The Truth About the Drug Companies
By Marcia Angell

Second, the pharmaceutical industry is not especially innovative. As
hard as it is to believe, only a handful of truly important drugs have
been brought to market in recent years, and they were mostly based on
taxpayer-funded research at academic institutions, small biotechnology
companies, or the National Institutes of Health (NIH). The great
majority of "new" drugs are not new at all but merely variations of
older drugs already on the market. These are called "me-too" drugs.
The idea is to grab a share of an established, lucrative market by
producing something very similar to a top-selling drug. For instance,
we now have six statins (Mevacor, Lipitor, Zocor, Pravachol, Lescol,
and the newest, Crestor) on the market to lower cholesterol, all
variants of the first.

http://www.nybooks.com/articles/17244

Every day Americans are subjected to a barrage of advertising by the
pharmaceutical industry. Mixed in with the pitches for a particular
drug—usually featuring beautiful people enjoying themselves in the
great outdoors—is a more general message. Boiled down to its
essentials, it is this: "Yes, prescription drugs are expensive, but
that shows how valuable they are. Besides, our research and
development costs are enormous, and we need to cover them somehow. As
'research-based' companies, we turn out a steady stream of innovative
medicines that lengthen life, enhance its quality, and avert more
expensive medical care. You are the beneficiaries of this ongoing
achievement of the American free enterprise system, so be grateful,
quit whining, and pay up." More prosaically, what the industry is
saying is that you get what you pay for.

Is any of this true? Well, the first part certainly is. Prescription
drug costs are indeed high—and rising fast. Americans now spend a
staggering $200 billion a year on prescription drugs, and that figure
is growing at a rate of about 12 percent a year (down from a high of
18 percent in 1999).[1] Drugs are the fastest-growing part of the
health care bill—which itself is rising at an alarming rate. The
increase in drug spending reflects, in almost equal parts, the facts
that people are taking a lot more drugs than they used to, that those
drugs are more likely to be expensive new ones instead of older,
cheaper ones, and that the prices of the most heavily prescribed drugs
are routinely jacked up, sometimes several times a year.

Before its patent ran out, for example, the price of Schering-Plough's
top-selling allergy pill, Claritin, was raised thirteen times over
five years, for a cumulative increase of more than 50 percent—over
four times the rate of general inflation.[2] As a spokeswoman for one
company explained, "Price increases are not uncommon in the industry
and this allows us to be able to invest in R&D."[3] In 2002, the
average price of the fifty drugs most used by senior citizens was
nearly $1,500 for a year's supply. (Pricing varies greatly, but this
refers to what the companies call the average wholesale price, which
is usually pretty close to what an individual without insurance pays
at the pharmacy.)

Paying for prescription drugs is no longer a problem just for poor
people. As the economy continues to struggle, health insurance is
shrinking. Employers are requiring workers to pay more of the costs
themselves, and many businesses are dropping health benefits
altogether. Since prescription drug costs are rising so fast, payers
are particularly eager to get out from under them by shifting costs to
individuals. The result is that more people have to pay a greater
fraction of their drug bills out of pocket. And that packs a wallop.

Many of them simply can't do it. They trade off drugs against home
heating or food. Some people try to string out their drugs by taking
them less often than prescribed, or sharing them with a spouse.
Others, too embarrassed to admit that they can't afford to pay for
drugs, leave their doctors' offices with prescriptions in hand but
don't have them filled. Not only do these patients go without needed
treatment but their doctors sometimes wrongly conclude that the drugs
they prescribed haven't worked and prescribe yet others—thus
compounding the problem.

The people hurting most are the elderly. When Medicare was enacted in
1965, people took far fewer prescription drugs and they were cheap.
For that reason, no one thought it necessary to include an outpatient
prescription drug benefit in the program. In those days, senior
citizens could generally afford to buy whatever drugs they needed out
of pocket. Approximately half to two thirds of the elderly have
supplementary insurance that partly covers prescription drugs, but
that percentage is dropping as employers and insurers decide it is a
losing proposition for them. At the end of 2003, Congress passed a
Medicare reform bill that included a prescription drug benefit
scheduled to begin in 2006, but as we shall see later, its benefits
are inadequate to begin with and will quickly be overtaken by rising
prices and administrative costs.

For obvious reasons, the elderly tend to need more prescription drugs
than younger people—mainly for chronic conditions like arthritis,
diabetes, high blood pressure, and elevated cholesterol. In 2001,
nearly one in four seniors reported that they skipped doses or did not
fill prescriptions because of the cost. (That fraction is almost
certainly higher now.) Sadly, the frailest are the least likely to
have supplementary insurance. At an average cost of $1,500 a year for
each drug, someone without supplementary insurance who takes six
different prescription drugs—and this is not rare—would have to spend
$9,000 out of pocket. Not many among the old and frail have such deep
pockets.

Furthermore, in one of the more perverse of the pharmaceutical
industry's practices, prices are much higher for precisely the people
who most need the drugs and can least afford them. The industry
charges Medicare recipients without supplementary insurance much more
than it does favored customers, such as large HMOs or the Veterans
Affairs (VA) system. Because the latter buy in bulk, they can bargain
for steep discounts or rebates. People without insurance have no
bargaining power; and so they pay the highest prices.

In the past two years, we have started to see, for the first time, the
beginnings of public resistance to rapacious pricing and other dubious
practices of the pharmaceutical industry. It is mainly because of this
resistance that drug companies are now blanketing us with public
relations messages. And the magic words, repeated over and over like
an incantation, are research, innovation, and American. Research.
Innovation. American. It makes a great story.



But while the rhetoric is stirring, it has very little to do with
reality. First, research and development (R&D) is a relatively small
part of the budgets of the big drug companies—dwarfed by their vast
expenditures on marketing and administration, and smaller even than
profits. In fact, year after year, for over two decades, this industry
has been far and away the most profitable in the United States. (In
2003, for the first time, the industry lost its first-place position,
coming in third, behind "mining, crude oil production," and
"commercial banks.") The prices drug companies charge have little
relationship to the costs of making the drugs and could be cut
dramatically without coming anywhere close to threatening R&D.

Second, the pharmaceutical industry is not especially innovative. As
hard as it is to believe, only a handful of truly important drugs have
been brought to market in recent years, and they were mostly based on
taxpayer-funded research at academic institutions, small biotechnology
companies, or the National Institutes of Health (NIH). The great
majority of "new" drugs are not new at all but merely variations of
older drugs already on the market. These are called "me-too" drugs.
The idea is to grab a share of an established, lucrative market by
producing something very similar to a top-selling drug. For instance,
we now have six statins (Mevacor, Lipitor, Zocor, Pravachol, Lescol,
and the newest, Crestor) on the market to lower cholesterol, all
variants of the first. As Dr. Sharon Levine, associate executive
director of the Kaiser Permanente Medical Group, put it,

If I'm a manufacturer and I can change one molecule and get
another twenty years of patent rights, and convince physicians to
prescribe and consumers to demand the next form of Prilosec, or weekly
Prozac instead of daily Prozac, just as my patent expires, then why
would I be spending money on a lot less certain endeavor, which is
looking for brand-new drugs?[4]

Third, the industry is hardly a model of American free enterprise. To
be sure, it is free to decide which drugs to develop (me-too drugs
instead of innovative ones, for instance), and it is free to price
them as high as the traffic will bear, but it is utterly dependent on
government-granted monopolies—in the form of patents and Food and Drug
Administration (FDA)–approved exclusive marketing rights. If it is not
particularly innovative in discovering new drugs, it is highly
innovative— and aggressive—in dreaming up ways to extend its monopoly
rights.

And there is nothing peculiarly American about this industry. It is
the very essence of a global enterprise. Roughly half of the largest
drug companies are based in Europe. (The exact count shifts because of
mergers.) In 2002, the top ten were the American companies Pfizer,
Merck, Johnson & Johnson, Bristol-Myers Squibb, and Wyeth (formerly
American Home Products); the British companies GlaxoSmithKline and
AstraZeneca; the Swiss companies Novartis and Roche; and the French
company Aventis (which in 2004 merged with another French company,
Sanafi Synthelabo, putting it in third place).[5] All are much alike
in their operations. All price their drugs much higher here than in
other markets.

Since the United States is the major profit center, it is simply good
public relations for drug companies to pass themselves off as
American, whether they are or not. It is true, however, that some of
the European companies are now locating their R&D operations in the
United States. They claim the reason for this is that we don't
regulate prices, as does much of the rest of the world. But more
likely it is that they want to feed on the unparalleled research
output of American universities and the NIH. In other words, it's not
private enterprise that draws them here but the very opposite—our
publicly sponsored research enterprise.

Over the past two decades the pharmaceutical industry has moved very
far from its original high purpose of discovering and producing useful
new drugs. Now primarily a marketing machine to sell drugs of dubious
benefit, this industry uses its wealth and power to co-opt every
institution that might stand in its way, including the US Congress,
the FDA, academic medical centers, and the medical profession itself.
(Most of its marketing efforts are focused on influencing doctors,
since they must write the prescriptions.)

If prescription drugs were like ordinary consumer goods, all this
might not matter very much. But drugs are different. People depend on
them for their health and even their lives. In the words of Senator
Debbie Stabenow (D-Mich.), "It's not like buying a car or tennis shoes
or peanut butter." People need to know that there are some checks and
balances on this industry, so that its quest for profits doesn't push
every other consideration aside. But there aren't such checks and
balances.
2.

What does the eight-hundred-pound gorilla do? Anything it wants
to.

What's true of the eight-hundred-pound gorilla is true of the colossus
that is the pharmaceutical industry. It is used to doing pretty much
what it wants to do. The watershed year was 1980. Before then, it was
a good business, but afterward, it was a stupendous one. From 1960 to
1980, prescription drug sales were fairly static as a percent of US
gross domestic product, but from 1980 to 2000, they tripled. They now
stand at more than $200 billion a year.[6] Of the many events that
contributed to the industry's great and good fortune, none had to do
with the quality of the drugs the companies were selling.

The claim that drugs are a $200 billion industry is an understatement.
According to government sources, that is roughly how much Americans
spent on prescription drugs in 2002. That figure refers to direct
consumer purchases at drugstores and mail-order pharmacies (whether
paid for out of pocket or not), and it includes the nearly 25 percent
markup for wholesalers, pharmacists, and other middlemen and
retailers. But it does not include the large amounts spent for drugs
administered in hospitals, nursing homes, or doctors' offices (as is
the case for many cancer drugs). In most analyses, they are allocated
to costs for those facilities.

Drug company revenues (or sales) are a little different, at least as
they are reported in summaries of corporate annual reports. They
usually refer to a company's worldwide sales, including those to
health facilities. But they do not include the revenues of middlemen
and retailers.

Perhaps the most quoted source of statistics on the pharmaceutical
industry, IMS Health, estimated total worldwide sales for prescription
drugs to be about $400 billion in 2002. About half were in the United
States. So the $200 billion colossus is really a $400 billion
megacolossus.

The election of Ronald Reagan in 1980 was perhaps the fundamental
element in the rapid rise of big pharma—the collective name for the
largest drug companies. With the Reagan administration came a strong
pro-business shift not only in government policies but in society at
large. And with the shift, the public attitude toward great wealth
changed. Before then, there was something faintly disreputable about
really big fortunes. You could choose to do well or you could choose
to do good, but most people who had any choice in the matter thought
it difficult to do both. That belief was particularly strong among
scientists and other intellectuals. They could choose to live a
comfortable but not luxurious life in academia, hoping to do exciting
cutting-edge research, or they could "sell out" to industry and do
less important but more remunerative work. Starting in the Reagan
years and continuing through the 1990s, Americans changed their tune.
It became not only reputable to be wealthy, but something close to
virtuous. There were "winners" and there were "losers," and the
winners were rich and deserved to be. The gap between the rich and
poor, which had been narrowing since World War II, suddenly began to
widen again, until today it is a chasm.

The pharmaceutical industry and its CEOs quickly joined the ranks of
the winners as a result of a number of business-friendly government
actions. I won't enumerate all of them, but two are especially
important. Beginning in 1980, Congress enacted a series of laws
designed to speed the translation of tax-supported basic research into
useful new products—a process sometimes referred to as "technology
transfer." The goal was also to improve the position of American-owned
high-tech businesses in world markets.

The most important of these laws is known as the Bayh-Dole Act, after
its chief sponsors, Senator Birch Bayh (D-Ind.) and Senator Robert
Dole (R-Kans.). Bayh-Dole enabled universities and small businesses to
patent discoveries emanating from research sponsored by the National
Institutes of Health, the major distributor of tax dollars for medical
research, and then to grant exclusive licenses to drug companies.
Until then, taxpayer-financed discoveries were in the public domain,
available to any company that wanted to use them. But now
universities, where most NIH-sponsored work is carried out, can patent
and license their discoveries, and charge royalties. Similar
legislation permitted the NIH itself to enter into deals with drug
companies that would directly transfer NIH discoveries to industry.

Bayh-Dole gave a tremendous boost to the nascent biotechnology
industry, as well as to big pharma. Small biotech companies, many of
them founded by university researchers to exploit their discoveries,
proliferated rapidly. They now ring the major academic research
institutions and often carry out the initial phases of drug
development, hoping for lucrative deals with big drug companies that
can market the new drugs. Usually both academic researchers and their
institutions own equity in the biotechnology companies they are
involved with. Thus, when a patent held by a university or a small
biotech company is eventually licensed to a big drug company, all
parties cash in on the public investment in research.

These laws mean that drug companies no longer have to rely on their
own research for new drugs, and few of the large ones do.
Increasingly, they rely on academia, small biotech startup companies,
and the NIH for that.[7] At least a third of drugs marketed by the
major drug companies are now licensed from universities or small
biotech companies, and these tend to be the most innovative ones.[8]
While Bayh-Dole was clearly a bonanza for big pharma and the biotech
industry, whether its enactment was a net benefit to the public is
arguable.

The Reagan years and Bayh-Dole also transformed the ethos of medical
schools and teaching hospitals. These nonprofit institutions started
to see themselves as "partners" of industry, and they became just as
enthusiastic as any entrepreneur about the oppor-tunities to parlay
their discoveries in-to financial gain. Faculty researchers were
encouraged to obtain patents on their work (which were assigned to
their universities), and they shared in the royalties. Many medical
schools and teaching hospitals set up "technology transfer" offices to
help in this activity and capitalize on faculty discoveries. As the
entrepreneurial spirit grew during the 1990s, medical school faculty
entered into other lucrative financial arrangements with drug
companies, as did their parent institutions.

One of the results has been a growing pro-industry bias in medical
research —exactly where such bias doesn't belong. Faculty members who
had earlier contented themselves with what was once referred to as a
"threadbare but genteel" lifestyle began to ask themselves, in the
words of my grandmother, "If you're so smart, why aren't you rich?"
Medical schools and teaching hospitals, for their part, put more
resources into searching for commercial opportunities.

Starting in 1984, with legislation known as the Hatch-Waxman Act,
Congress passed another series of laws that were just as big a bonanza
for the pharmaceutical industry. These laws extended monopoly rights
for brand-name drugs. Exclusivity is the lifeblood of the industry
because it means that no other company may sell the same drug for a
set period. After exclusive marketing rights expire, copies (called
generic drugs) enter the market, and the price usually falls to as
little as 20 percent of what it was.[9] There are two forms of
monopoly rights—patents granted by the US Patent and Trade Office
(USPTO) and exclusivity granted by the FDA. While related, they
operate somewhat independently, almost as backups for each other.
Hatch-Waxman, named for Senator Orrin Hatch (R-Utah) and
Representative Henry Waxman (D-Calif.), was meant mainly to stimulate
the foundering generic industry by short-circuiting some of the FDA
requirements for bringing generic drugs to market. While successful in
doing that, Hatch-Waxman also lengthened the patent life for
brand-name drugs. Since then, industry lawyers have manipulated some
of its provisions to extend patents far longer than the lawmakers
intended.

In the 1990s, Congress enacted other laws that further increased the
patent life of brand-name drugs. Drug companies now employ small
armies of lawyers to milk these laws for all they're worth—and they're
worth a lot. The result is that the effective patent life of
brand-name drugs increased from about eight years in 1980 to about
fourteen years in 2000.[10] For a blockbuster—usually defined as a
drug with sales of over a billion dollars a year (like Lipitor or
Celebrex or Zoloft)—those six years of additional exclusivity are
golden. They can add billions of dollars to sales—enough to buy a lot
of lawyers and have plenty of change left over. No wonder big pharma
will do almost anything to protect exclusive marketing rights, despite
the fact that doing so flies in the face of all its rhetoric about the
free market.

As their profits skyrocketed during the 1980s and 1990s, so did the
political power of drug companies. By 1990, the industry had assumed
its present contours as a business with unprecedented control over its
own fortunes. For example, if it didn't like something about the FDA,
the federal agency that is supposed to regulate the industry, it could
change it through direct pressure or through its friends in Congress.
The top ten drug companies (which included European companies) had
profits of nearly 25 percent of sales in 1990, and except for a dip at
the time of President Bill Clinton's health care reform proposal,
profits as a percentage of sales remained about the same for the next
decade. (Of course, in absolute terms, as sales mounted, so did
profits.) In 2001, the ten American drug companies in the Fortune 500
list (not quite the same as the top ten worldwide, but their profit
margins are much the same) ranked far above all other American
industries in average net return, whether as a percentage of sales
(18.5 percent), of assets (16.3 percent), or of shareholders' equity
(33.2 percent). These are astonishing margins. For comparison, the
median net return for all other industries in the Fortune 500 was only
3.3 percent of sales. Commercial banking, itself no slouch as an
aggressive industry with many friends in high places, was a distant
second, at 13.5 percent of sales.[11]

In 2002, as the economic downturn continued, big pharma showed only a
slight drop in profits—from 18.5 to 17.0 percent of sales. The most
startling fact about 2002 is that the combined profits for the ten
drug companies in the Fortune 500 ($35.9 billion) were more than the
profits for all the other 490 businesses put together ($33.7
billion).[12] In 2003 profits of the Fortune 500 drug companies
dropped to 14.3 percent of sales, still well above the median for all
industries of 4.6 percent for that year. When I say this is a
profitable industry, I mean really profitable. It is difficult to
conceive of how awash in money big pharma is.

Drug industry expenditures for research and development, while large,
were consistently far less than profits. For the top ten companies,
they amounted to only 11 percent of sales in 1990, rising slightly to
14 percent in 2000. The biggest single item in the budget is neither
R&D nor even profits but something usually called "marketing and
administration"—a name that varies slightly from company to company.
In 1990, a staggering 36 percent of sales revenues went into this
category, and that proportion remained about the same for over a
decade.[13] Note that this is two and a half times the expenditures
for R&D.

These figures are drawn from the industry's own annual reports to the
Securities and Exchange Commission (SEC) and to stockholders, but what
actually goes into these categories is not at all clear, because drug
companies hold that information very close to their chests. It is
likely, for instance, that R&D includes many activities most people
would consider marketing, but no one can know for sure. For its part,
"marketing and administration" is a gigantic black box that probably
includes what the industry calls "education," as well as advertising
and promotion, legal costs, and executive salaries—which are whopping.
According to a report by the non-profit group Families USA, the
for-mer chairman and CEO of Bristol-Myers Squibb, Charles A. Heimbold
Jr., made $74,890,918 in 2001, not counting his $76,095,611 worth of
unexercised stock options. The chairman of Wyeth made $40,521,011,
exclusive of his $40,629,459 in stock options. And so on.[14]
3.

If 1980 was a watershed year for the pharmaceutical industry, 2000 may
very well turn out to have been another one—the year things began to
go wrong. As the booming economy of the late 1990s turned sour, many
successful businesses found themselves in trouble. And as tax revenues
dropped, state governments also found themselves in trouble. In one
respect, the pharmaceutical industry is well protected against the
downturn, since it has so much wealth and power. But in another
respect, it is peculiarly vulnerable, since it depends on
employer-sponsored insurance and state-run Medicaid programs for much
of its revenues. When employers and states are in trouble, so is big
pharma.

And sure enough, in just the past couple of years, employers and the
private health insurers with whom they contract have started to push
back against drug costs. Most big managed care plans now bargain for
steep price discounts. Most have also instituted three-tiered coverage
for prescription drugs—full coverage for generic drugs, partial
coverage for useful brand-name drugs, and no coverage for expensive
drugs that offer no added benefit over cheaper ones. These lists of
preferred drugs are called formularies, and they are an increasingly
important method for containing drug costs. Big pharma is feeling the
effects of these measures, although not surprisingly, it has become
adept at manipulating the system—mainly by inducing doctors or health
plans to put expensive, brand-name drugs on formularies.

State governments, too, are looking for ways to cut their drug costs.
Some state legislatures are drafting measures that would permit them
to regulate prescription drug prices for state employees, Medicaid
recipients, and the uninsured. Like managed care plans, they are
creating formularies of preferred drugs. The industry is fighting
these efforts—mainly with its legions of lobbyists and lawyers. It
fought the state of Maine all the way to the US Supreme Court, which
in 2003 upheld Maine's right to bargain with drug companies for lower
prices, while leaving open the details. But that war has just begun,
and it promises to go on for years and get very ugly.

Recently the public has shown signs of being fed up. The fact that
Americans pay much more for prescription drugs than Europeans and
Canadians is now widely known. An estimated one to two million
Americans buy their medicines from Canadian drugstores over the
Internet, despite the fact that in 1987, in response to heavy industry
lobbying, a compliant Congress had made it illegal for anyone other
than manufacturers to import prescription drugs from other
countries.[15] In addition, there is a brisk traffic in bus trips for
people in border states, particularly the elderly, to travel to Canada
or Mexico to buy prescription drugs. Their resentment is palpable, and
they constitute a powerful voter block—a fact not lost on Congress or
state legislatures.

The industry faces other, less familiar problems. It happens that, by
chance, some of the top-selling drugs —with combined sales of around
$35 billion a year—are scheduled to go off patent within a few years
of one another.[16] This drop over the cliff began in 2001, with the
expiration of Eli Lilly's patent on its blockbuster antidepressant
Prozac. In the same year, AstraZeneca lost its patent on Prilosec, the
original "purple pill" for heartburn, which at its peak brought in a
stunning $6 billion a year. Bristol-Myers Squibb lost its best-selling
diabetes drug, Glucophage. The unusual cluster of expirations will
continue for another couple of years. While it represents a huge loss
to the industry as a whole, for some companies it's a disaster.
Schering-Plough's blockbuster allergy drug, Claritin, brought in fully
a third of that company's revenues before its patent expired in
2002.[17] Claritin is now sold over the counter for much less than its
prescription price. So far, the company has been unable to make up for
the loss by trying to switch Claritin users to Clarinex—a drug that is
virtually identical but has the advantage of still being on patent.

Even worse is the fact that there are very few drugs in the pipeline
ready to take the place of blockbusters going off patent. In fact,
that is the biggest problem facing the industry today, and its darkest
secret. All the public relations about innovation is meant to obscure
precisely this fact. The stream of new drugs has slowed to a trickle,
and few of them are innovative in any sense of that word. Instead, the
great majority are variations of oldies but goodies—"me-too" drugs.

Of the seventy-eight drugs approved by the FDA in 2002, only seventeen
contained new active ingredients, and only seven of these were
classified by the FDA as improvements over older drugs. The other
seventy-one drugs approved that year were variations of old drugs or
deemed no better than drugs already on the market. In other words,
they were me-too drugs. Seven of seventy-eight is not much of a yield.
Furthermore, of those seven, not one came from a major US drug
company.[18]

For the first time, in just a few short years, the gigantic
pharmaceutical industry is finding itself in serious difficulty. It is
facing, as one industry spokesman put it, "a perfect storm." To be
sure, profits are still beyond anything most other industries could
hope for, but they have recently fallen, and for some companies they
fell a lot. And that is what matters to investors. Wall Street doesn't
care how high profits are today, only how high they will be tomorrow.
For some companies, stock prices have plummet