Billion-dollar babies – The Economist Nov 2015 | From the print edition

The high cost of R&D is used to explain why drugs giants merge, and why they must charge high prices. The reality is somewhat different

AS THEY announced the proposed merger of Pfizer and Allergan to create the world’s biggest drugmaker, on November 23rd, the two firms’ bosses stressed the scale that is needed to keep inventing blockbuster treatments. As Ian Read, Pfizer’s boss, put it, the merger will create “a leading global pharmaceutical company with the strength to research, discover and deliver more medicines and therapies to more people around the world.”

A more convincing explanation for the deal is that, by shifting Pfizer’s tax domicile from America to Ireland, where Allergan is domiciled, the combined group’s tax rate will fall from about 25% to 17-18%. But even leaving that aside, the common suggestion that size is needed to create a research-driven powerhouse does not stack up. The figure of $2.6 billion cited by PhRMA, the American drugmakers’ lobby, for the cost of developing a new drug, is questionable. And the industry is in any case moving away from a model in which giant firms throw huge sums at in-house research in a quest for ground-breaking new treatments.

Start with the $2.6 billion figure. Two years ago, when the number being bandied about was just $1 billion, even the boss of GSK, one of Pfizer’s biggest rivals, described it as a myth. Médecins Sans Frontières, a charity, claims that new drugs can be developed for as little as $50m and no more than $190m, even taking into account the cost of those that fail during clinical trials. Some of the assumptions used to arrive at the $2.6 billion figure are easy to pick apart. One example is the padded estimate for the drug firms’ cost of capital. But at least as important is that the figure is based on data from between 1995 and 2007. It says more about the failures and inefficiencies of the drug giants’ in-house laboratories back then than it does about how much it should cost to bring a new treatment to market now. That matters because the industry has been moving towards a new model.

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