Research and Development in the Pharmaceutical Industry

Research and development in the pharmaceutical industry is an intricate and exciting path from idea to implementation. It’s the intersection of science and innovation, leading to significant medical advancements. This process includes a series of systematic steps focused on discovering, developing, and introducing new drugs to the market. But what makes R&D so crucial in the pharmaceutical field? It’s the engine behind new therapies and remedies, offering hope and healing to countless people around the globe.

Essential Elements of Pharmaceutical Research and development

Foundations of Drug Development

Grasping the essential elements of research and development (R&D) in the pharmaceutical industry is vital. This field integrates multiple disciplines and includes several key stages:

1. Basic Research: The initial phase, focusing on fundamental studies of diseases and potential treatments.
2. Drug Discovery: The process of identifying promising compounds that could be developed into new medications.
3. Preclinical Testing: Early testing on cells and animals to evaluate safety and efficacy.
4. Clinical Trials: Comprehensive testing on humans, conducted in multiple phases to ensure safety and effectiveness.
5. Regulatory Approval: Securing approval from regulatory authorities such as the FDA.
6. Manufacturing: Scaling up production while ensuring quality control.
7. Post-Market Surveillance: Ongoing monitoring of drug safety and efficacy in real-world use.

Recent Trends in Pharmaceutical Research and development and New Drug Approvals

In 2019, the pharmaceutical industry invested $83 billion in research and development (R&D). This investment spanned various activities, including the discovery and testing of new drugs, incremental innovations like product extensions, and clinical testing for safety monitoring or marketing purposes.

The proportion of revenue allocated to R&D by pharmaceutical companies has also increased. In 2019, these companies spent about one-quarter of their revenues on R&D, nearly double the share from 2000.

The number of new drug approvals has risen over the past decade. From 2010 to 2019, the FDA approved an average of 38 new drugs per year, with a peak of 59 approvals in 2018.

A significant portion of recent drug approvals consists of specialty drugs. These drugs typically treat chronic, complex, or rare conditions and may require special handling or patient monitoring. Many specialty drugs are biologics, which are large-molecule drugs derived from living cell lines. These drugs are expensive to develop, difficult to replicate, and often come with high price tags.

The factors that influence R&D spending in drug companies can be summarized as follows:

1. Projected Global Revenues: Companies estimate the potential lifetime earnings from a new drug, considering the prices it can fetch in various markets and the expected sales volume at those prices.
2. Development Costs: The anticipated expenses involved in developing a new drug, including research, testing, and regulatory approval processes.
3. Policies and Programs: Government policies and programs that affect the supply and demand for prescription drugs also play a crucial role.

When determining a drug’s revenue potential, companies consider various factors such as the prices and sales volumes of existing drugs, which provide insights into consumers’ and insurance plans’ willingness to pay. It’s important to note that when setting the price of a new drug, companies aim to maximize future revenues after accounting for manufacturing and distribution costs.

Creating new drugs is an expensive and unpredictable endeavor, with many candidates never reaching the market. Only about 12% of drugs that enter clinical trials are eventually approved by the FDA. Recent studies estimate that the average R&D cost per new drug ranges from under $1 billion to over $2 billion. These figures encompass the costs of laboratory research and clinical trials for successful drugs, as well as the expenses for those that fail at various stages of development. Additionally, these estimates include the company’s capital costs, representing the value of other investments forgone during the R&D process. Such costs can constitute a significant portion of the total expenses for developing a new drug. The development process often spans a decade or more, during which the company does not see a financial return on its investment.

The federal government influences R&D decisions in three primary ways. Firstly, it boosts demand for prescription drugs, thereby encouraging new drug development, by subsidizing the purchase of prescription drugs through various federal programs (such as Medicare and Medicaid) and offering tax preferences for employment-based health insurance.

Secondly, the federal government enhances the availability of new drugs by funding basic biomedical research, which lays the groundwork for private industry to develop new medications. Tax incentives, such as credits for all companies and specific ones for drug companies developing treatments for rare diseases, encourage investment in R&D. Additionally, R&D investment deductions can be used to reduce tax liabilities immediately. The patent system and certain laws that delay FDA approval of generic drugs also provide pharmaceutical companies with a period of market exclusivity, allowing them to maintain higher prices and thus making new drugs more profitable, which boosts R&D investment.

Thirdly, some federal policies impact the number of new drugs by affecting both demand and supply. For instance, federal recommendations for specific vaccines increase their demand, incentivizing drug companies to develop new ones. Federal regulatory policies that influence the returns on drug R&D can lead to changes in both the supply of and demand for new drugs.

more affordable, widely-used drugs of the 1990s.

Research and development Spending

Pharmaceutical R&D spending encompasses various activities, including:

• Invention: Research and discovery of new drugs.
• Development: Clinical testing, preparation and submission of FDA approval applications, and designing production processes for new drugs.
• Incremental Innovation: Developing new dosages and delivery methods for existing drugs and testing these drugs for additional uses.
• Product Differentiation: Clinical testing of a new drug against an existing one to demonstrate superiority.
• Safety Monitoring: Post-market clinical trials required by the FDA to identify side effects not observed in shorter trials during development.

In real terms, private investment in drug R&D by members of the Pharmaceutical Research and Manufacturers of America (PhRMA) was approximately $83 billion in 2019, up from about $5 billion in 1980 and $38 billion in 2000. Although these figures do not include spending by many smaller drug companies outside PhRMA, they broadly represent the industry’s overall R&D spending trend.

Projected Revenues

A company’s revenue projections for a drug are based on the prices it expects the drug to fetch in various global markets and the quantities it anticipates selling at those prices. These projections are influenced by the observed prices and sales volumes of existing drugs in different markets. For established pharmaceutical companies, the revenue from current products is also a crucial source of funding for their research and development (R&D) projects.

Formulating Revenue Expectations

To estimate a potential drug’s future revenues, a company considers the drug’s potential market size, which is influenced by the prices it might achieve in sales to different patient groups and in negotiations with payers, both domestically and internationally. The prices of existing drugs, including their variations across different patient populations, play a significant role in determining R&D spending on future drugs. However, according to the Congressional Budget Office (CBO), current R&D spending does not affect the future prices of the resulting drugs.

Revenue Insights from Existing Drugs

The revenue generated by current drugs offers valuable insights into the potential market size for new drugs. This data reflects the willingness of consumers and insurance plans to pay for treatments. The number of prescriptions for these drugs helps estimate the number of potential patients, their likelihood of using drug therapies at observed prices, and the popularity of alternative treatments.

Market Size Expectations

Sales revenues from unrelated drugs also inform companies about market size expectations. They provide insights into the acceptable costs of drug treatments for various conditions, considering factors like duration, severity, and impact on quality or length of life.

Anticipated Revenues

Expected revenues for a new drug depend on projected unit sales in different global markets. These projections are based on the number of potential patients, the proportion of those populations likely to purchase the drug at envisioned prices (considering available substitutes), and the number of prescriptions required for a treatment course.

Pricing Strategy Post-Approval

Once a new drug is approved, the Congressional Budget Office (CBO) expects its developer to set prices with a forward-looking approach. This means pricing is aimed at maximizing net revenues without considering the development costs.

Revenues as a Source of R&D Funding

In the pharmaceutical industry, revenues from brand-name drugs have traditionally been a key source of funding for research and development (R&D). These drugs often generate substantial cash flow due to their low manufacturing and distribution costs relative to their sales revenues. Established companies typically prefer to use their current revenues to finance R&D rather than relying on external funding sources like venture capital.

Shift in R&D Funding Sources

Recently, the share of R&D funded directly by revenues has decreased. This is because more R&D is now being conducted by research-focused drug companies that have few or no products on the market. Over the past decade, small or emerging drug companies have developed an increasing share of new drugs. These companies often have limited or no revenue and must seek external financing, such as venture capital and collaborative agreements with larger pharmaceutical companies.

Drug development also takes place in university research labs. Many universities receive grants from the National Institutes of Health (NIH) for basic biomedical research. Additionally, universities may collaborate with private drug companies to conduct applied research aimed at developing new drugs

R&D Costs in Drug Development

The financial commitment required to develop a new drug is substantial and multifaceted. Beyond direct expenses incurred in preclinical research and clinical trials, pharmaceutical companies also face significant opportunity costs. These arise from the substantial capital tied up in the lengthy drug development process, which often spans over a decade.

The R&D journey involves escalating costs with each successive phase of clinical trials. Despite this, drug developers often maintain their investment, even when projected costs outweigh potential returns. This strategic decision is influenced by the potential for new insights into the drug or its market, which could ultimately increase its value.

Essentially, the development of a new drug is a high-stakes endeavor characterized by substantial financial investment, extended timelines, and continuous evaluation of potential returns.

The High Costs and Risks of Drug Development

Drug discovery is inherently a high-risk endeavor. Pharmaceutical companies routinely initiate multiple projects, understanding that the vast majority will not result in a marketable product. Even after progressing through preclinical stages, fewer than 15% of drugs ultimately gain market approval.

Developing a successful drug is incredibly expensive. Estimates of average R&D costs per approved drug vary widely but generally fall within the billion-dollar range. These figures encompass both direct expenditures and opportunity costs associated with capital invested in unsuccessful projects. It’s important to note that these estimates are based on diverse datasets and methodologies, making direct comparisons challenging. Nevertheless, they consistently underscore the substantial financial investment and high failure rates inherent in drug development.

Preclinical Research and Development

While the preclinical phase of drug development is shorter than clinical trials, it represents a substantial portion of overall R&D costs. This is primarily due to the high number of drug candidates initiated in this stage that ultimately fail to progress to clinical testing. On average, preclinical development accounts for approximately 31% of total R&D expenditures for a new drug, equating to around $474 million. When factoring in capital costs, this figure climbs to 43%.

Given that the potential return on preclinical R&D investments is contingent upon successful completion of both preclinical and clinical phases, the overall timeline for realizing a return is extended compared to clinical trial expenditures. The average duration of the preclinical phase is roughly 31 months, followed by an average of 95 months for clinical trials, totaling approximately 10.5 years. However, it’s important to note that these are averages, and the development timeline can vary significantly. For instance, one study examining ten cancer drugs reported a median development time of 7.3 years from discovery to approval.

Clinical Trials: A Complex and Costly Phase

Clinical trials demand significantly more resources and time compared to preclinical research. This phase is divided into several stages:

• Phase I: These trials primarily focus on assessing a drug’s safety in humans by testing different dosages on a small group of healthy volunteers. In cases where high toxicity is anticipated, patients with the target disease may participate.
• Phase II: Involving a larger group of patients with the target condition, Phase II trials evaluate a drug’s biological activity and identify potential side effects.
• Phase III: These extensive trials determine a drug’s clinical effectiveness. Given the need to distinguish genuine therapeutic effects from random variations in patient outcomes, larger patient populations are required when the anticipated therapeutic benefit is modest.
• Phase IV: Conducted post-market approval, Phase IV trials monitor long-term drug efficacy and identify previously undetected side effects. While not always mandatory, these trials can be essential for detecting rare adverse reactions or demonstrating a drug’s superiority over competitors for marketing purposes.

Despite the rigorous process, a substantial number of drugs fail to secure FDA approval. For every 100 drugs entering Phase I, approximately 60 advance to Phase II, just over 20 reach Phase III, and only about 12 ultimately gain market authorization. This attrition rate significantly impacts overall R&D costs, as expenses incurred on failed drug candidates are incorporated into the average cost per approved drug.

Costs escalate progressively throughout the clinical trial phases. On average, companies invest around $1.065 billion in clinical trials for each approved drug, surpassing the preclinical expenditure by a factor of two. This breakdown includes approximately $28 million for Phase I, $65 million for Phase II, and $282 million for Phase III. For drugs successfully completing the initial three phases, the average total cost is estimated at $375 million. The remaining portion of clinical trial expenses reflects investments in drug candidates that were discontinued or unsuccessful.

Public Policy and Pharmaceutical R&D

Federal policies significantly impact the research and development (R&D) spending of pharmaceutical companies, both in terms of amount and direction. While policies from other countries and different government levels also play a role, they are not covered in this discussion.

Demand and Supply Influences:

• Demand: Federal health care programs and subsidies primarily drive the demand for new drugs.
• Supply: Policies such as federal support for basic research, tax incentives for R&D spending, and market exclusivity regulations influence the supply of new drugs.
• Both: Vaccine policies and regulatory frameworks affect both supply and demand.

Changes in these policies can either make R&D investments more attractive by increasing demand or encouraging supply, or less appealing by doing the opposite.

Federal Health Care Programs and Subsidies: Various federal health care programs and subsidies boost the demand for health care services and products, including prescription drugs. This, in turn, stimulates R&D spending. Programs like Medicare, Medicaid, TRICARE, the Veterans Health Administration, the Children’s Health Insurance Program, and health insurance marketplaces established by the Affordable Care Act play a significant role. In 2019, federal and state expenditures on prescription drugs made up about 40% of total U.S. retail expenditures on these drugs.

Changes to these programs can significantly influence R&D spending. For example, the implementation of Medicare Part D in 2006 led to a substantial increase in prescription drug sales to enrollees. Additionally, Medicare enrollees with full Medicaid benefits saw improved coverage for prescription drugs

Support for Basic Research

The federal government plays a crucial role in funding basic biomedical research, which is essential for the development of new drugs. Pharmaceutical companies depend on the outcomes of this research, such as identifying disease targets for new therapies. This foundational research generates knowledge that effectively lowers R&D costs for private companies and encourages private investment in R&D by expanding the range of profitable drug development opportunities. Notably, increased funding for basic health-related research at institutions like the NIH has been shown to boost private drug R&D in related therapeutic areas.

Public Investment Rationale: Private firms often have limited incentives to invest in basic research because the knowledge generated (e.g., identifying a disease target) is not easily converted into a marketable product (e.g., a drug). The more a company can keep this information proprietary, the more valuable it is to them, thus increasing their incentive to invest. However, since information can be shared at low cost, it is challenging to keep it within a single firm. Consequently, private companies are often hesitant to conduct basic research, as they cannot retain much of the discovery’s value. For instance, once a disease target is identified, multiple companies could develop drugs targeting it, reducing the original company’s incentive to invest in the research. This leads to underinvestment in basic research by private firms, from a societal perspective, as the social benefits of additional basic research would outweigh the costs.

Policies Affecting Market Exclusivity

The federal government has implemented various policies to grant manufacturers periods of market exclusivity, aiming to boost the supply of new drugs. During these exclusivity periods, new drugs are priced higher than they will be once generic versions enter the market. These higher prices provide a return on R&D investments, encouraging companies to develop new drugs. However, this incentive is limited to the manufacturer’s own drug, as other companies can introduce competing drugs in the same therapeutic market, provided they do not infringe on existing patents.

U.S. Patent System: The primary method for granting temporary market exclusivity is through the U.S. patent system. Typically, patents expire 20 years after the application date, but pharmaceutical companies can receive additional years of patent protection because patented drugs cannot be sold until they complete clinical trials. Often, drug patent applications are filed before clinical trials begin to avoid disclosures from those trials being considered “prior art,” which could invalidate a patent if filed later. Recognizing that a drug might spend several years of its market exclusivity in clinical trials without generating revenue, the Hatch-Waxman Act allows pharmaceutical companies to seek up to five additional years of patent protection.

Vaccine Policies

Federal Policies Increasing Vaccine Demand and R&D: Several federal initiatives boost the demand for vaccines, consequently increasing research and development (R&D) spending. For instance, the Vaccines for Children program offers free vaccines to children from low-income families. Additionally, the Centers for Disease Control and Prevention (CDC) issues vaccination schedules for both children and adults, with specific recommendations for various groups such as healthcare workers, travelers, pregnant women, and individuals with certain health conditions. These recommendations encourage people to get vaccinated, while federal subsidies help reduce the cost of vaccinations for consumers. A study found that the 1991 recommendation for infants to receive the hepatitis B vaccine and the 1993 expansion of Medicare to cover influenza vaccinations led to increased vaccine development, indicating that manufacturers anticipated higher demand due to these recommendations.

Federal Policies Affecting Vaccine Supply: Federal policies also impact the supply of vaccines. The Vaccine Injury Compensation Fund, established in 1986, aims to encourage vaccine development by protecting manufacturers from lawsuits related to adverse reactions to childhood vaccines. The introduction of this fund was linked to an increase in new vaccine development.

COVID-19 Vaccine Development: In 2020, the federal government directly invested over $19 billion to support the private development of COVID-19 vaccines through the Biomedical Advanced Research and Development Authority (BARDA).

Regulatory Policies: Federal regulatory policies also play a role in influencing drug supply and demand.