The Magic Money Machine and the Great Prescription Drug Funding Fallacy

If you can predict the content from the title, you're cheating.

I have a Magic Money Machine in my attic. If I feed it a $1000 bill, it spits out $10,000 twelve months later. A 900% annual gain is nothing to sneeze at, even if the attic is dusty.

However, what if I don't have $1000 to feed it? Am I out of luck? Not necessarily.

If my credit is good, I can borrow $1000 at, say, 10%, and still feed the machine. After 12 months the machine spits out $10,000 and I repay $1000 in principal and $100 in interest, netting a gain of $8900.

While this is still great, it's not a gain of $9000. It looks like there is a $100 price to be paid for not having $1000 sitting around in the beginning.

However, this is not correct. If I don't feed my $1000 into the machine, I can instead loan it out for 12 months at 10% interest. This means that the operation of the machine produces a gain of $8900 12 months out independent of whether I have the money or have to borrow it, just as long as the interest rate is the same.

What does this have to do with prescription drug funding? Good question.

When talking about the Magic Money Machine, I only mentioned one, when in fact I have 5. I also neglected to mention that these machines are really old, and fairly likely to chew up the $1000 bill input after 6 months, and not spit out anything. I can clean and try to maintain the machines, but each one has a mind of its own and nothing is certain.

To relate this to prescription drug funding, we assume that each machine is analogous to a development program for a specific drug, but with no payback, if any, until at least 7(?) years have passed.

To feed $1000 into a given machine, or to embark on a development program for a specific drug, is a matter of judgment under extreme uncertainty. Both risk and reward must be projected and weighed.

For drug development, one of the most important risks is political. Even if everything else goes perfectly, a government may at any time decide that it wants to do something that greatly reduces the future revenue derived from those drugs which actually reach production. The more likely this seems to be, the less likely that a development project for a given drug will be undertaken.

Even without waiting for the future, we already have threats and actual government actions of things like price controls, re-importation, parallel trading, and buyer market dominance.

When trying to justify their actions, governments and their apologists often resort to statements like the following :

1. Drug companies are some of the most profitable in the world. (There is some doubt that this is really true or significant)

2. Drug companies have a relatively small percentage of their budgets allocated to R&D.

3. Drug companies spend a relatively small percentage of their revenues on R&D.

4. Even drug companies themselves often say that revenues are needed to support drug development.

The fallacy in all of the above statements is that drug development decisions primarily rise or fall on the projected future revenues expected to be derived from a specific drug. To a first order, current profits or revenues are not or should not be a primary factor in the decision. Looking back at the Magic Money Machine, having the money in hand to insert in the machine did not affect the gain to be expected, and it should not have been a factor in the decision to operate a given machine.

Of course, a drug company typically has alternatives to simply borrowing money for development. It can sell stock, convertible debt or form a joint venture, probably among other alternatives.

Should current trends continue, it seems quite possible that in 25 years the only new drugs being developed will be for pets.

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I liked your money machine

I liked your money machine analogy. Big Pharma is gambling on future success. Some of the ways it loads the dice include:

me toos (molecular copycats of competitors successes)
evergreening ( as above, but with own drugs)
disease mongering (lets make everyone think they are sick)
patent shennanigins to slow competitors (keeps the lawyers in $$$)

Remember: when they get a winner it is a huge moneymaker. Pfizer have just repatriated $28 BILLION from an Irish bank account (overseas profits). Thats a lot of money machines!

Insider http://pharmagossip.blogspot.com

Interesting Reading A quick

Interesting Reading
A quick roundup of some interesting posts and news stories. First up, Brad Warbiany notes that we who don't believe in the "living constitution" just haven't seen the unabridged version. Amendment 1.5: Nothing in the preceding text is construed to...

Rather than getting tangled

Rather than getting tangled up in the money machine comparison, I do think that there is a problem with the current method of drug development. What has happened is that it has become a big money venture, with the idea that if enough money is pumped into drug development, something will come out of it.
It's a bit like a gambler progressively increasing the size of his bets, even when he loses a bet, or several bets. It creates a situation of either enormous winnings or enormous losses.

What is needed is a new paradigm of drug development, certainly not to the exclusion of all other types, but based on more intelligent drug design.

The good news is that what

The good news is that what works for my dog, cat, monkey, *mouse*, etc. will probably work on me. That's what most drug companies have proved anyway. So we'll just see a black market created for medicine.

Capitalism is dead. Long live capitalism!

Trent, Don, you forgot the

Trent,

Don, you forgot the related justification: “drug companies spend more on marketing than R&D.” That one is my favorite.

It didn't really fit with the others because it is a future investment made after the drug is in production. It wouldn't be made if it weren't expected to increase revenue more than the amount expended for advertising.

It is a serious problem, however, in that if advertising is banned or restricted, then the expected revenues will be lower and this is then another factor tending to reduce the development of new drugs.

Regards, Don

Stefan, The "lost

Stefan,
The "lost opportunity" cost of not loaning the money out at 10% interest is $100, meaning that if you gross $9000, it still costs you another $100 over the principal investment, so you net $8900.
Every decision costs. I used to administer Workers' Compensation claims for divers welding the bases of offshore oil rigs in the Gulf of Mexico. Death claims were a certainty, however they were not as high in respect to economic potential as the construction of the Empire State Building.

Stafan, if you loan the

Stafan, if you loan the money out you get $100 in income, if you put it in the machine you get $9000 in income. The net benefit of using the machine is the difference between those two, which is $8900. That is, it's $9k minus the opportunity cost of the next best use for the money.

Stefan, I believe Don is

Stefan,

I believe Don is noting that another way to express the measure of the return from the machine is the $9,000 minus the $100 opportunity cost (i.e., the $100 you would have earned, but did not, since you put the money in the machine rather than lending it out at 10%).

If I don’t feed my $1000

If I don’t feed my $1000 into the machine, I can instead loan it out for 12 months at 10% interest. This means that the operation of the machine produces a gain of $8900 12 months out independent of whether I have the money or have to borrow it, just as long as the interest rate is the same.

Your statement doesn't make any sense given what you said above. If you have the $1000 in hand and feed it into the machine, then you net $9000 in 12 months, not $8900.

Don, you forgot the related

Don, you forgot the related justification: "drug companies spend more on marketing than R&D." That one is my favorite.