How Much Does It Really Cost to Develop a Cancer Drug?

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Cancer drugs can cost hundreds of thousands of dollars and increasing complexity suggests that prices for these drugs are going higher. For instance, Novartis (NYSE: NVS) won approval for a new cancer drug last month that will cost $475,000. Cancer drug companies say prices are justified by sky-high costs associated with researching and developing these life-saving medicines but is that true?

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In this week's episode of the Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes is joined by contributor Todd Campbell to discuss new research that pegs the cost to develop a new cancer drug at $757 million. Listen in to learn how researchers came up with that figure, what other costs are responsible for high drug prices, and what's being done to rein prices in.

A full transcript follows the video.

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This video was recorded on Sept. 13, 2017.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Wednesday, September 13th, and we'll be talking about the cost of developing a cancer drug on the show today. I'm your host, Kristine Harjes, and I'm joined today by Motley Fool Healthcare contributor Todd Campbell. Todd, how is the week treating you?

Todd Campbell: Hi, Kristine! Boy, we're going to be talking about some pretty mind-blowing numbers today, aren't we?

Harjes: Yeah, big numbers that are going to be hard to wrap your brain around, but they'll still be really interesting.

Campbell: Kristine, I actually have an idea to help listeners put the numbers in perspective.

Harjes: OK, let's hear it!

Campbell: Alright. I'm going to go out on a limb, Kristine, you can agree or disagree with me, and say that most of our listeners probably own a car, and many of them own a house. Do you think that's pretty fair to say?

Harjes: Yeah, that seems like maybe most of our listeners.

Campbell: OK. So, I felt like, for perspective's sake, it might be helpful to throw two numbers out that our listeners can keep in the back of their mind as we dig into the subject. The first one was the average amount that Americans pay to own a car. What's their payment? And that number is $475. 

Harjes: Is that monthly?

Campbell: That's the monthly payment, that's right. $475 per month. The next number I wanted to throw out there is the monthly mortgage payment, and that's $1,500 per month on average. So, typically speaking, that's what most Americans are paying for their car and their home. And Kristine, I don't know if you would agree with this, but I feel like those are generally speaking, two of the most expensive line items in a monthly budget.

Harjes: For sure, and those numbers actually sounded higher than I would have guessed. 

Campbell: Yeah, I was a little surprised. But I'm a little more frugal, perhaps, especially with my autos. But, yeah. Keep those numbers in mind, listeners, as we go and talk about some figures that are astronomical. It's going to be hard to get your arms around them, no question.

Harjes: Yeah. You're contextualizing expenses. We're about to talk about how expensive it is to create a drug. So, one more time so that we have them fresh at the top of our minds, remind me, what's the car payment, and what's the home payment?

Campbell: $475 a month for the car, and $1,500 a month for the mortgage.

Harjes: OK. got you. So, there's a reason that we're talking today about how expensive it is to develop a cancer drug, and that reason is, there is a recent study that was published in a very well-known journal that comes from the American Medical Association claiming that they had figured out how much it costs on average to make a cancer drug.

Campbell: Right, numbers have been floating around for years, the back and forth of how much does it really cost to develop a drug. We'll get into a little more depth later on why those numbers are important to drug makers. But, I think you basically have to be living under a rock not to realize that drug prices have become a major consideration, not just from an investment standpoint, what it might mean for the drug makers who are developing these drugs, but obviously for consumers, either through higher health insurance premiums or directly, are paying the brunt of the cost of these more expensive medicines. We have these two researchers who went out and said, "Maybe we can actually put a specific figure to the sky-high cost of developing drugs. And we can figure out exactly how high sky-high really is." And that's what was published this past week in JAMA Internal Medicine, and I'm sure, if our listeners reached out to us, we can get them a copy. But you can also search for that online.

Harjes: Yeah, absolutely. This was specifically for cancer drugs. What they did was look at 10 cancer drugs from 10 different companies that had never gotten a previous FDA approval, and who did have their first drug approved between the years 2006 and 2015. They looked at the entire research and development expenses, all the way up through that approval. With that, it would also incorporate the cost of failed drugs that didn't actually get approved by the FDA, and they landed on a final number for how much these companies are spending. Todd, do you want to do the reveal?

Campbell: Do you want to do the drum roll, Kristine?

Harjes: I don't know how it's going to sound on the mic, but listeners, do it on your steering wheel or wherever you're listening.

Campbell: So, what's that cost, Kristine?

Harjes: They found that it costs a median of $757 million to create one of these drugs.

Campbell: It is absolutely amazing how much money we're talking about. With nine numbers, $757 million. That includes some opportunity cost, so, basically, what you could do with the money other than try to develop new drugs. If you X out that opportunity cost, you're still talking about $648 million in spending to get these drugs across the finish line. And I know we have listeners out there, statisticians, who are going, "Wait, what do you mean, they only looked at companies that were getting their first drug approved? Isn't that going to skew the numbers?"

Harjes: Well yes, absolutely. And they acknowledge that. 

Campbell: And they did that for a reason, and the reason is, other studies that have been done in the past tend to look at large pharmaceutical companies that have been around a long time, and therefore might be a little bit bloated, so they have a little more in the selling, marketing and general expenses that theoretically could skew the actual research and development costs of individual drugs. So, they said, let's just take it from scratch, from a company that's relatively new, it's developing some stuff in the pipeline, they spend a bunch of money over a period of time ahead of getting a drug approval, how much money did they spend divided by that one drug that was approved? And that's the median number we came up with. There were a lot of interesting points that they raised in the study. It's a really interesting read.

Harjes: Yeah. One of the ones that stood out to me was how large the ranges of the spending figures were. They ranged from $157 million at the low end $1.95 billion at the high end to get to that median of $757 million.

Campbell: Right, and listeners are probably like, wait, Kristine how is that even possible? How can one company be spending $200 million and another company spending a billion?

Harjes: Do you know the answer?

Campbell: I'm assuming it has something to do with the indication being studied, whether or not you had to go into Phase III, whether or not you had to conduct multiple of Phase III trials, and how many patients actually had to be studied in each of those.

Harjes: Yeah, there are going to be so many different factors that go into that, but of course, trial design is everything. And also how many different drugs you had to try before you hit the jackpot. If the first lottery ticket that you buy is the winner, then it's going to come in at a lower expense.

Campbell: Right. On average, these new, young companies have four different drugs that were in their pipeline, they were hoping that one of them would end up proving out, and sure enough one of them did end up proving out. The other thing that really struck me, Kristine, with the sheer numbers in revenue that these drugs have generated. We're talking about the expense, we're talking about huge numbers, how much it costs to develop these drugs. But then you find out, let's not cry too many tears for the drug maker.

Harjes: Yeah. Reminder, the range of spending was $157 million to $1.95 billion. If you total that up, the ten drug makers in aggregate spent $7.2 billion. If you look at what they made off of those drugs, they spent $7.2 billion, they made $67 billion in total. The median revenue for one of these drug makers was $1.66 billion, and that was just within a median time frame of four years post-approval.

Campbell: David Gardner would call that a spiffy-pop.

Harjes: Yeah, that's an incredible ROI, return on investment.

Campbell: Yeah, and if you look at, on a median perspective, each of those drugs, the median had been on the market now for four years, and the median number in revenue is $1.6 billion. So, even if you look at the median, halfway in the middle, you're talking about a very nice return. Again, there was a very large range in revenue as well. But still, you're talking about nine of the ten generating a profit that's greater than what they had to put out to be able to bring this drug to the market.

Harjes: Just to give a little bit of color on what types of drugs we're talking about here, a lot of them are drugs that are coming from companies that we talked about all the time on the show. Do you want to share with our listeners a couple of the ones that made the list?

Campbell: I think this is actually going to be, keep those numbers that we talked about at the top of the show in mind here. I'm going to throw out some monthly costs so you can put that in perspective. Again, we were talking about $475 for the car, $1,500 for the mortgage. But if you want to go out and buy Pfizer's and Astellas' Xtandi, it's going to cost you over $5,000 per month. And that's a prostate cancer drug.

Harjes: Yeah, this is a drug that gets around $2 billion in annual sales.

Campbell: If you want to go out and you need to get prescribed Exelixis' Cabometyx, it's going to cost you a whopping $13,600 per month depending on the dose.

Harjes: Right. And these are list prices that you're using, I'm assuming?

Campbell: Actually, no. I gave them the benefit of the doubt, I'm actually going with the Federal Supply price. This is the price that the government pays, which is going to be a factor based upon the negotiated prices that they actually charge to different commercial insurers.

Harjes: OK, interesting. In any case, most patients who are on this drug are insured, so they're not paying that entire sum out of pocket.

Campbell: Right, unless you're falling into the donut hole. If you're on Medicare, there could be some patients that get whacked with a big bill. But yes, as long as you have insurance, the insurance is picking up that tab. But, as we all know, Kristine, we've talked about this before in the past, the insurers don't make a lot of money on each individual person. So, one way or another, those costs are flowing through to us as consumers.

Harjes: Yeah, we do pay in the end, but because of the insurance industry, we end up paying more of an even split among the whole population.

Campbell: Right. Kristine, let me give you a few more of these to really hammer home the point. If you're going to get prescribed Johnson & Johnson's and AbbVie's Imbruvica, the government would be paying $6,800 to $8,300 per month. If you were going to get Seattle Genex's Adcetris, you'd be paying $5,000. (unclear 11:35) would set them back around $8,000. On and on and on. I think it's important for listeners, both from investing standpoint and as patients, as people, to recognize that there's really no end in sight to the sales that are being generated by these companies. The growth for each one of these drugs, all but one that I just listed, is double digits year over year.

Harjes: Yeah, they are relatively recently approved drugs. So, they're still under patent protection. There's really no end in sight for being able to command such high prices. We want to dig in a little bit to what the justification is for those prices and some of the arguments around what different types of treatments might be priced out going forward.

In 2014, I saw a statistic that the direct medical cost of cancer care top $87 billion in the U.S. alone. To me, that begs the question, where do we go from here? Is specifically cancer treatment going to continue to be so expensive?

Campbell: It's an eye-popping amount of money we're spending on cancer drugs now. We've eclipsed $100 billion in spending on oncology medicine. It's a major issue, and I think it's no real surprise that one of the authors of the study that we referenced earlier in the show actually came from Memorial Sloan Kettering, which is a very highly regarded cancer center, and in the past they've been very vocal about the concern of high-priced drugs making it to market that haven't been proven to boost overall survival. Instead, most approvals for cancer drugs, because cancer is so hard to treat, are based on surrogate endpoints, things like progression-free survival and overall response rate. It's a very big, big problem to investors and to patients, because the costs that are associated with these drugs, the reason we're spending so much on the costs, is climbing incredibly fast. The inflation rate for drug development, especially in the preclinical stage drugs, is throwing much more rapidly than other parts of the economy. And those costs have to be borne by somebody. And you can't just go out and say, "We're going to cut prices across the board," and mandate it, because then what happens to innovation? If you don't generate out a tremendous reward, then that capital, that investment, will head somewhere else -- either toward building the next Amazon, or whatever.

Harjes: Right. So, as a drug maker, when you're looking at your opportunity cost, where should you deploy your capital, you're going to figure out, where do I have the best risk versus reward? And one of the reasons why these cancer drugs are getting more and more expensive, and across the board, not just even in oncology, drugs are getting more expensive, it's because they're going toward more narrowly defined targeted patient populations. So, just by the rules of economics, if you're trying to make a bunch of money, but you have a very small pool of people that you're selling your product to, it has to be a pretty expensive product in order for you to even recoup your investment that you put into it. So, if you're looking at a drug like, say, the gene therapy that was approved on August 30th that we talked about a couple times on the show now, Kymriah from Novartis, this is a drug that potentially only has a couple of hundred patients that it could actually help. So, the price is absolutely astronomical. This is a drug that's going to cost $475,000 for a treatment.

Campbell: $475,000. And really what we're talking about there is a 20 day vein-to-vein treatment. So, 20 days, it's going to cost $475,000. It's pretty jaw-dropping. I think you really alluded to something, and that's, from a drug makers perspective, they're looking at it and saying, "Yeah, precision medicine is wonderful, but it's incredibly complex, and with that complexity comes costs. And the higher these costs are earlier in drug development, the more selective we have to be in choosing which drugs we're going to pursue." And that's kind of scary from a patient perspective, because it means the only drugs that are actually going to end up moving further and further, deeper and deeper into the clinic toward market, are going to be those drugs that are the most commercially relevant.

Harjes: Yeah. We had a listener email that I wanted to highlight. This one comes from someone named Gene from San Diego, who worked in the pharmaceutical development industry for 15 years. He used to work for Pfizer, now works for Takeda, which is pretty cool. He sent us an email and asked about the price tag for Kymriah, and he also brings up a point about, is this a red flag, that a huge price tag is needed to make the economics of some of these new forms of therapy, like CAR-T treatment, work? And should we be nervous as investors about the potential for price reform across the board?

Campbell: I think it's something we have to bear in mind. Obviously, anyone who's been paying attention in the last couple of years knows that price played a very major role in the debates for the last presidential election. I think a lot of the rhetoric has died down a little bit on the pricing issue as people realize just how complex this whole system, and reforming this whole system, would be, and the unintended consequences, obviously, shouldn't be dismissed. If you make changes to the system as it is today and it results in no longer pursuing the development of the drug that saves lives, well, you're talking about real people on the line here, so you have to be very careful in the way that you approach these things, and you have to make sure that all of the participants are being treated fairly. And that includes the drug makers, who are, of course, absorbing a lot of risk, all of the risk upfront, to develop these medicines. I think that's something that's been recognized by the current Administration and the new FDA head, Scott Gottlieb, who actually just had a very important and useful -- recommended reading, folks -- speech this past week where he talked about, where do we go from now? How do we go about reforming, from the FDA's perspective, drug development so that more drugs can reach the market more quickly, and perhaps help reign in spending that way? I think it's also important, or interesting, Kristine, because you brought up Kymriah, to look at it and say, $475,000, that's an incredibly high price tag for a relatively small population. In the aggregate, it's not going to move the needle much one way or the other. What happens is, say, Kite Pharma's Axi-Cel gets approved, and now you can treat thousands of patients, and then these drugs get expanded into other indications, and now they're treating tens of thousands of patients. Well, obviously, $475,000 is unsustainable. So, one of the models they're looking at for these drugs is to say, "OK, maybe we'll do indication based pricing." So, maybe we charge $475,000 in acute lymphoblastic leukemia, but maybe the price of a larger indication like non-Hodgkin lymphoma is going to be $350,000. I don't know, I'm throwing numbers out there, but you get the idea.

Harjes: Right. It's really interesting when you consider these different types of pricing models that are being thrown out there. Novartis says that if a patient doesn't respond to their new drug, Kymriah, they won't charge you. So, there are so many different ways that you could tackle the pricing issue. And it does seem like the FDA is considering a whole range of different solutions to this. I would agree that the speech he gave on Monday, he was to the Regulatory Affairs Professionals Society, at their annual conference, it was a really great speech. He starts off going through the history of how long it used to take before the for science could actually be applied in a clinical setting, and in humans, and could actually be delivered to people in the form of new and better medicine. And he talks about how fast that cycle has evolved and become, but that there's still so many regulatory challenges. So, he touches a lot on different potential solutions that the FDA is considering, and where they might go from here.

Campbell: Yeah. To hammer home that point, too, because it's an important one, Kristine, he talked about discovering or postulating that germs existed and were the cause of disease, it then took hundreds of years for us to get to the point where we were actually developing treatments that addressed the fact that we could spread germs. Then you look at Kymriah, Kymriah made it from the University of Pennsylvania's research department to now commercialization in about five years. So, hundreds of years versus five years, and obviously far more complex to create something like a CAR-T.

Harjes: Yeah, absolutely. One last note that I want to touch on before we sign off for the day, research and development is not the only expense that these big pharma companies or the little biotechs have. There's also, as you alluded to earlier, pretty high SG&A, your general administrative costs. The percentage of SG&A to sales is a pretty good way of looking at whether or not these companies are efficient and effective.

Campbell: I'm really glad you brought this up, Kristine. This is another area that, I know the insurance industry, for one, has been banging the drum and saying, "Come on, people, it's not the research and development costs that are increasing the costs of drugs, it's the spending of these companies on selling general administration, which can range from 20-40% depending on the company." If you're spending that much of your revenue on sales and marketing, maybe there's a problem, because those costs are showing up somewhere in the price.

Harjes: Yeah, absolutely. And we've talked about this before on the program. Having direct-to-consumer ads is something that's completely unique to the United States, and it has its benefits but it also has its drawbacks. In any case, it's definitely a line item, and a huge one.

Campbell: Yeah, and that doesn't even include all the money that's spent by the feet on the street, the sales team that's actually out pounding the pavement knocking on doctors' doors, educating them about the drug and trying to convince them to prescribe their medicine over someone else's medicine. I think, from an investing standpoint, because we are an investing show and I think it's important to have a takeaway in talking about these huge numbers and what this may mean, obviously, we have to be aware that there could be some changes in the future. And we don't know how those changes will end up playing out in terms of profit. These pricing by indication schemes, for example, we don't know exactly what that will do to profit yet. I think, from an investing standpoint, there's two different things you can do to try and make sure that you're investing in companies that are operationally very strong companies that can withstand hiccups as we go through this period of change. And the two metrics that I think people should focus on are high operating margin companies and companies that spend very little on SG&A.

Harjes: OK. So, when you look at those two together, what companies stand out to you? 

Campbell: There were five companies -- and I looked at larger companies, I didn't look at development stage companies. I wanted to look at mid and large-cap companies. And there were five companies that I thought had very high operating margins, the highest operating margins across the industry. There was United Therapeutics, there was GileadAmgen, and Celgene was among them as well. But then, if you look at who spends the least on SG&A, of those five, only Gilead and Biogen make that list, too. So, perhaps those are two of the operationally best investments out there in biotech, to withstand change.

Harjes: OK, those are some good takeaways. Thank you so much, Todd! We've reached the end of another Healthcare episode, and this one will be my last one for nearly a month as I'm off to Greece for vacation. Listeners who are familiar with Greece, please send me some recommendations. Our email is industryfocus@fool.com. I'll be flying in and out of Athens, and I'll spend half the trip traveling with a friend and half solo. Plan on hitting a bunch of islands, but really have no concrete plans. While I'm gone, you'll still hear from Todd each week. A couple of episodes were pre-recorded, and my colleague Michael Douglass will be stepping in for another show. In the meantime, I hope you all have a wonderful few weeks. 

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Todd Campbell, I'm Kristine Harjes. Thanks for listening and Fool on!

Kristine Harjes owns shares of Gilead Sciences and Johnson & Johnson. Todd Campbell owns shares of Amazon, Celgene, Gilead Sciences, and Pfizer. The Motley Fool owns shares of and recommends Amazon, Biogen, Celgene, Exelixis, Gilead Sciences, and Johnson & Johnson. The Motley Fool has a disclosure policy.