Why do I dislike drug companies?

Oh yeah, this is why.

When most companies want unadulterated positive news coverage, they usually buy an advertisement. No need, however, when the Wall Street Journal chooses to present a one-sided infomercial under the guise of an interview, such as it did in this weekend’s interview with Eli Lilly and Company CEO Sidney Taurel. The article begins,

Is the future of your health riding on what happens in Washington? Sidney Taurel thinks it might be. The Eli Lilly CEO ticks off a list of former “death sentences” being cured or turned into chronic conditions – “AIDS, leukemia, Hodgkins, hopefully solid tumors within the next few years. The potential for medical research is unlimited. We just need to make sure we don't interdict it by the wrong policies.”

And what might those “wrong policies” be? Anything, it would appear, that reduces the financial incentives for drug companies to invest in research and development.

Per the usual, Mr. Taurel tries to present the high cost of drugs as an either/or proposition. The WSJ reports,

We are at a “crossroads” in the U.S., he [Taurel] says, “between people who want a government-run system and those of who want a free market” in health care.

Actually, that’s not the choice at all. The real choice is whether the US can afford the drug companies’ version of R&D? Can we afford their business model? It is a business model, one might add, that is already changing. Much of the R&D is being outsourced in order to save money, and, I would add, a portion of that R&D is being conducted at public universities and the National Institutes of Health, which are, of course, already funded by the taxpayer. Likewise, the marketing budgets of major pharmaceutical companies are many multiples higher than they were two decades ago. Add to that the legal shenanigans surrounding patents and generic competitors, and Mr. Taurel’s black-and-white, us-versus-them, good-versus-evil characterizations of the drug industry become the height of arrogance and bad faith.

Further, one point that is often overlooked in this debate concerning “free markets versus government interference” is how much the major pharmaceutical companies depend upon the government to protect not only their profits, but their markets. If you take arguments, such as Mr. Taurel’s, to their logical end, a world without any government interference whatsoever would be just as damaging to the drug companies as a government-run system. If Big Pharma, Inc. invested a gazillion dollars in its new WonderDrug, and then fully priced it, what would happen when the only market for that drug is too small—at any price—to recoup the investment? Simply put, drug companies rely upon the middle market a great deal, because there aren’t enough wealthy customers in the world to recoup the cost of development and make a profit besides. And the middle market, of course, relies upon programs sponsored by government and private business to help buy the drugs. In effect, it’s already a ‘government-run system,’ but one which the drug companies have gamed. No wonder they’re loth to see changes.

And, of course, there is an elephant in the room concerning the drug-discovery process. It is said that the US pharmaceutical industry has a very large lead over other countries in terms of innovation, and that new laws and regulations could endanger that lead. But if the cost of innovation is too dear for us to bear, how is it that other countries will find it less so? Against whom, exactly, are we competing at this break-neck pace? There is an inherent flaw in such thinking, in believing that innovation has only one speed (the fastest) and one cost (the highest).

There are many solutions to such a problem. For instance, the current business model for innovator pharmaceutical companies is basically this: (a) research thousands of promising molecules for a variety of therapies; (b) costly R&D follows with costly clinical trials; (c) if you’re lucky, a couple of promising drugs hit the market; (d) you charge an arm and a leg to make up the cost of development and see a profit before the patent expires.

Part of the cost of new drugs can be chalked up to (d). Pharmaceutical companies are forever mindful that the clock is always ticking, that in effect, you better make all the money you can before the patent life expires, because after that time, profits will fall by as much as 80% to 90% in a matter of months once generics hit the pharmacy shelf. Couldn’t we simply change the patent law concerning pharmaceutical innovations so that the clock doesn’t begin ticking until the relevant drug is on the market? As it is now, the patent clock begins ticking when the patent is approved, often very early in the drug-discovery process, giving companies even less time to maximize profits from their invention. Or even more radically, couldn’t we just extend the patent life of pharmaceutical products, so that the revenue stream is “lighter, but longer.” Such a move could lower the unit price for consumers, as well as provide greater long-term security to the drug firms by virtually annuitizing their revenue stream. The yearly revenue might well be lower, but they would at least be assured of having such revenues over a longer period of time.

Of course, this sounds good in principle, but who trusts the drug companies when CEOs such as Mr. Taurel so blatantly misrepresent their businesses to the rest of us?

Some of the biggest critics of pharmaceutical companies are not—despite Mr. Taurel’s shrill words—so-called government interventionists, but are instead hard-nosed capitalists who view the US pharmaceutical industry as coddled, pampered, lazy, and unimaginative. For example, in a recent article appearing on The McKinsey Quarterly’s website, Maria A. Gordian, Navjot Singh, and Rodney W. Zemmel explain that many drug companies are simply lousy at managing the risks characteristic of the drug industry:

Clearly, pharmaceutical executives must also apply more rigor to their decision-making processes and steel themselves to make tougher decisions during Phase II. The results of the study, confirmed by our experience, suggest that drugmakers let too many compounds proceed to Phase III despite negative clinical and statistical evidence. One problem is wishful thinking: teams may work on a given compound for years and therefore run the risk of losing their objectivity. Senior executives can feel pressured by investor expectations and therefore allow projects to proceed despite the risks.

Poorly designed incentives also come into play: some drugmakers reward senior managers for the number of products in the pipeline at one stage or another and not necessarily for making good decisions about them. This should change. Similarly, incentives for scientists should be tailored around faster development times for lower-risk compounds and the need to develop medically unique products.

Mr. Taurel is correct in that the financial incentives to innovate cannot be taken away from pharmaceutical companies without doing great harm to the industry, but in Mr. Taurel’s view of things, it would seem that he prefers a system in which the innovators are also shielded from risk and mismanagement. You can’t take your coated aspirin, Mr. Taurel, and have it, too.