Competitiveness key to innovation.

The majority of new drug development now takes place at startups with little to no commercial revenue. Contrary to the claim that raising prices on old drugs drives innovation, large pharmaceutical companies, generally defined as those with $10 billion or more in annual sales, rarely discover new drugs. Large companies have bureaucratic research and development (R&D) processes, in which scientists have comparatively little incentive to innovate. Researchers at emerging firms, on the other hand, may be driven to innovate by the remunerative model such firms use — i.e,. researchers share more fully in the economic rewards of successful drug development. Therefore, the majority of new drugs are now discovered and brought into human clinical trials by emerging startup companies — defined as those with $500 million or less in annual sales, or less than $200 million in annual R&D spending — funded by venture capital and hedge funds. In 2020, early-stage, unprofitable companies brought nearly 62 percent of new industry-originated drugs approved by the FDA to the clinic, with no less than 54 percent of drugs brought to the clinic by emerging firms in each of the last seven years (2016–2022).

Emerging companies are taking their innovations to market without the help of Big Pharma. Large companies that fail to discover drugs in-house often assert that the venture capital used for drug innovation would disappear if large companies sold drugs at lower prices. This claim assumes large companies will purchase the rights to sell drugs developed by emerging companies, whether through licensing agreements to sell on the emerging company’s behalf or by acquiring the emerging company altogether. But this model of drug development, which peaked in the 2010s, is quickly fading as emerging companies increasingly bring new innovations to market on their own. Our analysis found that, in 2013, 23 percent of emerging companies that originated novel drugs retained marketing rights to those drugs through the entire FDA approval process. By 2022, that percentage had more than tripled, to 75 percent. In fact, some drugs originated by profitable companies are now licensed to emerging companies to sell. Of the 17 drugs originated by established companies in 2022, four are currently marketed by emerging companies.

Emerging companies innovate more while earning less revenue and spending less on R&D. Startups rely on venture capital to develop new and innovative drugs with a higher level of accountability than large companies, spending less per innovative drug developed than large, inefficient companies.

Our analysis shows the pharmaceutical industry is rapidly evolving in favor of agile startups that embrace new ways of innovating and are free of the bureaucratic processes that plague larger companies. In practical terms, emerging companies are developing new medicines with fewer resources, all while charging patients less.

Our analysis found that, in 2013, 23 percent of emerging companies that originated novel drugs retained marketing rights to those drugs through the entire FDA approval process. By 2022, that percentage had more than tripled, to 75 percent.

As we have discussed previously, the reason for this efficiency is that the most talented biopharmaceutical scientists gravitate toward startups. At biotech and pharma startups, a top scientist will receive stock options, which can translate into substantial wealth if the company successfully takes a drug candidate through the FDA approval process. These economic opportunities are largely absent at large companies. Furthermore, bureaucratic decisionmaking at large companies creates diseconomies of scale, in which promising drugs are abandoned because they do not fit into a larger corporate strategy or existing product lines.

Contrary to their rhetoric, large pharmaceutical companies often fail to turn their enormous profits into innovative R&D. Instead, they acquire startups where the innovation has already taken place. In most cases, these smaller companies would have been able to gain FDA approval for their drug candidates if they had remained standalone companies.

The pharmaceutical industry’s increasing reliance on emerging companies with smaller R&D budgets shows that policies to curb high drug prices — especially policies that target excessive price increases on older drugs sold by large firms — are unlikely to harm innovation. Furthermore, coupling such policies with those designed to reduce the costs and risks of drug development, such as allowing more drugs to come to market after successful Phase II studies, can give us the best of both worlds: a more innovative biopharma ecosystem and a more affordable one.