Price spikes are key to pharma R&D – it creates better care in the long term

David Austin and Tamara, Yale and University and California Berkely and Economist at Congressional Budget Office, Chief of Health Policy Studies Unit in the Health Analysis Division of the Congressional Budget Office, Hayford  “Overpatented, Overpriced: How Excessive Pharmaceutical Patenting is Extending Monopolies and Driving up Drug Prices”, , accessed 6/30/24. Cinj - WH

Anticipated Revenues

A company’s expectations about the revenues it could earn from a drug depend on the prices that the company anticipates the drug could command in various markets around the world and the quantities that the company anticipates might be purchased at those prices. Those expectations are informed by the prices and sales volumes observed for existing drugs in various markets. For established drug companies, current revenue streams from existing products also provide an important source of financing for their R&D projects.

How Revenue Expectations are Formulated. A company develops its expectations about a potential drug’s lifetime future revenues based on the drug’s potential market size, which depends on the prices it might command in sales to different patient groups and in negotiations with payers, domestically and abroad. In that sense, the prices of existing drugs—including variations in prices to different patient populations—help determine R&D spending on future drugs. (The converse is not true: In CBO’s assessment, current R&D spending does not influence the future prices of the drugs that result from that spending.)

Revenues generated by existing drugs provide information about the potential market size for new drugs by indicating consumers’ and insurance plans’ willingness to pay for drug treatments. The number of prescriptions for those drugs support inferences about the number of potential patients, their propensity to use drug therapies at the observed prices, and the popularity of competing therapies.

Sales revenues from other unrelated drugs also help companies form expectations about market size. They reveal information about the magnitude of drug-treatment costs that the market currently tolerates, both in general and for various conditions that will have more or less in common—with regard to duration, severity, or effects on quality or length of life—with the conditions the new drug would treat.

Expected revenues also depend on anticipated unit sales in different markets around the world. Those quantities are determined by the number of potential patients for the drug in those markets, the shares of those populations that might buy the drug at the prices the manufacturer envisions for those markets (taking into account any substitute drugs that might be available), and the number of prescriptions a course of treatment would require.

Once a new drug has been approved, CBO expects that its developer would set its price in a forward-looking fashion, meaning the price is set to maximize the net revenues from the drug without regard to how much it cost to develop.

Real (inflation-adjusted) pharmaceutical revenues increased sharply from the mid-1990s until around the mid-2000s, when patents on a number of blockbuster drugs expired and lower-cost generic equivalents were introduced. Revenues then declined slightly from the mid-2000s through the mid-2010s, a result of those patent expirations and the 2007–2009 recession. Revenue growth returned with the introduction of some expensive new drugs (see ).

Figure 5.

Worldwide and Domestic Revenues of PhRMA Member Firms

Billions of 2019 Dollars

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Revenues from drug sales have grown substantially since 1980, although that growth was interrupted by patent expirations of some widely used drugs and by the 2007–2009 recession. Revenue growth has since resumed, in part due to expensive new drugs.

Data source: Congressional Budget Office, using data from PhRMA, 2019 PhRMA Annual Membership Survey, Table 4 (PhRMA, 2019),  (PDF, 2.15 MB). See .

PhRMA revenue data reflect payments received by manufacturers, excluding cash discounts, Medicaid rebates, returns, and allowances for marketing expenses.

PhRMA = Pharmaceutical Research and Manufacturers of America.

Revenues as Source of Funding for R&D. In the pharmaceutical industry, revenues have traditionally been an important source of R&D financing for established companies with brand-name drugs to sell. Brand-name drugs can generate large volumes of cash because their manufacturing and distribution costs are typically very low relative to their sales revenues. Established companies appear to prefer to finance their R&D with current revenues whenever possible rather than to rely on outside funding sources such as venture capital. Outside financing involves transactions costs as well as other implicit costs, such as compensation for risks borne by outside investors who cannot perfectly monitor a firm’s efforts and skills.

The share of R&D funded directly by revenues has declined in recent years because an increasing amount of R&D is now conducted by research-oriented drug companies with few or no products on the market. Over the past decade, small or emerging drug companies have developed a rising share of new drugs. Those companies have relatively little revenue (some have none at all), and most of them must seek outside financing, such as venture capital, and collaborative agreements with larger drug companies. Although venture capital still only finances a small share of the drug industry’s R&D spending in total, it supports a much larger share of the R&D spending of smaller firms than of large established companies.

Drug development also occurs in university research labs. In addition to grants funded by the National Institutes of Health (NIH) that many universities receive for performing basic biomedical research, universities may collaborate with (and be funded by) private drug companies to perform applied research toward the development of new drugs. The funding for that R&D may come predominantly from revenues, as the collaborations typically involve established pharmaceutical companies.