Pharmaceutical Costs, Technology Innovation, Opportunities & Reality
Pharmaceutical (branded or ethical, and generic) companies, like other companies, have the following code of conduct:
• Maximize profits through invention and marketing of drugs.
• Market safe drugs and comply with expected performance and regulatory standards.
• Minimize environmental impact.
As long as companies are able to achieve the above objectives any inefficiencies in the product development, marketing, and manufacturing processes become irrelevant as the related costs are absorbed. Until recently, the priority has been to invent a new molecule, get it approved by regulatory authorities and get it to market. If profits are threatened, the development of additional and alternate markets is the first choice to regain revenue. With upcoming losses due to patent expirations, we are seeing the start of consolidation, acquisition, and relationships with biotech companies and with companies in the developing countries.
Branded (ethical) pharmaceutical companies have believed in product innovation rather than process innovation. Based on pure financial numbers, this has been their ethos. Due to the need to develop new molecules and speed them to the market, the pharmaceutical business model has had little incentive to develop innovative process development and manufacturing technologies. In addition, the current regulatory conditions are also not conducive to process innovation. Technocrats and bureaucrats would most likely say that should not be the case now or in the future.
Regulatory oversight for the pharmaceutical industry is critical and necessary. In recent years, regulatory agencies have promoted innovation in process development, API (Active Pharmaceutical Ingredients) manufacturing, and formulation methods. Companies might try to innovate, but the financial justifications for innovation are weak unless the API and formulation costs are totally out of line. For innovation to occur and to hold, it has to come from within rather than being driven by regulatory bodies and others.
As good corporate citizens, pharmaceutical companies should have the best technologies so that their customers' needs are met, profits maximized, and environmental impact minimized. Most would agree that pharmaceutical companies do deliver on new drugs, service, and profits; however, their process development and manufacturing technologies are not state of the art. They are low on the priority chart in the pharmaceutical business. We have seen, and will continue to see, minimal effort in this area. The rationale for this posturing is discussed and explained later in this article.
The best way to discuss this is to review the pharmaceutical business model and the costs and various relationships from a different perspective. This discussion is focused on small molecules but could be extended to pharmaceuticals in general.
What is a drug?
Drugs are a combination of Active Pharmaceutical Ingredients (API) and appropriate inert excipients. Pharmaceutical companies screen and explore molecules that will cure a disease and select the best ones for further testing. If a molecule cures a disease with minimal side effects, it is marketed. Although companies do manufacture and formulate the drugs, their manufacturing technologies are not current.
Cost of an API
To understand the pharmaceutical business model, it is worth understanding the price relationship between the API, the tablet, and the drug market price. Relationships between brand (ethical) and generic pharmaceutical companies also need to be considered. My overview is very general and extremely simplified. I will call my review "Everything we want to know about the cost of Active Pharmaceutical Ingredient (API) and the corresponding tablet but are afraid to ask."
An API is an organic chemical that has a unique property: being toxic to specific bacteria in order to cure a disease. Since APIs are a fine/specialty chemical, like any other chemical, their factory costs can easily be estimated. Using a defined stoichiometry, any chemical engineer and/or chemist well versed in estimating factory costs and manufacturing methods can calculate the costs with reasonable accuracy. Similar methods can be used to estimate the factory cost of a tablet. If the factory costs are higher than the cost estimates, it suggests that there are opportunities to improve manufacturing technologies and thereby profits.
Factory cost of an API 2-Benzhydrylsulfinyl acetamide [Provigil/Modafinil] is used in the illustration. Stoichiometry is outlined in US patent 6,875,893. Although the yield and operating parameters of the process described in the patent are not optimized, the process envisioned is based on what I will call a "quality by design" process. Some of the processing steps that will improve productivity and throughput, based on my experience and knowledge, are included in the cost estimate.
A contract manufacturing organization (CMO) would sell the API to a formulator who in turn would sell it to a pharmaceutical company. Cost information in Table 1 below is used to illustrate the API, tablet, and average wholesale selling price (AWP) relationship.
Raw material prices were obtained from different suppliers. Conversion costs are based on my experience and what I consider to be reasonable for a specialty chemical product. Factory cost of the acetamide is about $8.34 per pound. It is sold at $13.91 per pound ($30.60 per kilo) with 40 percent profit margin to a formulator. This API is converted to tablets and sold at $210.65 per kilo. Tablets are bottled and sold by number rather than by weight. Table 2 below illustrates the cost component of the API in each tablet and the cost of bottled tablets.
All of the above costs are based on having a plant in the US. If the plant were located in India or China, due to currency parity and other factors the costs would be lower by at least 15-20 percent.
Annual API Requirement for a Blockbuster drug
Branded/ethical or generic pharmaceutical companies will sell these tablets at a price of their choosing. Generally a drug is considered a blockbuster if its annual revenue exceeds one billion dollar per year. Average wholesale selling price (AWP) of the 200 milligram tablet Modafinil is $10.58 1Pharmaceutical companies sell the tablets to other companies for further sale to consumers. Recently, 200 milligram Provigil/Modafinil tablets sold for about $15.00-$16.00 per tablet at a national drug chain. Based on Cephalon's Annual report 2, Modafinil has sales of about one billion dollars and would be considered a blockbuster drug.
Figure 1 below illustrates the amount of bulk API that is needed to produce sufficient tablets to have one billion dollars in revenue for different drug dosages. For simplification, it is assumed that the API and formulation yields are 80 percent.
For 200 milligram tablets to reach one billion dollar per year in revenue, about 25,000 kilos of API per year is needed. If the pharmaceutical company's dosage and selling prices (AWP) are different, the needed API volume for a blockbuster drug will change correspondingly. This is discussed later.
Figure 2 below illustrates the cost of API per tablet at different dosage for API ranging in cost from $10.00 kilo to $100/kilo. A formulation yield of 80 percent is assumed.
API and Tablet Factory Costs vs. Tablet selling price
Based on the AWP, I would conclude that it is set at the highest level the market will bear, and pharmaceutical companies will recover and fund their costs related to marketing, drug trials, research of new molecules, etc. It has been said that with the low success rate of developing a useful drug, the current pricing methods are necessary. This might be true. However, we do need to review the relationship between AWP, the cost of API per tablet, and the cost of each tablet.
Based on the API manufacturing and tablet formulation cost estimate, the cost of API in each 200 milligram tablet is about 0.76 cents and the cost of each finished tablet is about 5.27 cents. Revenue generated by the sale of the bulk API and tablets would be about $0.77 million per year and about $5.3 million per year respectively, negligible compared to the yearly revenue generated by a blockbuster drug. Even if these API and formulation costs for each tablet were doubled or tripled, compared to AWP, they would still be minor.
With such a high monetary differential between AWP, and API and formulated drug costs, the impact of any savings due to manufacturing innovation will be inconsequential and will not have any after tax impact compared to after tax savings from improving marketing, clinical trials, and drug development methods. Thus, there is no incentive for branded or generic pharmaceutical companies to innovate API process development, manufacturing, or the tablet formulation technologies. Still, their technologies have to be the best they can be. Anything short will increase costs.
Branded (ethical) and Generic relationship
Generic companies have changed the playing field. Similar to branded companies, they also do not have any financial gain from technology innovation. This is explained as follows:
At present the generic companies do not have new molecule development costs, their profit margins will be comparatively higher than the margins of brand companies. Due to lower expenses, generic drug AWP is lower than the brand pharmaceutical AWP although they are still at the highest level. Generic AWP is also many multiples higher compared with API and formulation costs and can achieve their margins. Like branded companies, they do not have any incentive to innovate manufacturing technologies. ROI on any investment to improve technology, based on AWP, will not meet any financial norms resulting in minimal or no investment.
Generic pharmaceuticals have found another creative method to increase their profits. This is through challenging the branded (ethical) patents 3,4. If a generic company challenges the ethical drug patent, the branded company has to defend it due to the revenue it could loose and subsequently prevent them from funding the discovery of new molecules. In a win-win negotiation, the ethical drug company offers money to the generic company for not entering the market until the patents expire, e.g., one time payment of $200 million 5,6,7,8 (or whatever can be negotiated). The branded drug company may also make the challenging generic producer the contract manufacturer of the API and the drug tablet. This allows the generic company to make additional profits at the API and the formulation stages for "x" years until the patent expires along with six months exclusivity. Even with these concessions, the branded company, based on the above pricing model, is able to generate sufficient monies for the development of new molecules, as these costs are amortized over "x" years. There is no significant effect on the cost of the tablet and AWP. There may be other relationships between the brand and generic companies that might not be public.
Once the patent expires, a generic company will produce and sell the drug after regulatory approvals at the highest price the market will bear. With these opportunities for the generic companies, we should not be surprised to see additional patent challenges in the coming years.
Prescription generic drugs are priced lower than the branded drugs. Recently, this has started to change further as mass merchandisers like Wal-Mart or Target have started the selective selling of prescription drugs at 13.3 cents per tablet for one month's supply. Some of the drug and food stores have joined in with similar marketing strategies. This basically suggests that lower drug prices are feasible, and the marketers are profitable. If a generic company does not want to develop new molecules, in their efforts to expand their business they could significantly reduce their costs and selling prices through manufacturing technology innovation. If this happens, the game could change further. There are signs that this is slowly becoming reality.
Generic companies are in an enviable situation. As they gear up to form the Collaborate —> Cooperate —> Compete scenario, we will see drug prices stay at a higher level. Through Teva Pharmaceutical Industries, Ltd., we are seeing the application of this "3C" strategy 9. Other companies are experimenting with this strategy and every success in this field is rapidly going to embolden other generics firms to participate.
Current Manufacturing Model
As stated earlier, the total cost of bulk API and bulk tablets is inconsequential compared to the revenue generated from the wholesale sale of the tablets. Even if the API costs are multiple times higher, branded companies have no interest to drive the costs down as their interest is inventing and marketing a new molecule.
If a pharmaceutical company were producing the API, any investment to improve manufacturing technologies would be for either of the following reasons:
1. Cost of a competitive API is lower than their molecule.
2. To appease the financial analysts, stakeholders, and/or regulators that the company is investing in upgrading its technologies even though there is no return on investment.
The production volume of 2-Benzhydrylsulfinyl acetamide needed to generate one billion dollar sales is about 25,000 kilo/year. This volume is not high enough to have the most innovative process. However, it is a business opportunity for companies producing the API. They can innovate manufacturing technologies, lower the API costs, and improve their profits.
Alternate Manufacturing Model
For manufacturing and technology innovation in pharmaceuticals, we need a disruptive paradigm shift. Since the small-molecule APIs are specialty chemicals, it would be productive to benchmark API costs, manufacturing methods, and technologies to respective specialty chemical methods. I would consider changing the current business model, where the small molecules are produced internally, to complete outsourcing of the API (specialty chemical) and formulation to companies who are "good to great". These companies have the financial incentive to improve their profit margins and will invest in technologies that will improve their productivity and deliver consistently high quality. "Quality by design" is their forte. They apply "Jugaad" 10 to minimize costs and to maximize quality and customer service to achieve their profits
Independent of who produces the API or formulates the tablets, we also need to "STOP" repeated sampling and isolation at every intermediate step. Such a move will force companies to innovate and move from "quality by analysis" to "quality by design" manufacturing. In our endeavor, we cannot forgo good manufacturing practices. Based on my experiences, at times we are using an "armored tank" when a "bicycle" will suffice to produce API. We need to have a complete command of the process rather than the process driving us. We have been, and are, victims of "analysis paralysis".
To get out of this situation, alternate manufacturing scenarios could be considered. Contract manufacturing organizations (CMO) can specialize in certain chemistries, unit processes, and operations and campaign their production. Based on the amount of API needed, some of the products could be campaigned in pilot plants to mini-plants. Modular plants could also be an excellent option for batch or continuous processes.
At 10 milligram tablet size, if the market grows from one to 10 billion dollars per year, the API requirement will increase from about 1.25 metric tons to 12.5 metric tons per year. This will move production from a laboratory to a pilot plant. For a 200 or 500 milligram tablet drug, a mini-plant with a continuous process could be a distinct possibility. Better production scheduling may even lower the financial impact due to reduced in-process inventories resulting in improved cash flow. Laboratory scale can be at mini-plant scale so that the facility can also be modular and flexible enough to accommodate different unit processes and operations. Such methodologies due to the high price differential between the cost of API and AWP of the drug have never been considered, as there has been no need. Maybe its time has come.
Table 3 below illustrates the API requirements at two different AWP levels and different dosages for a blockbuster (billion dollars per year) drug at 80 percent formulation yield. Specialty and fine chemical companies produce products at such levels and do a great job as they use the best manufacturing technologies available to produce products with high on-stream time and the highest product quality.
Innovation in manufacturing methods, improved process technologies, along with good manufacturing methods can deliver excellent processes and can handle low to high production rates. Better manufacturing technologies for API and formulation will improve profits at that level. For API, the improvements come in the way of improved yield, reduced waste, reduced and better solvent use, improved productivity, and improved business processes. For formulations they come with the blending, size uniformity and uniform admixing, etc. In the supply chain there are opportunities and one has to pick them. Improved technologies will also significantly reduce their carbon footprint. With fine/specialty chemicals practicing innovative process, the question is why pharmaceutical companies haven't gone there? The answer is simple. There has been no need and the simplest thing we humans can say is "No. Can't be done, or Prove it." 11
Companies that are excellent in manufacturing API and formulating drugs should be the innovation driver rather than the companies who know how to invent and market only. Based on a purely financial basis, branded and generic pharmaceutical companies have the least incentive to innovate and excel in manufacturing technology innovation if they are producing API's and formulating them to produce the drug. They might innovate due to regulatory/competitive pressures or if a "creative destructor"<sup>12</sup> challenges their turf. There is considerable discussion of process and technology improvement but in the final analysis "return on investment" will drive innovation.
Irrespective of the sourcing options, the companies who sell the formulated drug have to be held accountable for the product quality that is ultimately consumed.
1 http://www.fdhc.state.fl.us/Medicaid/Prescribed_Drug/xls/drug_pricing_091005.xls accessed November 13, 2009.
2 Cephalon, Inc. SEC filings10-K February 23, 2009 and 10-Q October 28, 2009.
3 Hatch-Waxman Act, Accessed January 11, 2010.
4 H. J. Higgins, S. J. H. Graham; Balancing Innovation and Access: Patent Challenges Tip the Scales Science, Vol. 326 pgs 370-371.
5 Reuters.com US trade agency wants to end deals delaying generics accessed November 14, 2009.
6 www.livemint.com US Bill a challenge for Indian generic firms Accessed January 12, 2010.
7 K. D. McDonald, J. E. Mauk; Reverse Payments in Hatch-Waxman Cases and the Continuing Anti-Trust Patent Battle Accessed November 10, 2009.
8 Federal Trade Commission Staff, Pay-for-Delay January 2010 Accessed January 13, 2010.
9Dr. Satish Acharya, The productivity tiger - time and cost benefits of clinical drug development in India, Life Sciences and Health Care Practice at Deloitte Consulting, Zurich Accessed November 10, 2009.
10Girish Malhotra, What is Jugaad (new management fad from India)? December 10, 2009.
11 Roger L. Martin & Jennifer Riel, Innovation's Accidental Enemies, Business Week, pg 72, January 25, 2010.
12Girish Malhotra, Pharmaceutical Manufacturing: Is It the Antithesis of Creative Destruction? Pharmaceutical Manufacturing 2008.