Yves here. Many have explained why the big drug companies, despite wrapping themselves in R&D, are actually not that much in the business of innovation. They have been spending more money on marketing than research for a long time. And collectively they spend more money on buybacks than on research. Moreover, for decades, the overwhelming majority of new drug applications are actually minor modifications intended to extend the life of the patent. A large degree of “research” is driven by copyright and other art accounting1 it contributes to the dominance of large pharmaceutical companies in reported R&D spending, as opposed to other measures of actual drug research.
This paper clearly points out that small biotech companies, which are not affected by drug price reductions, are responsible for many clinical trials, which are a decent representative of innovation.
By Fred Ledley, Professor of Natural & Applied Sciences and Management, Bentley University and Director, Center for the Integration of Science and Industry, Bentley University; Henry Dao, Researcher & VP of Portfolio Management, Bentley University; and Cody Hyman, Assistant Professor, Finance, Bentley University. Originally published on the website of the Institute for New Economic Thinking
The two years since Congress passed the Inflation Reduction Act (IRA) have seen a flurry of comments from both public and industry advocates debating its effect on drug prices and development. Some commentators celebrate the beginning of public representation in drug price negotiations; others lament the loss of shareholder control over pharmaceutical markets. However, all parties have intensified their efforts to gain political influence.
But while the past two years have been a bonanza for experts, advocates, and advocates, scholarship has struggled due to a lack of publicly available data on key data to make judgments about all claims: drug prices and drug development costs; foundations that run biotechnology and pharmaceutical companies; and the emergence of conflicts of interest between authors and publishing houses.
Two papers this week from the Center for the Integration of Science and Industry at Bentley University show how basic scholarship can reinvent the IRA debate. Original paper, published in a journal Clinical Trialsexamined the financials of 1,378 public biopharmaceutical companies to understand their contributions to drug discovery, their main sources of new capital, and how R&D spending has varied in response to changes in revenue or new investment from 2000 to 2018. Second, our new INET working paper, examines the relationship between drug price indicators (consumer or producer) and investment in the biotechnology industry.
This study shows that approximately 5% of public biopharmaceutical companies are large, profitable drug manufacturers, accounting for approximately 90% of global drug sales, revenue, and R&D spending. They also distribute more cash to shareholders through dividends and stock buybacks than they receive from stock sales. For these companies, revenue serves as the main source of innovation capital and R&D spending varies in proportion to revenue.
In contrast, 95% of public biopharmaceutical companies are small biotechnology firms, often with no products, little revenue, and poor profits but they fund about 60% of clinical trials. These companies raise most of their capital for innovation through dividend offerings, rather than cash flow. Importantly, the analysis shows no correlation between consumer indicators or manufacturer drug prices and investments or prices in biotechnology companies.
These results suggest that the analysis of the IRA’s impact on the pharmaceutical industry cannot be based on the assumption that valuations and strategies can be predicted from discounted cash flows, revenues, or profits. While these principles may apply to large, profitable pharmaceutical companies, they do not describe small, biotechnology-based companies or the biopharmaceutical industry as a whole. However, as we write in our INET paper, much of the research that has informed the debate on the IRA is based on the analysis of large pharmaceutical manufacturers and ignores the unique nature of many biotechnology firms.
Reframing the debate based on evidence of effectiveness suggests that the biopharmaceutical industry and investors should not be adversely affected by the IRA’s drug pricing provisions and may benefit. Our models suggest that large pharmaceutical companies can maintain both their profits and the number of new drug approvals at current levels by reallocating R&D spending to the later stages of clinical development and replenishing their pipelines through in-licensing or acquisition of clinical-stage products from smaller biotechnology firms. One immediate effect of such a strategy would be to increase the asset value of these large companies relative to their R&D costs, which could improve their fundamentals in traditional asset-based valuation models.
For small biotechnology companies, our analysis suggests that changing drug prices will not have a negative impact on investment or valuation. At the same time, the growing demand for licensing or acquisition of their clinical-stage products by large pharmaceutical firms can create greater competition for these assets, increasing the price of these purchases and the potential returns for investors.
On its own, lowering drug prices can have a positive impact on the market. Higher health care costs have been shown to have negative effects on consumer spending and credit. Health care costs are also a big drag on business finances, with employers covering 73-83% of employee health care costs or an average of $8,435 per person ($23,968 per family). Although prescription drugs account for about 9% of total health care costs, any reduction in health care costs would benefit companies and their investors throughout the broader economy.
It could be argued that various institutional investors, who hold large equity in large pharmaceutical companies, can build value for their broader portfolios by advocating for reduced drug prices in their pharmaceutical portfolio rather than opposing the expected reductions under the IRA.
Although our research may not justify the Panglossian view of the blindness of the IRA’s impact on the biopharmaceutical industry or on the stock markets, it should set aside the industry’s unsubstantiated claims that the IRA’s drug pricing provisions represent a major threat to their firms, their shareholders. , or the invention of medicine. In fact, the biggest threat may be the industry’s persistent claims that the IRA will have a negative impact, which could translate into negative sentiment among investors and negative market volatility.
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1 This factoid is dated but easy to understand and I am very confident, representative. Long ago, Bristol Myers owned Clairol. Hair coloring is a surprisingly profitable business (and actually has barriers to entry, there’s a lot of chemical technology involved). A product made for pennies a box sells for dollars a box. A member of the C-suite told me years ago about the many games that Bristol used to shift as much from the drug business to Clairol as possible, both to increase the profits of the reported drugs (which Wall Street offered higher multiples than color or OTC drugs) and similarly, the amount as many drugs as possible were classified as related to the study.
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