1 Economics of the Pharmaceutical Industry Prof. Brook K. Baker Northeastern University School of Law Health GAP (Global Access Project) UKZN – IP and Access to Medicines

2 How Does the Drug Industry Work How do patents affect prices? How much money does Pharma make and where does it go? How much money and time does it take to research and develop an new medicine? How do patent distort R&D? Is R&D efficient? Are high profits necessary to future research and development of life-saving drugs?

How Patent Monopolies Affect Price The right to exclude others creates a power to set the price so as to maximize profits. Drug companies prefer to “segment” markets so they can maximize profits in each segment (Ramsey pricing, territories and sectors.) In high-income inequality countries, the profit maximizing strategy is to sell at a high price to the rich elite. (Demo.) To maintain the monopoly and to maximize profits, the poor lose out – drugs are not affordable. 3

How much money does the drug industry make? 4

The Global Pharmaceutical Market Continues to Grow 2009 Global Pharmaceutical Market IMS estimate $750 billion 2010 Global Pharmaceutical Market IMS estimate $825 billion 2013 Global Pharmaceutical Market IMS Projected $975 billion

Where Does the Drug Dollar go in the US? Is the distribution likely to be different in developing countries and/or with respect to generic drugs where the price is much lower? 6

Where Does the Money Go Inside the Drug Company?  7 Biggest Drug Companies R&D as a % of Revenue = 13.9% Profits as a % of Revenue = 17% Marketing/Administra tion = 32% Other (capital, labor, materials) = 39% 7

8 Marketing & Lobbying Advertising to doctors = $7.2 billion. The pharmaceutical industry has 100,000 “detailers” in the U.S., one for every 2 ½ prescribing doctors. Drug samples = $16 billion. Direct-to-consumer advertising = $4.8 billion. From , the pharmaceutical and health product industries spent $1.1 billion lobbying the U.S. Congress.

9 How Profitable is the Pharmaceutical Industry? The pharmaceutical industry was 1 st in the world rd in th in nd in rd in 2008 Drug companies earned an after-tax median profit of 9.6% compared to 6.3% for all other Fortune 500 companies (2007).

10 The Research and Development Explanation The drug industry argues it needs to maximize profits so it can continue to engage in life-saving research into new medicines. Industry claims it needs to charge high prices in developing countries in order to sustain its profit margins so that it can invest in research and development for important new drugs. Does this R&D excuse hold up?

11 What does R&D Cost – Is it $802M (Dimasi) or 2006 Federal Trade Commission estimate -- $868million

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14 Regardless of actual costs, do patents distort R&D? The pursuit of “blockbusters” “Evergreening” “Me-too drugs” Proliferation of “marketing studies” “Disease mongering” Neglect of “neglected diseases”

“Blockbusters” and “Evergreening” Blockbuster drugs are drug with a very high volume, usually for chronic conditions, that are prevalent in rich countries, leading to extraordinary profits. There were 114 drugs in 2006 that earned more than $1 billion/year in sales. Once a medicine is highly profitable it pays develop minor, but patentable variations that allow you to extend the patent. This is called evergreening. 15

16 Blockbuster ARVs No TB, malaria, or tropical disease blockbusters

“Me-Too Drugs” Other companies try to gain market share from “blockbusters” by introducing a slight variation, one that doesn’t violate the patents but is patentable itself. This results in some competition, but only for an existing, high cost therapy instead of a newer more innovative medicine in a neglected class. In the resulting “oligopolistic” market, there is very little price competition. 17

18 “Disease Mongering” Disease mongering consists of Over-promotion of a medicines, i.e., over promotion of anti-depressants and erectile dysfunction medicines in the U.S. Creation of a new disease, i.e., restless leg syndrome, with a new (patented) medicine.

19 Marketing Studies Drug companies conduct “comparison” trials, which they publish selectively when they want to make a marketing claim. Unless true therapeutic superiority is shown, these studies have little social value, but add considerably to the costs of R&D.

20 Is Drug Company R&D Truly Innovative in Terms of Therapeutic Gain? Not very: Light found that only 2-3% of new drug candidates offered important therapeutic gains and another 7-9% offered modest gains (total 9-12%). An FDA study from the last decade found that only 22.5% of all new candidates received a priority review standard based a “significant improvement” standard. Important nonetheless: There have been important new medicines for heart disease, diabetes, and mental illness. New formulations and improved compounds can improve adherence and result in different side effect profiles.

21 Who Contributes to R& D for Breakthrough Drugs? Source: Donald Light (2005)

22 No R&D for Neglected Diseases Because of the lack of profit incentives for disease primarily affecting poor people (or for vaccines and antibiotics), there is very little R&D on neglected diseases and very little research on pediatric and tropical-country formulations. The 14 most NTDs are: Buruli ulcer, Chagas disease, cholera/epidemic diarrhoeal diseases, dengue fever, guinea-worm, endemic treponematoses (yaws, pinta, endemic syphilis), sleeping sickness, leishmaniasis, leprosy, lymphatic filariasis, onchocerciais, schistosomiasis, soil- transmitted helminthiasis, and trachoma. Less than 1% of the 1393 new drugs registered between were for tropical diseases. The R&D pace is picking up – multinational companies are currently working on 41 projects, both in public- private partnerships and alone, with at least four candidates submitted for approval.

23 Does Drug Companies’ Profitability Ultimately Depend on Sales in Developing Countries? Where do drug companies make most of their sales? Where are their sales most profitable? How dependent is overall profitability on sales in developing countries?

24 Global Drug Market Share by Sales vs. % Global Population Europe31.1% (pop. 12%) Africa, & Asia,8.3% (pop. 72%) North America45.5% (pop. 5%) Latin America4.8% (pop. 9%) Japan & Australia8.8% (pop. 2%) Total Global Sales 2007 = $702 Billion

25 Poorest Regions - Percentage of Global Pharmaceutical Sales 2007 Sub-Saharan Africa 1.2% 1.2% How important are these tiny markets to R & D incentives? Indian subcontinent1.4% Asia2.7% 13.1% All of Africa, Asia & Latin America = 13.1%

But the Market is Tilting Towards Emerging Markets 26

Big Pharma Intentions – Exploit Tier-1 Emerging Markets

Tier-2 Emerging Markets

30 Conclusion – The Problem The R&D excuse simply does not add up. Drug companies research and invest in order to maximize profits, mainly in rich country market, for chronic and deadly diseases affecting rich people, and secondarily to exploit rich and middle-income populations in developing countries. They do not do R&D on diseases primarily affecting the Global South where there is little prospective profit. Because patents form the basis of their monopoly pricing power, drug companies act to exclude or delay generic competition.

31 Economics of the Generic Industry Very diverse industry – ranging from companies with emerging R&D capacity to mom & pop shops. Quality is variable Marketing varies from local to global R&D of generics typically focuses on manufacturing efficiencies and formulations, including unfortunately, therapeutically inappropriate fixed-dose combinations (to avoid price controls). Focus is on large-production runs at efficient economies of scale.

32 What is the cost structure of generic manufacturing? Capital costs of building a pharmaceutical plant (1/7 in India vs. U.S.) Building in quality (GMP), human capital, physical plant, and operating procedures. Utilities and transportation (expensive in many developing countries) Labor costs (again 1/7 in India compared to U.S.)

33 The key role of APIs (Active Pharmaceutical Ingredients) APIs comprise 70% of the cost of manufacturing a medicine. Therefore, lowering the price of APIs is very important The cost of APIs is primarily lowered through economies of scale and competition among API producers When Brazil entered the market in 1996 to buy APIs and manufacture 3TC, the global price of the API fell from over $20,000/per kilo to less than $300/per kilo because of new economies of scale.

34 Incentives vs. Disincentives for Generic Competition Market aggregation, esp. small and poor country markets with middle-income markets. Large, profitable markets incentivize multiple entry, efficient production, and low- mark-up sales. Guaranteed payment. Eight entrants produces competitive pricing. Patent status, DE, and fear of Big Pharma lawsuits. Costs of product development ($1.5 million) and multiple registrations ($1.5 million). Risks re loss of market share, too many competitors. Costs of developing supply systems.

35 The Economics of local production Added costs: poor infrastructure, lack of human resources, lack of manufacturing/operational know-how, high utility costs, developing marketing/distribution systems. Often cannot reach efficient economies of scale – must go regional or even global.

36 Local Production v. Lower-Cost Imports Local production promotes technology transfer, industrial development, associated industries Local production must meet GMP standards Patient safety Funder requirements Multiple and local sources of supply are important to prevent stock-outs and price shocks. India (and now China) have achieved significant cost advantages and technical competence. The major cost items – active pharmaceutical ingredients – are mainly produced in India and China. Many local producers are just finishers (Mozambique)

The Future of the Generic Industry Big Pharma is out- sourcing manufacturing and clinical trials to India and China. Big Pharma is buying up major generic companies to access their distribution systems and to stop competition. If the generic industry sells out to Big Pharma, what will we do? 37