Sunday, December 02, 2007

Drug Companies and Their Big Marketing Budgets

A recent post of mine was pretty down on the drug companies (or at least GlaxoSmithKline). Now I'm back to defending them.

Amy Tenderich, was diagnosed with Type I diabetes several years ago and was galvanized to start my favorite patient blog, Diabetes Mine. She recently blogged about the big marketing budgets of pharmaceutical companies and the relative paucity of money they spend on R & D. As usual, I have some thoughts on this.

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A recent post of mine was pretty down on the drug companies (or at least GlaxoSmithKline). Now I'm back to defending them.

But first, a disclaimer. The subject is an extremely complex one and an attempt to arrive at a truly informed opinion would require a great deal of time which given my regular gig, hanging with the wife and kid, and watching old Picket Fences reruns is in precious short supply. But ignorance won't stop me from pontificating on this topic because I believe it is important and engaging. The bottom line is, if you've got a more solid viewpoint than mine, I'm happy to be educated!

Amy Tenderich, was diagnosed with Type I diabetes several years ago and was galvanized to start my favorite patient blog, Diabetes Mine. Her writing is passionate, engaging, and represents the informed work of an advocate seeking to better both her life and the lives of others affected by this disease.

She blogged recently about an article in Newsweek decrying the lack of progress the drug companies are making at bringing new and innovative products to market. In the article she cites, ex-Intel CEO Andrew S. Grove skewers the industry. Grove has Parkinsons disease and is understandably upset at the lack of progress being made by pharma as is Tenderich for diabetes.

He notes the incredible progress the computer industry has made compared with that of the drug trade. In the years he worked at Intel, integrated circuits went from 1,000 transistors per chip to 10 billion transistors per chip. For the treatment of Parkinson's in that same period, "we have gone from levodopa to levodopa" (not entirely true but a not unreasonable first approximation).

Tenderich too is concerned about the same thing. She points out that the drug industry spends a third of its revenues on marketing but only a fifth on R & D. I assume she pointed out this lack of priority as a reason for why the pharmaceutical industry lags the computer industry.

Well guess what. I looked up Intel's 2006 financials (see page 33). With revenues of $35 billion, they spent $6 billion on R & D which comes to only 17%. This is less than Pharma. I can't calculate the percent spent on marketing because Intel doesn't break their expenses down that way (it will certainly be less than a third though because marketing, general, and administrative were lumped together and were around $6 billion as well).

Let's assume for argument's sake that Intel is representative of its industry as a whole. We then note three things:
  1. The semiconductor industry spends the same (or even a lower) percentage of revenues on R & D than pharma.

  2. The semiconductor industry seems to be accomplishing far more with its research dollars than pharma.

  3. Pharma probably spends a higher percentage on marketing
Taken together, these facts raise several questions. First of all, why is the semiconductor/computer industry progressing in leaps and bounds while pharma is languishing in the doldrums?

Truthfully, there is an implicit assumption that hasn't been proven and is likely unprovable, namely that the progress made in medical interventions isn't as extraordinary as that made in computer science.

Sure, we can measure the strides made in IC chip technology with CPU cycle times and transistor densities. However, medical science doesn't lend itself to such simple benchmarks. Ask yourself: does the 10 million-fold increase in transistor density described above really outstrip say the dramatic reduction in mortality in AIDS or in some cancers? Who can say?

If age-specific breast cancer mortality rates have fallen by only a percentage point or two, that doesn't sound nearly as sexy as the strides companies like Intel can boast. Let me remind you however that the former corresponds to a few thousand lives saved each year. These patients and their family members are probably more impressed with that than with having fancier Gameboys.

So just because the semiconductor industry can cite some cute statistics doesn't mean we should discount medical advances over the same period.

I'd also like to point out as though we really need to be reminded of this: human biochemisty, physiology, and pathology is almost unimaginably complex. Diseases such as Parkinson's and diabetes are tough nuts to crack. Getting to the moon was comparatively easy and was accomplished back in the sixties with computers less powerful than the one driving your $10 throw-away watch. Don't downplay either the complexity of these or other diseases nor the vast array of factors that have to be taken into account to ensure drug efficacy and safety.

The second question that I would raise is why aren't drug company R & D budgets significantly bigger than their marketing budgets? This is equivalent to asking why pharma doesn't shift more of its revenue from marketing towards R & D. I think the reason is straightforward and has to do with risk.

R & D money by definition is money spent on speculation. Marketing money is "safe". As the venture in question becomes more risky, the safer thing is to partition capital towards marketing (safe) and away from R & D (risky). The fact of the matter is that there are few high-stake risks more threatening than those assumed by drug companies.

Consider that it costs over $800 million dollars to bring a new drug to market (in 2000 dollars). This number includes the presumably less risky "me too" drugs that are relatively simple modifications of existing drugs. One can only imagine the cost of bringing a completely novel drug class to market.

Then one must figure in the post-market risks. Pfizer just took a $2.8 billion write-off for their inhaled insulin technology, Exubera. It was a lousy performer in the marketplace. Merck is going to spend untold billions settling their Vioxx lawsuits.

And there's something else that drug companies are having to deal with that's relatively new. This is something that can dramatically increase the risk of development thus causing CEO's to flee even further in the direction of marketing and away from R & D: evidence-based access.

It used to be that to get your drug covered by a health plan all you needed was to show that it was incrementally better than the old drug. If your new drug only needs to be taken once a day rather than twice like the old drug, that was enough for it to be added to the authorized formulary of the insurance companies. No more.

With evidence-based access, not only does your drug have to be better, it has to be demonstrably better at improving outcomes. It may get past the FDA but if you want your drug to get on the insurance companies' formularies, you have to also show an economic advantage. For example, if your antibiotic can be taken just once a day compared to twice a day, will patient compliance be better with demonstrably better outcomes (i.e. eradication of infections)? Obviously this is much harder to prove and this increases the risk of bringing that drug to market. So you can see, many factors and many risks are involved in the drug industry that make comparisons with companies like Intel unfair.

In the best of all worlds, companies developing medical technologies would spend the bulk of their non-operational costs on R & D and none on marketing. If the technologies they produce are so great, shouldn't they just sell themselves? Unfortunately that's not how the world works. You can bet that your competitors are investing in marketing like crazy. It would be corporate malpractice for a CEO to not do the same thing.

In the final analysis, it's the competition between companies for increased market share that drives American pharmaceutical companies to be the most innovative and productive in the world. Not that either Grove or Tenderich were advocating this, but government regulation of R & D budgets or in some other way interfering with managements' drive to maximizing shareholder return will surely cause us to lose that edge.

Of course for those with serious medical conditions such as Parkinson's or diabetes, this is small consolation. What is really necessary is for advocates like Grove and Tenderich to continue to speak out as they are doing. If the drug companies can be convinced that there's a big enough market from a demanding enough constituency, they will seek to fill that vacuum.

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