Lynn C. Klotz, Ph.D. Bridging BioScience & BioBusiness

Orphan drugs are one way it aims to get them.

The word “blockbuster” is reserved for drugs with over one billion dollars in yearly sales. From big pharma’s own discovery and development (DD&D) data, even blockbusters could lose money. Profitability depends significantly on an intangible, the discount rate used to calculate net present value (NPV).

Drugs for rare diseases, so-called orphan drugs, can be blockbusters if priced high enough. Prices for orphan drugs are already very high, some well over $200,000 per patient per year. There are a number of incentives for orphan drug developers. The FDA’s 50% tax credit and less expensive clinical trials can save over $350 million clinical trial costs.

If only 10% of the 7,000 orphan diseases were targeted for drugs, the potential market would be 50% to 200% of current worldwide drug sales, based on $50,000 and $200,000 yearly price. Clearly, orphan drugs cannot command so much of the market. If this many orphan diseases are to be targeted, the only solution may be to radically reduce price. But at lower prices, company profits disappear, so foundations and governments must step in to fund DD&D.

The goal of the “what if” calculations in the analysis here is to better understand drug development strategy and limitations for orphan drugs.

Big Pharma NPV Cost and Income for a Typical Drug

The NPV drug discovery and development cost and NPV income over a drug’s lifetime for one set of assumptions is shown in Figure 1 (red curve). 

The DD&D costs are from the 2010 study conducted by Eli Lilly and Company based on data from 13 big pharmas. The companies that submitted data in 2008 for the study were Abbott, AstraZeneca, Bristol-Myers Squibb, Boehringer Ingelheim, Eli Lilly, GlaxoSmithKline, Johnson & Johnson, Merck Research Labs, Novartis, Pfizer, Roche, Sanofi-Aventis, and Schering-Plough.

The maximum sales for a drug are assumed to be $1 billion per year and income to be 25% of sales leading to the maximum undiscounted income of $250,000 per year in Figure 1 (blue curve). This sales-over-time curve has a typical shape: sales ramp up, some years of maximum sales, and then declining sales as patents expire and generics compete.

The area between the data and the heavy horizontal black line is a crude measure of profit or loss.  For the undiscounted data, the area under the income curve is bigger, so the drug is profitable from this viewpoint of raw costs and income. However, using the typical big pharma 11% discount rate, the area between the cost curve and black line is bigger, so the drug is unprofitable. The loss is simply a consequence of discounting to NPV—cash spent in the past is greater in the present; cash earned in the future is less in the present.

Figure 1. Undiscounted and discounted DD&D cost and income for a drug over its 30-year lifetime. There are 13 years of sales before generics compete. The dollar axis is in millions. Discounting for both DD&D cost and income is from year of launch, year 0. The cost curves are jagged, following the widely varying costs for the phases of DD&D.

Table 1 shows discounted income minus discounted cost. Drugs with sales just at the blockbuster billion dollar mark lose money under two of the assumptions used in the calculations.

Even with 13 years of sales to recoup costs before patents expire and generics compete, a drug with maximum yearly sales of exactly $1 billion loses $401 billion at the 11% discount rate. The loss is bigger, $697 million, if the drug loses patent protection after only 9 years of sales. If maximum yearly sales are $2 billion, the drug will be highly profitable, netting $1.2 billion over its lifetime.

Profit or loss depends significantly on discount rate. If a 3% rate is used, as suggested by the U.S. Panel on Cost-Effectiveness in Health and Medicine, most blockbuster drugs will be profitable. Cost of capital, which is often used to set discount rate, is the rate the company’s cash would return if invested in stocks or bonds. Looking at it another way, the 11% may be viewed as the minimum rate of return that big pharma would accept for a drug development project.

Clearly a number of assumptions are made in carrying out these calculations. Besides discount rate, there are other variables that would change profitability. These include income ramp up rate, years of patent protection, income as a percent of sales, lower or higher DD&D costs, and years from discovery to sales. But the general observation is valid: Even a borderline blockbuster drug can lose money by big pharma’s accounting. (The spreadsheet for this “what if” analysis is available from our company.)

Table 1. NPV income minus NPV DD&D cost for a drug’s 30-year lifetime. Income is assumed to be 25% of sales.

Why Orphan Drugs are Attractive to Big Pharma

There are a number of FDA incentives for orphan drug developers. Perhaps the most important is the 50% tax credit for clinical research and testing expenses. The tax credit applies to the undiscounted clinical trial cost. The credit can be applied to federal taxes incurred in the prior year or for up to 20 years against future taxes. Unlike deductions, credits can be deducted directly from income tax, whereas deductions are applied to taxable income.

Moreover, a 2013 study by EvaluatePharma found that Phase III clinical trial costs were $85 million for orphan drugs vs. $186 million for all drugs, a savings of $101 million dollars for orphan drugs. The $101 million savings from the EvaluatePharma analysis and the 50% tax credit would save big pharma a total of over $350 million in undiscounted clinical trial costs, a big incentive. 

How to Find an Orphan-Drug Blockbuster

As defined by the FDA, rare or orphan diseases are those that affect 200,000 or fewer people in the U. S. There are 30 million afflicted with nearly 7,000 orphan diseases in the U.S. Table 2 shows yearly sales for drugs for four hypothetical orphan diseases ranging from 600 to 200,000 affected. 

From a pharmacoeconomic point of view, a drug price of $50,000 a year is acceptable cost effectiveness provided the disease is completely arrested; that would likely be the case for an enzyme-deficiency genetic disease where the drug would be administered every year for life. For orphan cancers, the $200,000 price could be acceptable if a permanent cure is achieved with short-term treatment; it would not be acceptable if the drug is administered for several years or the patient remains incapacitated. An earlier GEN article explains cost effectiveness, and cost utility a measure that accounts for quality of life if a permanent complete cure is not achieved. 

Perusing the Orphanet list of the 7,000 identified rare or orphan diseases, the largest group are those with less than 600 affected, most with less than 60 affected. These represent no commercial opportunity.

Looking at the graph on the Orphanet website suggests that about 50% of orphan diseases have more than 6,000 U.S. affected (2 per 100,000 in the graph represents 6,000 U.S. affected based on 300 million U.S. population). These are the diseases that represent a commercial opportunity. For instance, charging $200,000 gives yearly U.S. sales of $840 million; and worldwide sales could be two to three times greater depending on the disease. Blockbuster commercial opportunities clearly exist for diseases with 6,000 or more affected.

Table 2. Estimated yearly sales for orphan drugs with two selling prices and for differing numbers affected. The market penetration is assumed to be 70%.

Orphan Drugs are a Here-and-Now and a Growing Blockbuster Opportunity

Table 3 shows that blockbuster orphan drugs are profitable even at high discount rates for different cost and income scenarios.    

Prior to the 1983 Orphan Drug Act, only 38 orphan drugs were approved. By the end of 2013, 425 drugs had been approved by the FDA for orphan indications with worldwide sales of about $90 billion, which represents 9% of the trillion-dollar prescription drug market. Sales are predicted to grow to $127 billion in 2018. The FDA Office of Orphan Products Development (OOPD) designated a record 260 drug applications as orphans last year, a 38% jump from 2012. According to a former FDA OOPD director, “It is entirely conceivable that orphans might one day account for most of the FDA’s drug approvals.”

Prices for orphan drugs are very high, often between $200,000 to $400,000 per year per patient. There are a number of reasons for the high prices. Orphan diseases are often life threatening, and usually there is only the one orphan drug. Drug companies need high prices to recover research and development costs from sales to only a small number of patients. Insurers have limited negotiating power because of the small number of patients, and lack of competitive drugs gives sellers little reason to reduce price.

What is the potential market for orphan drugs? Based on the observation from the Orphanet graph that half of the 7,000 identified rare diseases, or 3,500, are in theory targets for orphan drug development because they have more than 6,000 U.S. affected. Since only 425/3,500 = 12% of orphan diseases have drugs, we have barely scratched the surface of the potential market.

Suppose the 3,500 orphan diseases each have an average of 15,000 affected, again from looking at the Orphanet graph. At a selling price of $50,000 per year per person, potential yearly sales would be $2.6 trillion dollars (3,500 x 15,000 x $50,000), well over twice the worldwide sales for the whole pharmaceutical industry. Even if we assume that only 20% of the 3,500 orphan diseases could be targeted by companies, the potential sales would be $520 billion, which is over 50% of worldwide sales for the whole industry; and if priced at $200,000 per year per patient, more than two times current worldwide sales.

If all these orphan diseases are to be targeted, the only solution is to radically reduce price, perhaps more than tenfold. But at lower prices, company profit disappears, so foundations and governments must step in to fund and carry out DD&D. Virtual DD&D operations controlled by foundations can discover, develop, manufacture, and sell drugs for very low prices.

These calculations assume that all drugs provide a complete cure, a dubious assumption. If those with a disease are improved but far from cured, cost utility is the correct economic measure, and radically lower drug prices should meet that measure. 

Table 3. NPV income minus NPV DD&D cost over an orphan drug’s 30-year lifetime. Income is assumed to be 25% of sales.

Lynn C. Klotz, Ph.D. ([email protected]), is co-managing director of Bridging BioScience & BioBusiness. The material in this article comes from the Topic Books on Bridging BioScience & BioBusiness' website.

Previous article“Seed” Enhancers Seize Control during Stem Cell Development
Next articlearGEN-X Partners with LLS on Development of Waldenström’s Macroglobulinemia Treatment