Market Barriers to the Development of Pharmacotherapies for the Treatment of Cocaine Abuse and Addiction: Final Report. Internal Rate of Return and Reducing the Time to Market

09/12/1997

Another important investment criterion used by some companies is the internal rate of return (IRR). The IRR is the rate of interest at which the present value of all net cash flows into and out of a project over a specified time interval equals zero. A higher IRR makes an investment opportunity more favorable.

According to its report on the pharmaceutical industry, the former congressional Office of Technology Assessment (OTA) estimated that the pharmaceutical industry achieves IRRs in the range of about 14 percent (OTA 1993). To maintain such a rate, companies may seek individual investment opportunities with higher rates, e.g., above 20 percent, to account for the risk associated with drug development efforts, the majority of which do not ultimately yield marketable medications.

Consideration of acceptable IRR for prospective cocaine medications readily reveals two key findings. First, if the cost of developing a successful cocaine medication is comparable to OTA estimates of the recent cost of developing other medications, pharmaceutical companies will be hesitant to take on such efforts early in the R&D process. OTA estimated that the fully capitalized cost of a medication at launch was as much as $359 million in 1990 dollars, equivalent to cash outlays of $135 million over 13 years. When these factors are applied to the market scenarios described above, not even the optimistic doubling scenario at the high wholesale price of $2.50 per patient per day meets the 20 percent IRR threshold, let alone the more conservative saturation and half-entry scenarios.

Second, pharmaceutical companies may be more interested in a late-entry scenario in which a company takes on further development after initial R&D - and its inherent risk - have been conducted (or sponsored) by another entity. Late entry might occur if, as has happened with other medications, the government were to complete the early years of product development and then turn over the rights of the product to a company.

As indicated in Figure 19 (below), a late-entry scenario that requires only 8 years to complete development of a cocaine medication, at an estimated total cash outlay of $70 million, may be more favorable. This scenario, entailing a shorter development time at lower cost, may be attained when the government, another company, or some combination of these has invested in early R&D. Thus, a large pharmaceutical company may be more willing to acquire or otherwise collaborate with a smaller firm with a substance abuse compound that has already passed milestones in the R&D pipeline, requiring less investment and fewer years to market. This scenario may also occur when a major advance in the science base has occurred that accelerates the drug discovery and development process. New research indicating that medications in development for other central nervous system disorders (mental illness, analgesia, anesthesia, etc.) have applications for substance abuse as well could shorten the development time table and lower costs.

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Figure 19: Late-Entry Scenarios: Reducing the Time to Market Improves Attractiveness of Developing a Cocaine Medication
     
Years to Product Launch/ Cost of Development (uncapitalized)
Market Scenario
13 yrs / $135 mil.
8 yrs / $70 million
Penetration
Peak Daily Patients in 000s
Peak Annual Revenue
Internal Rate of Return (in percent)
Doubling
500
$455 mil. 17.6 27.5
Saturation
250
$227.5 mil. 13.0 21.4
Half Entry
125
$113.8 mil. 8.4 15.4
         
Assumes, e.g., $2.50 wholesale cost per day for medication, 4 years from launch to peak sales, patent acquired 3 years after start of development.

Note that even the least ambitious penetration market scenario achieves the 20 percent IRR threshold value if the cost of the development phase is sufficiently reduced, Figure 20 (below).

Figure 20: How Cost of Medication Development Impacts the Attractiveness of Developing a Cocaine Medication
     
Cost of Medication Development
(8 yrs., uncapitalized)
Market Scenario
$70 million
$50 million $30 million
Penetration
Peak Daily Patients in 000s
Peak Annual Revenue
Internal Rate of Return (in percent)
Doubling
500
$455 mil. 27.5 30.7 35.2
Saturation
250
$227.5 mil. 21.4 24.5 28.9
Half Entry
125
$113.8 mil. 15.4 18.4 22.7
           
Assumes, e.g., $2.50 retail cost per day for medication per patient, 8 years of development until launch, 4 years from launch to peak sales, and 14 years of patent life, post-approval.