According to the PhRMA (Pharmaceutical Research and Manufacturers of America) U.S. drug companies spent $39.4 billion on research and development in 2005. Much of this money goes towards the clinical trials necessary for FDA approval. But how much does it cost to bring a drug to market?
In order to bring a drug to market, a firm must go through a variety of phases for FDA approval. There are pre-clinical trials on animals. Next, in phase I, a small number of healthy volunteers are tested in order to establish safe doses and to gather information on the compound. In phase II, 100-300 individuals with the disease are selected in order to determine safety and efficacy. Phase III repeats phase II, but instead uses a sample of 1000 to 3000 individuals and examines the long run health effects of the drug as well.
DiMasi, Hansen and Grabowski (2003) estimate the cost of bringing a drug from phase I to market. Their data come from the Tufts Center for the Study of Drug Development (CSDD). The firms included in their survey represent 42% of all pharmaceutical R&D expenditures in the U.S. The authors found that the time from the start of clinical testing to marketing approval was approximately 90.3 months. This figure is in addition to any development time which occurs before phase I clinical trials. The authors take into account the cost of money used to finance the R&D using a 9% real cost of capital estimate. The final estimate is that it costs–including the expense of failed drugs–$802 million to take a drug from phase I trials to approval. Over 50% of this figure is the cost of capital needed to finance the R&D over such a long period.
Some observers would say that reducing FDA restrictions would reduce the price of drugs consumers face. I do not believe this to be the case. After the R&D is spent, firms price their drug to maximize profits subject to consumer demand. Reducing R&D costs will reduce the sunk costs, but not the marginal costs for pharmaceutical producers. What reducing FDA restrictions will do is increase a firm’s incentive to invest in drug development, because the revenue threshold to make an adequate return on capital will be reduced with a lower cost of gaining approval.
DiMasi, Hansen, Grabowski (2003) “The price of innovation: new estimates of drug development costs,” Journal of Health Economics; Vol 22, pp. 151-185.