The Cost of Innovation

Highlights from "Large Molecules, Large Dreams: A Forum on Global Drug Pricing and Sustainable Medical Innovation," held August 12, 2004, at MIT's Sloan School of Management.
Sep 30, 2004
By Pharmaceutical Executive

Drug Companies Need Money To develop innovative products. Patients need innovative products whether they can pay for them or not. And a drug pricing policy that forgets either of these vital points is likely to be a disaster.

That was the subject of "Large Molecules, Large Dreams: A Forum on Global Drug Pricing and Sustainable Medical Innovation," held this summer at the Massachusetts Institute of Technology's Sloan School of Management. The forum brought together economists, pharma professionals, and representatives of other industries to discuss pricing issues—particularly differential pricing, the practice of charging different patients different amounts for the same drugs. At a time when differential pricing is under increasing fire from politicians and the media, the panelists saw it instead as a vital tool that allows companies to continue to develop new products, while fulfilling the industry's obligation to make lifesaving medicines available even to the poorest nations. They took a revealing look at why differential pricing is needed and how it can be preserved in the face of popular opposition, parallel trade, and price controls.

Following are some highlights from the meeting; remarks have been edited for clarity and brevity. A complete online archive of the conference, including additional presentations by Andrew Parece of Analysis Group, Inc., Stephen M. Sammut of Burrill & Company, and Yuri Dikhanov of the World Bank, among others, is available at entrepreneurship.mit.edu/forum/webcast.htm .

The $800 Million Megadifference Ernest R. Berndt

Louis B. Seeley Professor of Applied Economics, MIT Sloan School of Management


Ernest R. Berndt
The cost structure of the medical products industry is truly exceptional. From studies, including one by Tufts, we know that it takes between $800 million and $1.6 billion to bring the first new tablet, the first new vial, the first injection, to market. The incremental cost of producing the second unit is frequently tiny, say 25 cents. The difference between the cost of producing the first and the second tablets at the minimum is essentially $800 million.

While other industries, such as electricity generation, telecom, software, database services, and motion pictures, all have high fixed or sunk costs and relatively small incremental costs, for most medical products and biologics this difference is uniquely large. Let's call it the $800 million mega difference.

There are those who dream of developing new medicines that can benefit even people with limited ability to pay. For an industry with a megadifference cost structure, this dream is realistic. It is commercially feasible to supply products at very low prices to those who are less wealthy, provided that the up-front science costs can be recouped by selling at higher prices to those who can afford them.

Of course, everyone—especially those running for office—would like a system that requires paying uniform prices only slightly greater than the so-called second-tablet cost. But the magnitude of yesteryear's and today's science investments by the biotech, device, and pharmaceutical industries reflects industry's expectations that it will continue to be able to implement global price differentials.

Because of the megadifference cost structure, medical products industries are highly vulnerable to political and economic pressures to move to more uniform global pricing. But if industry is forced to do that, investments in up-front science will drop sharply. Even more sadly, the move to uniform pricing would result in higher prices in many countries, reducing access to those unable to afford medicines priced above incremental costs. Uniform pricing ironically would make access nonuniform.

If we want to sustain the flow of innovation from medical research and development, we either have to change the $800 million megadifference price structure or figure out some way, collectively across political parties and countries, to construct and maintain a system of global price differentials.

Rewarding Results Mark B. McClellan