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DBL%20Hendrix%20small.png College chemistry, 1983

Derek Lowe The 2002 Model

Dbl%20new%20portrait%20B%26W.png After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: Twitter: Dereklowe

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March 18, 2013

GlaxoSmithKline's CEO on the Price of New Drugs

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Posted by Derek

Well, GlaxoSmithKline CEO Andrew Witty has made things interesting. Here he is at a recent conference in London when the topic of drug pricing came up:

. . . Witty said the $1 billion price tag was "one of the great myths of the industry", since it was an average figure that includes money spent on drugs that ultimately fail.

In the case of GSK, a major revamp in the way research is conducted means the rate of return on R&D investment has increased by about 30 percent in the past three or four years because fewer drugs have flopped in late-stage testing, he said.

"If you stop failing so often you massively reduce the cost of drug development ... it's why we are beginning to be able to price lower," Witty said.

"It's entirely achievable that we can improve the efficiency of the industry and pass that forward in terms of reduced prices."

I have a feeling that I'm going to be hearing "great myths of the industry" in my email for some time, thanks to this speech, so I'd like to thank Andrew Witty for that. But here's what he's trying to get across: if you start research on for a new drug, name a clinical candidate, take it to human trials and are lucky enough to have it work, then get it approved by the FDA, you will not have spent one billion dollars to get there. That, though, is the figure for a single run-through when everything works. If, on the other hand, you are actually running a drug company, with many compounds in development, and after a decade or so you total up all the money you've spent, versus the number of drugs you got onto the market, well, then you may well average a billion dollars per drug. That's because so many of them wipe out in the clinic; the money gets spent and you get no return at all.

That's the analysis that Matthew Herper did here (blogged about here), and that same Reuters article makes reference to a similar study done by Deloitte (and Thomson Reuters!) that found that the average cost of a new drug is indeed about $1.1 billion when you have to pay for the failures.

And believe me, we have to pay for them. A lottery ticket may only cost a dollar, but by the time you've won a million dollars playing the lottery, you will have bought a lot of losing tickets. In fact, you'll have bought far more than a million dollar's worth, or no state would run a lottery, but that's a negative-expectations game, while drug research (like any business) is supposed to be positive-expectations. Is it? Just barely, according to that same Deloitte study:

In effect, the industry is treading water in the fight to deliver better returns on the billions of dollars ploughed into the hunt for new drugs each year.

With an average internal rate of return (IRR) from R&D in 2012 of 7.2 percent - against 7.7 percent and 10.5 percent in the two preceding years - Big Pharma is barely covering its average cost of capital, estimated at around 7 percent.

Keep that in mind next time you hear about how wonderfully profitable the drug business is. And those are still better numbers than Morgan Stanley had a couple of years before, when they estimated that our internal returns probably weren't keeping up with our cost of capital at all. (Mind you, it seems that their analysis may have been a bit off, since they used their figures to recommend an "Overweight" on AstraZeneca shares, a decision that looked smart for a few months, but one that a person by now would have regretted deeply).

But back to Andrew Witty. What he's trying to say is that it doesn't have to cost a billion dollars per drug, if you don't fail so often, and he's claiming that GSK is starting to fail less often. True, or not? The people I know at the company aren't exactly breaking out the party hats, for what that's worth, and it looks like the company's might have to add the entire Sirtris investment to the "sunk cost" pile. Overall, I think it's too soon to call any corners as having been turned, even if GSK does turn out to have been doing better. Companies can have runs of good fortune and bad, and the history of the industry is absolutely littered with the press releases of companies who say that they've Turned A New Page of Success and will now be cranking out the wonder drugs like nobody's business. If they keep it up, GSK will have plenty of chances to tell us all about it.

Now, one last topic. What about Witty's statement that this new trend to success will allow drug prices themselves to come down? That's worth thinking about all by itself, on several levels - here are my thoughts, in no particular order:

(1) To a first approximation, that's true. If you're selling widgets, your costs go down, you can cut prices, and you can presumably sell more widgets. But as mentioned above, I'm not yet convinced that GSK's costs are truly coming down yet. And see point three below, because GSK and the rest of us in this business are not, in fact, selling widgets.

(2) Even if costs are coming down, counterbalancing that are several other long-term trends, such as the low-hanging fruit problem. As we move into harder and harder sorts of targets and disease areas, I would assume that the success rate of drugs in the clinic will be hard pressed to improve. This is partly a portfolio management problem, and can be ameliorated and hedged against to some degree, but it is, I think, a long-term concern, unless we start to make some intellectual headway on these topics, and speed the day. On the other side of this balance are the various efforts to rationalize clinical trials and so on.

(3) A larger factor is that the market for innovative drugs is not very sensitive to price. This is a vast topic, covered at vast length in many places, but it comes down to there being (relatively) few entrants in any new therapeutic space, and to people, and governments, and insurance companies, being willing to spend relatively high amounts of money for human health. (The addition of governments into that list means also that various price-fixing schemes distort the market in all kinds of interesting ways as well). At any rate, price mechanisms don't work like classical econ-textbook widgets in the drug business.

So I'm not sure, really, how this will play out. GSK has only modest incentives to lower the prices of its drugs. Such a move won't, in many markets, allow them to sell more drugs to make up the difference on volume. And actually, the company will probably be able to offset some of the loss via the political capital that comes from talking about any such price changes. We might be seeing just that effect with Witty's speech.

Comments (30) + TrackBacks (0) | Category: Business and Markets | Drug Development | Drug Prices


1. PharmaHeretic on March 18, 2013 8:59 AM writes...

Any comments?

"In the latest effort to jumpstart its flagging business, AstraZeneca is consolidating R&D and global marketing operations over the next two years, a move that will eventually elminate 1,600 jobs by 2016, including 650 positions in the US."

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2. RB on March 18, 2013 9:12 AM writes...

From an investor's point of view, Big Pharma is a puzzle, unless you are in for the dividend, or as a defensive play (my opinion). It would seem almost impossible from an outsider's position to judge the fair value of a huge company like GSK, with scant detail available about the pipeline/future plans etc. Talk about "failing less" means nothing.

Have companies like GSK finally become so big that they have become so inefficient as to abrogate the advantages of their size? If you were an investor in big pharma in general over the last decade (and I'm not), you'd have needed reminding that the management has a duty of care to shareholders rather than themselves or the staff of the company. Senior management pay has been eye-wateringly high of late, in stark contrast to performance.

OK, that may be a bit of a non-sequitur with respect to Derek's post, but it was my initial reaction....

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3. NewStrategy on March 18, 2013 9:13 AM writes...

I think Sir Andrew is right on this one. There has been a major shake-up at GSK in the past few years as has been well documented -and heavily criticized- here but the fact of the matter is that the productivity gains have been very substantial indeed. Much of this has come from a very streamlined and highly synergized strategy that really has allowed the R&D organization to do more with less. That may be a cliche but it is manifestly true nonetheless.

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4. Am I Lloyd peptide on March 18, 2013 9:24 AM writes...

Is Witty saying that the cost of failures doesn't figure in the price of a product? His statement sounds boringly obvious at best, which seems to be the norm for most pharma CEO statements these days.

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5. Derek Lowe on March 18, 2013 9:31 AM writes...

Hello, #3, NewStrategy. It absolutely would not be a GSK comments thread around here without you, I have to say. It's like watching the birds migrate back to their summer homes.

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6. an ex-GSKer on March 18, 2013 9:40 AM writes...

I continue to watch GSK and still have many contacts in R&D. From what I read and hear, the many of the compounds now progressing through Phase 2/3 are me too molecules, lackin innovation and in many ways lacking substantial differentiation from the already approved & marketed molecules. Further, GSK is struggling with new, novel target identification since the previous very early target work has largely been stopped, which means that the remaining world is me-too's and less risk. Third, SIR ANDREW WITTY is a master politician who constantly trying to look as a leader within the UK business community; he has little experience in drug discovery and development, and is constantly looking ahead to his next gig after GSK.

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7. Anon on March 18, 2013 9:41 AM writes...

I just popped in to say that I was looking forward to Agilent(or whatever s/he calls him/herself these days)'s response, but they beat me to it! Always good for a laugh. We would miss you if you went away, NewStrategy!

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8. processchemist on March 18, 2013 10:07 AM writes...

"a very streamlined and highly synergized strategy"

Wow... Bingo!
One of purest buzzword's distillates I heard in the past 6 months. ROFL, really.

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9. Curious Wavefunction on March 18, 2013 10:12 AM writes...

"a very streamlined and highly synergized strategy"

Now doesn't that statement scream the word "detail"?

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10. Ellen on March 18, 2013 10:16 AM writes...

Is NewStrategy really a highly motivated GSK shill? Or is s/he just serving us up with the most consistently straight-faced irony since Bob Newhart?

Either way I love it.

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11. Helical_Investor on March 18, 2013 10:46 AM writes...

I rather like Witty, something like the Jamie Dimon of pharma. R&D is a bit of an odd expense. Like advertising, it has components of both 'expense' and 'capital expenditure'. With both of these expense categories, you can't really know how much was expense and how much added intangible value except with hindsight. Over simplified, R&D that goes nowhere or results in failures is an expense, and R&D that leads to revenues (through approved drugs) is more like a capital expenditure.

... for what that's worth, and it looks like the company's might have to add the entire Sirtris investment to the "sunk cost" pile.

For R&D intensive firms like pharmas the corollary is also true. Capital expenditures for M&A related to development programs, might in hindsight be better classified as an R&D expense. When a product results from a merger (e.g. JNJ and Cougar), the M&A is more a true capitalization cost. But when a drug fails that M&A spend was really a payment for R&D expenses incurred elsewhere, and thus an asset writedown occurs. So, perhaps the Herper article wasn't really bleak enough. He might have considered also including asset writedowns due to failed programs as additive to R&D expenses.


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12. Helical_Investor on March 18, 2013 10:57 AM writes...

This too needed additional comment.

"If you stop failing so often you massively reduce the cost of drug development ...

It can perhaps be read as 'we will stop taking risks'. This is part of the mentality that brought the plethora of 'me too' programs in years past. Programs that today, in an era of added emphasis on comparative effectiveness (over marketing skill?) are harder to generate returns on today. An unwillingness to fail serves short term goals at the expense of long term ones, a common catch-22 of publicly traded firms.


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13. barry on March 18, 2013 11:24 AM writes...

the best-proven way to reduce the failure rate in drug discovery is to stick to proven modes of action. But the potential return on such a me-too strategy (despite the ranitidine example) isn't as great as on a first-in-class.
So if you're trying to run a drug company, the task is to balance lower-risk projects against proven targets with higher-risk projects tragetting novel modes of action. If sir Andrew has figured out how to do that well, we all want to learn it.

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14. Hap on March 18, 2013 11:42 AM writes...

1) Witty has to listen to his investors, but isn't a strong distaste for risk in an inherently risky business an investing handicap?

2) While I assume that the levels of risk between a candidate for a known target and that for an unvalidated one are significant, the basic risk in developing any drug seems high enough (and the difference in price significant enough) to make avoiding riskier drugs seem not so good. If GSK can lower their general drug candidate failure rates, however, that would allow them to invest more in marginal candidates and still make reasonable money (and probably own the rest of pharma, eventually). They aren't alone in that position, though.

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15. Flem on March 18, 2013 12:25 PM writes...

Witty's assertions about prices and R&D efficiency is utter nonsense! Patented drugs are priced according to what the market will bear! If research becomes more efficant then profits will increase. Drug prices reflect profit opportunities and will go down when competition applied profit pressure on market share or if it opens up access to larger populations of users that could increase profits. duh! Drug prices are high not because of cost but because drugs are inelastic! You can buy a Ford instead of a BMW but you can't easily shop for an alternative to your healthcare or for a cheaper drug. (here's an opportunity for app!! "can't afford your medicine - there's an app for that!".

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16. Christophe Verlinde on March 18, 2013 12:52 PM writes...

I'm only a simple minded academic researcher, so don't bash me for asking. Why is the alarm bell always ringing for big pharma when in contrast, when I am reading my Chem&Eng News, the Profits listed in the latest quarterly/annual survey list large profit margins: Abbott 20.4%, Astra Zeneca 28.9%, ..., Pfizer 27.9%, Roche 26.1%, Sanofi 23.5% (for 2012)? Can somebody explain to me the discrepancy between the bleak picture and these seemingly vary large profit margins?

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17. Derek Lowe on March 18, 2013 1:48 PM writes...

#16 - Not a stupid question at all - in fact, it's occurred to me that I need to do a whole separate blog post on that issue. Coming soon. . .

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18. Diver dude on March 18, 2013 1:58 PM writes...

It not failure of drug candidates per se that's hurting the bottom line, it's late stage (Phase II and III) failure. 20-20 hindsight on many late stage failures is that the danger signals were there much earlier, it's just that no one picked them up because of the vested interest of senior management and project teams in project progression because of objectives, incentives and share price.

If GSK have genuinely addressed the "dumb incentives gives you dumb outcomes" problem, then what they say about the failures may well be true.

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19. Cellbio on March 18, 2013 2:09 PM writes...

Too early to see "streamlined synergies" materialize in increased earnings. Nice trick to play to cut expenses, potentially hurting future growth, to take advantage of prior managements wise investments in R&D that are starting to pay off.

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20. Matthew Herper on March 18, 2013 2:27 PM writes...

@16 When returns on R&D drop, they cut costs (and jobs) in order to maintain the profit margins. That's the profit margin investors want to justify the risk of drug development. When a company's profit margin drops too far too fast, that company gets bought. It's kind of like relativity: the speed of light must remain constant.

Why be in a business where failure is likely if the profit margins are thin? Then you can just be in the generics business. Or be WalMart.

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21. Passing by on March 18, 2013 2:31 PM writes...

Two points that strike me:

1. Is NewStrategy a Derek plant to keep us amused?

2. When I was at GSK (my job there disappeared 2 yrs ago) Witty was constantly saying the years of “me-too's” were over and payers will only pay for innovative meds, so it is odd that current insiders are saying nothing but “me-too's” in the pipeline

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22. johnnyboy on March 18, 2013 4:12 PM writes...

@16: the pharma industry is a bit different in that it has to invest large amounts into R&D in order to keep producing new drugs. As Matthew said, in the last 5 years pharma companies have been able to maintain decent profit margins, but at the cost of drastically cutting into their workforce, including R&D. This, combined with the absence of foreseeable blockbuster drugs to replace the ones currently going off-patent, means that even though profits are still good now, the outlook for companies being able to maintain these profits into the future is indeed bleak.

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23. Chemist turned Hedgie on March 19, 2013 2:59 AM writes...

It is fair to say that the market is not yet fully persuaded by the GSK R&D miracle rebirth, its two biggest virtues being a) 5% dividend yield, and b) not being AZN....

GSK's late-stage attrition has certainly dropped in recent years, but so has the perceived sales potential of those that survive. I too like Witty, but I sense I am in a declining fan club, the rhetoric divorced of hard results starting to get up a larger number of noses. Of course, if the MAGE A3 program works...

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24. dogbertd on March 19, 2013 6:33 AM writes...

I always love this argument that it costs $1Bn per drug because we're paying for all the failures (ergo this is why our drugs cost so much to you - the tax/insurance payer).

I can buy that it might cost $1Bn, but a blockbuster will bring that in after 1 year. So after that first year you've paid for your development costs and you've paid for all the failures along the way. But then you bring in another $1Bn the next year, and for as many years as you have patent exclusivity - all of that is gravy, right? And this is why loss of exclusivity can destroy a company's bottom line.

Pharma is still *highly* profitable when it works, and my guess is that, falling development costs or no, there will still be some good reason or other to justify screwing the payors for as much as can be got out of them.

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25. Lyle Langley on March 19, 2013 7:28 AM writes...

@24, and the rest of the post...

I think the whole argument of "it costs $1Bn to discover a drug" is fuzzy math. There needs to be two separate reporting structures in the pharma business. #1 - the overall cost of R&D - this includes all sunk costs on failed projects, but also on projects that may have been progressed knowing they would not succeed. E.g., compounds being taken to proof-of-concept knowing there are issues that would prevent development. The migraine drug from BI a few years ago that they went intranasal is one example. #2 - the cost it took for the successful drug to make it to the market. E.g., how much did it take to bring drug A to the market. #2 gets overinflated by #1; and #1 is not the true cost of getting a drug to the market. It's good marketing to use #1 for the cost of developing a drug because it can be used to justify a high price, but it's not the real number.

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26. emjeff on March 19, 2013 8:40 AM writes...

I am not a member of the Witty fan club, but I will say this - GSK is NOT developing "me-toos". A lot of what is in the pipeline is pretty innovative, and risky.

On another topic, I am astounded by the number of people on this site who think that making a profit is some kind of sin. Why do you socialists think people work, and why do you think that you know how much profit is enough?

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27. Bioorganic Chemist on March 19, 2013 9:15 AM writes...

I'll believe that drug discovery R&D is easy ("less than a billion dollars and you can have unlimited continuing profits!") and an incredible investment when I see all the new drug discovery startups pulling in investor money the way internet startups do. (Yes, I remember the early 90s.) Given that people keep dying of curable diseases, investors should be climbing over each other to take advantage of all of the available scientists and all of the easy profits from drugs. If the profit margins and ROI are that great, new drug development should be the smartest investment anyone can make. Yeah, right.

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28. Doug Steinman on March 19, 2013 11:10 AM writes...

Sorry to be late to the party again but let's be clear that sales are not profits and earnings are not profits. Profits are only determined after subtracting expenses (marketing, etc.) from earnings. So a drug that generates a billion dollars in sales is not generating a billion dollars in profits.

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29. Clone on March 21, 2013 4:09 AM writes...

#26 Re "Me Too" programs
GSK's strategy, which is mentioned frequently internally, is to avoid "Me Toos" and go for the high-risk, high potential novel stuff.
Examples in the pipeline: trametinib, darapladib, dolutegravir, losmapimod, prolylhydroxylase inhibitors, and new biologicals.

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30. Anonymous on March 28, 2013 9:30 AM writes...

The reason that GSK's pipeline is doing well now is that drugs discovered in the 1998-2008 period are now making it into the market and late stage clinic. However, GSK has laid off almost all of the people who discovered those drugs in order to buy companies like Sirtris and cut costs. So while the current P/E ratios may be good, I see the pipeline running dry in a few years once their efforts are spent, and there might be near as much to refill the pipeline.

As an example, there are several cancer drugs on the market now that were discovered by a group that was laid off in 2009. So I don't see many more innovative drugs there. Given the rewards shown to the people who invented most of GSK's current marketed drugs (all but one I know of have been laid off), I would not be surprised if current scientists are not afraid of success.

That is totally different from BW, where the scientists who invented a drug were given even more resources such that they could discover more new drugs and eventually earn Nobel awards.

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