Not so, according to analysis published at our think tank, the Equal Opportunities Research Foundation. Our research shows that the largest pharmaceutical companies are too often unable to turn their huge profits into discoveries. Rather, most innovations occur on a small scale. Unprofitable Start-up drugs are largely excluded from Medicare’s new price negotiation system. When it comes to pharmaceutical innovation, smaller is better.
For our analysis, we examined 428 recent Food and Drug Administration drug approvals and examined financial data from more than 4,000 pharmaceutical and biotech companies. We found that large companies, defined as those with annual sales of more than $10 billion, generate 86 percent of the industry’s revenue, yet only 36 percent of the drugs approved by the FDA. I discovered that. In contrast, emerging startups with less than $500 million in annual sales or less than $200 million in annual R&D spending generated 3% of industry revenue but half of all newly approved drugs. I discovered more than that.
You might think that the largest pharmaceutical companies with the largest R&D budgets would have the most productive laboratories. But it doesn’t work.
Large companies tend to be bureaucratic, risk-averse, and focused on increasing profits from existing drug product lines. Part of the reason is that the company’s largest and most influential shareholder cares more about quarterly profits than long-term success. The result is that large companies overinvest in low-quality but “safe” ideas and underinvest in better but risky ideas.
In contrast, small and medium-sized enterprises are agile and able to attract top scientific talent. The most creative scientists often work at startups, where they have more freedom. Startups can also generate far more wealth through stock options than the modest year-end bonuses of giants like Eli Lilly and AstraZeneca.
If the laboratories of large corporations are so unproductive, you may wonder why many of the world’s best-selling drugs are manufactured by them. This is because of the high FDA regulatory costs. Smaller companies may not always be able to afford the large-scale, multibillion-dollar clinical trials required for approval. As a result, large corporations treat emerging startups like their own farm teams, hoarding the best medicines and jacking up prices for profit.
The good news is that this situation is starting to change. Start-ups are increasingly bringing the best medicines to market themselves. In 2013, only 23 percent of successful drugs developed by startups reached FDA approval under the original developer. By 2022, that share has increased to 75%. If this trend continues, patients will benefit from a more competitive and diverse ecosystem of drug developers.
Opponents of drug price negotiations on Wall Street and Silicon Valley see no problem with large multinational corporations swallowing small businesses. They argue that mergers and acquisitions can help investors in these small businesses generate faster returns and encourage further investment in start-ups.
But investors also benefit when startups bring innovation to market. In fact, in the long run, investors can make more money if a start-up becomes a multi-billion dollar success story than if they buy it at a lower price and sell early. A more diverse ecosystem of successful and profitable biopharmaceutical companies will lead to more innovation, not less.
The Inflation Reduction Act’s drug negotiation provisions were designed with these considerations in mind. The law exempts drugs that account for more than 80% of a company’s sales to the Medicare program from that process, effectively eliminating emerging startups with only one FDA-approved drug.
And because all taxpayers fund the program through payroll taxes, more affordable medicines benefit all Americans, not just seniors on Medicare.
That’s why President Biden proposed expanding Medicare price negotiations from 20 drugs to 50 drugs a year, a sensible idea that would reduce the federal deficit and Medicare premiums. People often think that the only way to make Medicare sustainable is to raise taxes or cut benefits. But reducing the amount Medicare must pay for the care older adults receive will also help achieve this goal.
There are other things we can do to lower drug prices while protecting innovation. First, it could eliminate the Inflation Control Act’s punitive tax on companies that refuse to negotiate with the Medicare program. In a true negotiation, manufacturers should have the right to withdraw from Medicare. They are unlikely to do so, given the value of his 65 million person market for Medicare, but the right to do so would give Medicare an incentive to negotiate in good faith.
Second, it would reduce red tape at the FDA and allow more drugs to reach patients after mandatory mid-stage clinical trials. We already do this for cancer and HIV, and if it’s scientifically appropriate, there’s no reason why we shouldn’t do it for chronic diseases.
The real barrier to innovation in drug development is not that manufacturers can charge exorbitant prices. The cost of navigating the FDA approval process continues to increase. In other parts of the economy, innovation lowers the price of valuable goods and services. The pharmaceutical industry and its regulators should follow suit.
