Market Barriers to the Development of Pharmacotherapies for the Treatment of Cocaine Abuse and Addiction: Final Report. Appendix A: Market Analysis Model

09/12/1997

Drug development decisions on the part of pharmaceutical companies are based largely on determinations of risk-reward tradeoffs inherent in scientific and market factors. As described in this report, companies often have summary financial targets or hurdles that drive investment decisions. Two indicators of projected or actual financial performance that are often used in industry are net present value (NPV) and peak annual revenue (PAR). NPV is the difference between the present value of all cash inflows from a project and the present value of all cash outflows required for the investment, using an appropriate discount rate or required rate of return to calculate present values. PAR is the highest annual revenue achieved by a product during its market life.

Some of the main financial inputs to drug development decisions are: R&D costs; manufacturing, distribution, and marketing costs; opportunity cost of capital (or related parameters such as discount rate, interest rate, or required rate of return); sales revenues; and duration of the development and product/sales life. Factors that may not appear to have direct financial import, such as social stigma associated with a product, inclination of caregivers to consider pharmacological as opposed to behavioral interventions, or corporate commitment to further the greater societal good, do have financial implications that are considered by companies. The financial impacts of such factors can be estimated, if only at a rough level of approximation, and incorporated as such into decisions about pursuing projects.

This report uses a financial drug development model developed by The Lewin Group to quantify and portray basic relationships among such factors as market size, price, and revenue. The model is also used to simulate multiple, diverse scenarios of market conditions that could be faced by decision makers regarding development of new medications for treating cocaine abuse. Clearly, such decisions can be quite complex, and this model offers only a simplified quantitative tool for approximating relevant market conditions and outputs. Exhibit A-1 shows the input variables in the model.

Exhibit A-1. Input Variables in the Market Model

Uncapitalized R&D costs

Orphan drug status

Stage of entry

Years of orphan drug extension

Discount rate

Orphan drug tax advantage

Wholesale price

Years post-launch to competing drug

Peak market size

Years to replacement by competing drug

Weeks of prescription

First year MMDA* costs

Expected peak prescriptions

Duration of marketing campaign

Years post-launch to peak prescriptions

MMDA costs during marketing campaign

Years to patent expiration

MMDA costs after marketing campaign

*MMDA: manufacturing, marketing, distribution, administration

Each of these parameters can have a material impact on NPV and/or PAR.

Definitions of the model input variables are offered below. These include indications of the likely range of each variable, although the model allows entry of values outside of these ranges for most of these variables.

Uncapitalized R&D costs: Uncapitalized expenditures for R&D prior to marketing (range $50-250 million).

Estimates of the R&D expenditures required to bring a new drug from concept to market may vary widely, and are subject to multiple, complex, and often idiosyncratic conditions pertaining to a given product as well as various economic analyses and interpretations that are beyond the scope of this project. In its 1993 report, OTA estimated that the fully capitalized development cost of a medication approved by FDA in 1990 was as much as $359 million. Uncapitalized costs were about $135 million, spread over a 13-year development period. OTA also developed a hypothetical schedule of development costs over the development period, incorporating the preclinical and the clinical phases as well as the period to submit an NDA and gain FDA approval, as shown in Exhibit A-2. For any estimated level of uncapitalized R&D costs over a full development cycle, the model derives a distribution of costs over the development period based on the distribution of R&D costs from the OTA report. For any particular stage of entry (see below), the distribution of R&D costs is truncated up to that point.

Exhibit A-2. Average Annual Cash Outlays for Development of a Medication, 1990 Dollars

Yr. 1: $5 million

Yr. 8: $10 million

Yr. 2: $10 million

Yr. 9: $ 9 million

Yr. 3: $15 million

Yr. 10: $10 million

Yr. 4: $17.5 million

Yr. 11: $10 million

Yr. 5: $17.5 million

Yr. 12: $2.5 million

Yr. 6: $15 million

Yr. 13: $2.5 million

Yr. 7: $11 million

Total: $135 million

Source: Adapted from Office of Technology Assessment, 1993.

Stage of entry: Point in development cycle at which a company invests (range 0 to 13 years, or years corresponding to particular stages)

A company can choose to enter the product development cycle at various stages, including early research/preclinical, phase I trials, phase II, phase III, NDA submission, and at market approval. It is assumed that a typical product development cycle takes an average of 13 years. Each of the stages is associated with a particular average number of years to approval, i.e., 13 years at the beginning of the cycle, 9 years at the beginning of phase I trials, etc. The later a company enters the cycle (which may have progressed to that point with support of government or other research-based organizations or companies), the less is the assumed burden of development expenditures prior to any market approval.

Discount rate: The opportunity cost of capital applied to spending and revenues over the life of a product (range 10 to 20 percent annually).

The discount rate (or opportunity cost of capital or required rate of return) for the industry may vary from less than 10 percent to 20 percent or more depending upon financial conditions and other opportunities for investment relevant to companies. Riskier ventures tend to require higher rates than less risky ones. A typical rate used by large pharmaceutical companies is 12 percent.

Wholesale price per day: Average wholesale price per day of the medication (range $0.50 to $30.00).

Together with daily patients taking the medication this variable determines expected revenue to a pharmaceutical company. Pricing decisions by pharmaceutical companies are driven by a combination of factors including cost of development, cost of manufacturing, marketing and distribution, the existence of competing products or therapies, and perceived/actual price sensitivity of the market.

Peak market size: Expected peak daily number of patients taking the medication, i.e., patients enrolled in treatment and on a prescription on any given day (range 10,000 to 500,000).

This is a fundamental value driving this model. The alternative would be annual number of prescriptions written. When annual prescriptions written are combined with duration of the prescription (the next variable) it yields an estimate of daily patients taking the medication. Using daily patients as the parameter is preferred because there is better data about patients in treatment on a given day than there is on annual admissions to treatment (or the average duration of treatment, or the average duration of a course of medication). Generally, the more patients taking the medication, the higher will be revenue, given a stable price. It may take several years or more to achieve peak prescribing (another model parameter, below). Daily patients may be sensitive to price.

Weeks of prescription: Average time in weeks the patient will use/purchase the medication (range 4 to 52 weeks)

This factor is used with number of prescriptions made and the average dose to determine the total volume sold. For a medication for cocaine abuse, a likely prescription duration may be 3 months, which corresponds to the maximum duration of a course of naltrexone treatment for alcoholism. For opiate addiction, many patients are "maintained" indefinitely on methadone, and it is also possible to maintain patients on LAAM. A course of detoxification can be as brief as several days or last several months.

Years post-launch to peak prescriptions: This represents speed of product introduction and acceptance into the market (range 0 to 10 years).

The speed of product introduction can have an important impact on product profitability because of the limited patent life on medications, the threat of new medications entering the market, and the delay of achieving revenue from a product.

Expected peak prescriptions: Expected peak annual number of prescriptions written for the medication (derived from expected peak daily patients, and average weeks of taking prescription).

This number is determined by the number patients taking the medication on a given day, the duration of a course of medication, and the dose.

Years to patent expiration: Time in years from date of development decision until patent expires (range 0 years to 21 years).

Patent protection is critical to the profitability of a product, since generic companies tend to be very aggressive in pricing strategy. Patents are granted for nominally 17 years; companies may take a product into development for several years or more before applying for a patent, so that the time to patent expiration may exceed 21 years. Orphan drug status and certain forms of patent restoration may extend market exclusivity for a drug. Generic drug makers usually have far less need to recoup R&D investments, enabling major cost cutting relative to the price usually charged by the patent holder. Years of market exclusivity gained through orphan drug status run concurrently with any remaining years to patent expiration.

Orphan drug status: Whether or not a medication is expected to receive orphan drug status (1=yes, 0=no).

Orphan drug extension of market protection: Orphan drug status usually is granted effective at the time of FDA approval, and typically provides market exclusivity for 7 years.

Orphan drug tax advantage for development costs: Orphan drug status allows development costs to be expensed, effectively reducing development costs by 20 percent.

The Orphan Drug Act improves the economic incentives for development of medications to treat relatively rare disorders by first increasing the effective patent life for a drug granted orphan status, and second by allowing development costs to be expensed in the year incurred rather than requiring them to be capitalized and recouped against product revenues in the future. Years of market exclusivity gained through orphan drug status run concurrently with any remaining years to patent expiration. For a product whose patent expires, newly granted orphan drug status typically provides an additional 7 years of market exclusivity.

Years post-launch to introduction of competing drug: Expected years until introduction of competing product(s) (0 to 10 years).

Introduction of new products eliminates market exclusivity and reduces market penetration of the original product. Protection of market exclusivity (especially by patent or orphan drug status) delays the introduction of new products.

Years to replacement by competing drug: Expected market life of product after end of patent protection (0 to 10 years).

After market exclusivity expires, the market for a medication (i.e., for any given indication for that medication) typically erodes with the introduction of less-expensive generics and/or new competing therapies.

MMDA factors: Parameters pertaining to the duration and associated costs of manufacturing, marketing, distribution, and administration.

Companies make expenditures for manufacturing, marketing, product distribution, and administration over the life of a product. The model has parameters for first year MMDA costs as a ratio of first year revenue (range 1.0 to 2.0; typical value 1.2); duration of marketing campaign (typical value 5 years), MMDA costs during marketing campaign as a ratio of annual revenue (range 0.6 to 1.0; typical value 0.7), and MMDA costs after marketing campaign as ratio of annual revenue (range 0.2 to 1.0; typical value 0.5). For the purposes of simplifying the scenarios in this report, the "typical" MMDA factors shown here were held constant.