May 2008: The Truth About the Drug Companies

Big Pharma’s R&D excuse for steep prices is unfounded
May 1, 2008

The pharmaceutical industry is dominated by just 10 to 20 giant companies--roughly half European and half American--although they are really global in their reach. They all do business in much the same way, and often act more like an oligopoly than as competitors. And make no mistake: Their primary goal is to maximize profits. To keep investors happy, they need to top their performance every quarter, no matter how good it was last quarter. In health care, this imperative has perverse consequences.

As with most investor-owned health businesses, the pharmaceutical industry has a much freer rein in the U.S. than in other, more regulated economies. In particular, despite the fact that the government pays for many prescription drugs in the U.S., there is no public system of price regulation. Drug companies are free to charge whatever they like. The result is that prices in the U.S. for brand-name drugs are roughly twice as high as for the same drugs in Canada and Europe. The U.S. is thus the major profit centre for virtually all of the big drug companies.

The enormous price disparity between the U.S. and other countries has proved extremely embarrassing for the industry and for its many friends in Washington, D.C. In 1987, Congress, under industry prodding, passed a law forbidding Americans from buying prescription drugs from Canada or any other country. But, by the beginning of this decade, a million or so Americans had essentially decided to become outlaws, purchasing their drugs from Canadian pharmacies. As a result, the price disparity became widely known.

The industry was forced to admit that it was indeed charging Americans much more for their drugs than Canadians, but it had an excuse. It said that the high prices charged in the U.S. were necessary to cover their high research and development (R&D) costs. Canada and Europe, by regulating prices in various ways, were not doing their fair share of R&D, according to this argument. They were free riders. By default, then, the U.S. must shoulder the burden. By this line of reasoning, any attempt to moderate U.S. prices would cut into R&D and stifle innovation.

Is any of that true? Are the drug companies really strapped to cover their R&D costs? You could make that case only if they spent most of their revenues on R&D, and had enough left over for only modest profits. But, as I show in my book, The Truth About the Drug Companies, that’s far from the situation. In fact, the major drug companies spend only about half as much on R&D as they do on marketing, and less even than they have left over in profits.

To illustrate, let’s look at the top American drug companies: those listed in Fortune’s rankings of the 500 biggest companies in the U.S. In 2005, these nine companies had sales of $222 billion. According to their annual reports, they spent $32 billion of that on R&D, $71 billion on marketing and administration, and kept $39 billion in profits at the end of the year. So R&D was by far the smallest of the three figures. The profits were huge, as they are every year. That year, they amounted to 16% of sales, compared with just 6% for all the Fortune 500 companies. It’s hard to make the case, then, that the pharmaceutical firms are straining to cover R&D when they are so profitable and spend so much more on marketing.

It’s also hard to make the case that price regulation would stifle innovation when you look closely at the output of the big drug companies. Their major product now consists of trivial variations of top-selling drugs already on the market, like the six statin drugs to lower cholesterol. The fourth of these, Lipitor, is the top-selling drug in the world. These are called “me-too” drugs. They’re easy to make and very lucrative because they usually target vague, chronic conditions in essentially healthy people–conditions like social anxiety disorder, the industry term for shyness. Often they target precursors to disease, like high cholesterol, whose definition can be broadened. The market for these conditions is large and easily expanded. After all, there are more healthy people than sick ones. And if a condition is not sharply defined, then it’s easy to convince more people (and their doctors) that they have it. Who hasn’t been shy at some time? In fact, it’s been shown that ads for one “me-too” drug increase the sales of the others in the class. According to the FDA, fully 80% of new drugs that entered the market over the past seven years were unlikely to be improvements over existing drugs.

The few innovative drugs that do enter the market are usually based on publicly-funded research done in university or government labs all over the world. Sometimes the work is in the public domain, but often it is patented by universities or start-up biotech companies, then licensed to drug companies. Even the first drug in a “me-too family was usually based on publicly-funded research, often dating back to the 1970s and 1980s. The progenitor of Lipitor, for example, came on the market in 1987, the result mainly of publicly-funded work in the U.S. and Japan.

The paradox here is that, while drug companies talk the rhetoric of the free market and innovation, they are not too proud to take government handouts of all sorts, starting with the research on which their drugs are based and government-granted monopoly rights. And they are quite happy to demand protectionist legislation, like the ban on buying drugs from Canada.

This industry has the largest lobby in Washington, and Congress almost always gives it what it wants. One thing it wants now is to lessen the price disparity between the U.S. and other countries--not by lowering prices in the U.S., but by having them rise everywhere else. And it also wants to stop the embarrassing cross-border purchases of cheaper drugs. Washington is now using bilateral trade negotiations to try to achieve those ends. For example, it has induced Canada to crack down on drug sales to Americans, reportedly in exchange for the U.S. relaxing its barriers on beef and lumber.

Canadians should not be influenced by drug company arguments that price regulation in Canada should be relaxed in order to cover R&D costs and foster innovation. You need not worry about stifling innovative R&D. Drug companies do much less of it than they claim, and what they do they can easily afford. What this industry needs is more, not less, regulation, and I would strongly support national Pharmacare in Canada.

(Marcia Angell, MD, is senior lecturer in the Department of Social Medicine at Harvard Medical School and former editor-in-chief of the New England Journal of Medicine. Her most recent book is The Truth About the Drug Companies: How They Deceive Us and What to Do About It [Random House, 2004]. This article was adapted from her address to last year’s SOS Medicare Conference and is included in the recent CCPA/Lorimer book, Medicare: Facts, Myths, Problems & Promise.)