood clots), caused by the US Food and Drug Administration, resulted in approximately 22,000 deaths. And this is only one example. Unfortunately, while it’s easy to see the victims of toxic pills, we don’t notice the people who died due to the lack of access to proper medication. This means that the bureaucracy can safely ignore them.
As for patents, they also have their justification. If patenting new drugs became impossible, the profits of the manufacturers would significantly decrease, because other companies would copy their medications on a mass scale immediately after their introduction on the market. Patents provide an incentive to undertake research activities. At least in theory.
In practice, the reality is not as rosy. The economist Alex Tabarrok notes that the regulations related to the protection of intellectual property are too complex and too restrictive, which undermines their theoretical function. This creates the so-called gold-mine problem. Let’s suppose that a company X produces and patents an entirely original drug. In theory this drug is protected, but in practice other companies soon start to imitate it with minor changes and improvements (“me-too” drugs and “me-better” drugs), thereby reducing the profits of the company X. It is therefore possible that the patent does not provide sufficient incentive for innovation in and of itself (i.e. the new drug would have been developed even without the patent), and its only function is to delay the loss of competitive advantage. Meanwhile, for the imitator-companies bypassing patent protection is still a cost that’s worth incurring. This creates a perverse incentive as a result of which investments in research and development are in practice investments in the analysis and subtle copying of what already exists. And this is what happens with a large part of the USD150bn invested annually in pharmaceutical research and development activities. Mr. Tabarrok notes that patent law should be weakened in order to reduce the cost of production of generic drugs. The industry could then allocate the saved resources on the development of innovative medicines.
Creative destruction of the status quo
Fortunately, the pandemic could help solve the problems of both patents and procedures. The world cannot afford for the development of drugs treating COVID-19 to take 10 years. This is obvious even to the bureaucrats. In the end, they are also threatened by the disease. That is why most governments and regulatory authorities are simplifying the procedures associated with the development and approval of new medicines. The FDA has created special fast-tracked testing procedures for drugs related to the coronavirus. Suddenly it has turned out that officials may be available 24 hours a day and the innovators do not have to struggle in order to get an appointment. The authorities have also permitted more liberal modifications of drugs that are already in the testing phase. If something isn’t working, then it can be improved, rather than immediately throwing out the entire project in the trash bin. The pharmaceutical companies themselves are also changing and improving. Hundreds of companies are now looking for drugs treating COVID-19, which means that hundreds have to launch clinical trials simultaneously. This forces the companies to compete for resources, and more specifically, for the people who are to participate in these trials. They are being recruited from all over the world. The processing of data is accelerated thanks to the use of big data analytics and artificial intelligence technologies. Today, the pharmaceutical industry spends almost USD500m a year on artificial intelligence. But in five years these expenses are supposed to exceed USD2bn. And what about the patents?
Some companies still think in the old categories. Above all, they want to beat others by providing new solutions and patenting them in order to reap the benefits. For example, in March 2020, the company Gilead took over and secured the rights to Remdesivir, a drug that was originally used in the treatment of Ebola, and which may (perhaps) be suitable for the treatment of COVID-19 symptoms. The goal was clear: to be able to dictate the highest possible price. Following public outrage, the company bowed to the pressure and relinquished its claims. Another company, AbbVie, which held the rights to the drug Kaletra (it is used to treat AIDS but may also be useful in the fight against the coronavirus), voluntarily relinquished all rights to that medication in March. Its bosses realized that the times have changed and patent rights no longer guarantee anything. If need be, the governments would take over the drugs they protect anyway, pursuant to special emergency legislation. The executives of AbbVie probably became aware of this after the Israeli government used Kaletra for free and without any consultation, even before the company relinquished its rights.
In the article entitled “In the Face of a Pandemic, Can Pharma Shift Gears?”, published in the MIT Sloan Management Review, Markus Scholz and N. Craig Smith note that today the competition between pharmaceutical companies must be replaced with cooperation.
What does this mean in practice? Open access to research results, joint testing and production processes, as well as a departure from the standard drug valuation methods. These are not just demands – this is already happening.
Although Big Pharma is still excessively focused on gaining a competitive advantage, it seems to be more open. The largest companies, such as Roche, Sanofi, Johnson&Johnson, have already declared that they would share the resources and data from clinical trials with the governments and that they would support each other in increasing their capacity for carrying out such research. Mr. Scholz and Mr. Smith point out that pharmaceutical companies will also have to cooperate after they invent the new drug because a single corporation is not able to produce a vaccine for the whole world fast enough.
If the regulatory changes introduced by governments with regards to the drug testing and approval procedures become permanent and also apply to drugs other than those associated with COVID-19, if the patent law is revised and adapted to the current practice, and if pharmaceutical companies are able to break their old habits, then the pandemic could lead to an increase in innovation in this entrenched and insular industry. This is a very reassuring conclusion. While today people are dying of COVID-19, perhaps in the future more new and better medications will be developed, which will save people’s lives. The pandemic opens avenues for that.