A good portion of the pharmaceutical industry has been struggling lately, including big names such as Merck (NYSE:MRK), Schering-Plough (NYSE:SGP), and Bristol-Meyers Squibb (NYSE:BMY). While some companies, among them Abbott (NYSE:ABT) and Johnson & Johnson (NYSE:JNJ), show continual strength, the sector as a whole seems to be ailing. Why? Is the development of new medicines getting more difficult? Well, it's not quite that simple. For the answer, we need to examine three key areas: the increasing cost of development, attrition, and patent expirations.
Cost of development
It's hard to make money in an industry where the average product costs between $800 million and $1.7 billion to develop. And that high cost explains why big pharma wants blockbusters -- drugs that bring in more than $1 billion annually. Given the high cost of development, most drugs would have to drum up sales of at least $80 million per year or more for 10 years just to recover those upfront R&D costs. And that figure doesn't even include other expenses such as cost of goods, increased sales force and parternerships, and shared capital expenditures.
Attrition
With big pharma pouring billions of dollars into R&D, you'd think the number of approved drugs would be increasing. In fact, quite the contrary is happening. According to the Food and Drug Administration, applications for new drugs have fallen considerably. And only 8% of leading drug candidates will make it from preclinical testing to the market, down from a historical 14%. In fact, of newly discovered chemical structures, only one in about 10,000 ever makes it to the market nowadays. And to make matters worse, a drug's weakness may not be realized until it has been used on thousands of patients, as was the case with Merck's Vioxx and Pfizer's (NYSE:PFE) Bextra.
Patent protection
Drug patents are pretty straightforward: The compound is protected for 20 years from the time the patent is filed. The key here, though, is time of filing, because drugs require years of testing before approval -- and those of us who use the drugs should be very thankful -- but those lengthy clinical trials eat into the drug's patent life. Newly approved drugs, therefore, typically have only 12 years of exclusivity remaining. And once the patent protection is lost, generic drugs can rapidly devour as much as 80% of the profits.
The art and science of developing drugs will always be a tough nut to crack, and while the rewards are great, so are the risks. The companies that can capitalize on improving the cost of development, attrition, and patent protection will eventually provide the greatest reward for investors.
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Fool contributor M.D. Mitchell is down the street at the local junkyard looking for some good trash. He believes pills would be easier to swallow if they were coated with oil. He owns Pfizer, just a little piece. The Fool has a strict disclosure policy.
