Has the Inflation Reduction Act hindered pharmaceutical innovation? Evidence shows that the pharma industry can strategically manage disruptive change.
“How can you make sense of the future when you only have data about the past?”
—Clayton Christensen
This question, commonly attributed to the late scholar Clayton Christensen, captures the dilemma facing policymakers searching for a formula to lower drug prices without stifling innovation. It took on new urgency after 2019 with the introduction of several proposals designed to rein in escalating drug prices, including the Elijah E. Cummings Lower Drug Costs Now Act of 2019, the We PAID Act of 2019, the Prescription Drug Pricing Reduction Act of 2019, and the subsequent passage of the Inflation Reduction Act (IRA), which created a process for negotiating a “maximum fair price” for selected drugs covered by Medicare.
These proposals spawned numerous studies designed to model the impacts of drug price reductions on the pharmaceutical industry and innovation. (See background in “Implications of the Inflation Reduction Act for the biotechnology industry, INET Working Paper No. 233.) These models differed substantively in their methods, datasets, and assumptions, had different sources of funding, and—as might be expected—generated widely divergent predictions.
Models focused on internal R&D by large pharmaceutical manufacturers, financed from product revenue and guided by management strategies aimed at maximizing the return on investment from individual products, suggested that the drug price reductions anticipated under the IRA could reduce investment in innovation, leading to fewer drug approvals. In contrast, models that also considered R&D contributions from science-based biotech companies suggested strategies by which the industry could successfully mitigate any negative impacts of drug price reductions and sustain both their profits and productivity.
Three years later, empirical evidence is emerging to assess the utility of these models.
Our recent report characterized investment and business development activities by the biopharmaceutical industry in the six quarters following passage of the IRA in comparison to the previous six quarters. The analysis showed that following passage of the IRA, R&D spending by large pharmaceutical manufacturers rose to all-time highs; equity investments in biotech firms remained essentially unchanged and, although lower than pandemic-era records, were higher than pre-pandemic levels; the number of acquisitions increased to new highs; and the number of license agreements decreased, but remained above pre-pandemic levels. These results are consistent with other reports showing little or no short-term effects of the IRA on private investment, IPO activity, or M&A; no market response to the first round of price reductions announced in August 2024; and little change in industry guidance to shareholders concerning future revenue and earnings.
Significantly, this analysis found no evidence that the price reductions anticipated under the IRA would lead to reduced investment in innovation or compromised new product pipelines. Instead, the results provided evidence of increased strategic investment in both internal and external innovation aimed at sustaining a pipeline of new products. Increased internal investment is evident in record levels of R&D spending (expense) following passage of the IRA; increased external investment is evident in a highly selective rise in acquisitions of biotech companies with lead products in clinical development (specifically phase 2 or phase 3), and a selective increase in the number of equity offerings by biotech firms with clinical-stage products.
It should be noted that these changes are not necessarily a response to the IRA. The window of time covered by this analysis coincides with a period of social and economic turmoil as well as abrupt changes in pharmaceutical, equity, and debt markets associated with the pandemic and its aftermath. This period also coincides with growing concern about pending patent expirations on products currently generating as much as $183 billion in annual revenue.
Do these results give us a sense of the IRA’s impact? On one hand, the answer is yes; these empirical findings are indicative of a multifaceted and resilient industry that has the capacity to strategically manage disruptive change. The results are consistent with models suggesting that the industry can mitigate any negative impacts of IRA-driven price reductions through strategic allocation of internal R&D spending and increased acquisition of clinical-stage products from smaller biotech firms. While it is impossible to predict the productivity of industry’s renewed investments, historical clinical success rates suggest this could maintain or even increase the number of drug approvals in the future.
On the other hand, Christensen’s answer to the question— “How can you make sense of the future when you only have data about the past?” —was “You have to have a good theory.” The problem with that answer is that the theory also must be contextually relevant.
Many models used to predict the IRA’s impact on innovation fail this test. They fail because they focus primarily (or sometimes exclusively) on internal R&D in large pharmaceutical companies—which account for most product sales and R&D spending—and do not consider that as many as two-thirds of recent product launches originated in emerging, science-based biotech companies. Additionally, many large manufacturers now derive most of their revenue from sales of acquired products rather than products arising from internal innovation. This includes blockbuster drugs like pembrolizumab, acquired by Merck & Co. from Organon/Schering-Plough; nivolumab and apremilast, acquired by Bristol-Meyers Squibb from Celgene; sofosbuvir, acquired by Gilead Sciences from Pharmasset; and ibrutinib, acquired by AbbVie from Pharmacyclics.
Most new products originate in emerging biotech companies that do not have product revenue, have negative earnings, typically have only one significant product in development, finance R&D substantially through sale of equity, and attract investment based on their management teams, corporate partnerships, academic partnerships, novelty of their technologies, competitive positioning, patents, and even geographic location in addition to any consideration of returns. Most of these companies are simply scrambling to advance development of their core technologies or lead products with any resources available from capital markets, corporate partnerships, or government contracts or grants. Innovation in these companies is not explained by conventional finance or investment theory, but rather by the still-incomplete theories of science-based business focused on monetizing scientific, intellectual property.
Research described here was supported by grants from the West Health Policy Center and the National Biomedical Research Foundation to Bentley University.
