Valuing Innovative Drugs Based On Their Cost Of Manufacturing Will Prolong The Covid-19 Pandemic
The value of innovative medicines has absolutely nothing to do with its cost of production. Yet, not only does this myth persist, it appears to be growing. In the latest example, an article in the Journal of Virus Eradication claims that drugs being repurposed in the hopes they might be effective treatments for Covid-19, such as remdesivir and sofosbuvir, could be profitable at very low costs.
How do the authors come up with this conclusion? They claim that the costs of production range between $0.30 and $31.00 per treatment course (10–28 days). Therefore, even if the medicines are sold at cheap prices, these low prices would still be higher than their costs of production.
This claim is bunk because it fails to understand the actual costs of innovation. To understand these costs, it is necessary to distinguish between these innovative (branded) medicines and generic medicines.
The market for many drugs, such as statins and amoxicillin, is highly competitive because generic medicines are widely available. In these markets, drug prices reflect the costs of production and are typically a fraction of the cost in markets that are exclusively comprised of branded medications. This makes sense because the value generic manufacturers provide is their production expertise and ability to safely produce and deliver a product with known benefits.
This production expertise is not the most important value provided by innovative drug manufacturers. The value created by innovative manufacturers is their ability to successfully navigate the long, expensive, and risky process of discovering new treatments.
According to the Tufts Center for the Study of Drug Development, it costs $2.6 billion to successfully develop one new drug, including the cost of failures. Incorporating the post-approval R&D expenditures, the total cost reach nearly $2.9 billion. This process also takes 10 to 15 years to complete and is replete with failures.
A dangerous tension exists because once an innovative drug is discovered, manufacturing the compound is relatively easy. But, the value of innovative drugs is not reflected in the costs of physically manufacturing the products. The value is based on innovators discovery of new knowledge that directly leads to new and better treatments for patients.
The government grants patents and exclusivity to enable the prices of innovative drugs to reflect the value of the new knowledge created rather than the costs of producing a pill. Allowing prices to reflect the value of this new knowledge provides the innovative manufacturers with an opportunity to recoup the cost of creating it, which includes the costs of failures, and incents a vibrant innovative drug industry that is capable of finding treatments for cancer, heart disease, and Covid-19.
Without this opportunity, the incentive to undertake the costly process of developing innovative drugs would be diminished just as the incentive to become a doctor would be diminished if their salaries were artificially constrained to equal their cost of production. In the case of doctors, the equivalent cost of production could be viewed as how much it would cost to live in their respective hometowns. Take Kansas City, Missouri as the example.
The average rent in Kansas City, Missouri is $1,012 per month. The average costs for the other living expenses in the Kansas City area, which include food, utilities, transportation, and entertainment for a typical family of four, adds another $3,255 a month. Throw in a 20 percent kicker to cover the costs of the federal, state, and local taxes that must be paid, and a doctor’s cost of production in Kansas City can be considered to be around $61,400.
But, the salaries of doctors in Kansas City do not equal this “cost of production” salary. Nor should they. According to Glassdoor.com, the average base pay for a doctor is $168,121, and could be as high as $305,000. Doctors deserve these higher salaries, of course. And, the justification for these higher salaries is not simply the cost of a medical education either. Doctors earn higher salaries because patients highly value their medical expertise.
The same is true for innovative drugs, particularly the drugs that could be effective treatments for Covid-19. Unlike generic medications, the cost of physically producing a pill or an infusion drug is an irrelevant value benchmark. What is relevant is the practical knowledge the innovative manufacturer developed, and the broader societal benefits enabled by that knowledge. These benefits include the improved patient health outcomes, reduced patient mortality, reduced need (and expense) for other health interventions, and the potential increase in other social and economic benefits (e.g. reduced burdens on caregivers or the ability to return to work).
With respect to Covid-19, clearly, an effective treatment would create exceptionally large benefits. This pandemic is imposing trillions of dollars in financial costs on families and businesses, which pale in comparison to Covid-19’s impact on mortality, people’s health, and the strain it is imposing on the nation’s healthcare infrastructure.
The value of a potential medicines for Covid-19 depends on its ability to reduce the severity, mortality, and costs created by this coronavirus. Both remdesivir (which is still not FDA approved, but has received an emergence use authorization from the FDA) and sofosbuvir (which received FDA approval in 2017 and remains under patent) are demonstrating promise as treatments for Covid-19.
Should these drugs meaningfully lessen these costs, then these innovative medicines are highly valued and have earned an opportunity to recover the costs of innovation. Without this opportunity, there would be insufficient resources devoted toward developing effective treatments and vaccines that could bring the Covid-19 pandemic under control.
It is a myth that the value of innovative medicines is based on their cost of production. This myth is an obstruction that, if allowed to perpetuate, makes it more difficult for public health authorities to effectively manage the current health crisis.
I am a Senior Fellow in Business and Economics at the Pacific Research Institute and the Director of PRI’s Center for Medical Economics and Innovation. My research explores the connection between macroeconomic policies and economic outcomes, with a focus on the health care and energy industries. I have over 25 years of experience advising Fortune 500 companies, medium and small businesses, and trade associations. I received my Ph.D. in economics from George Mason University.