On March 15, the Centers for Medicare and Medicaid Services (CMS) released guidance on the drug price negotiations provisions of the Inflation Reduction Act (IRA). The guidance contains CMS’s interpretations for a range of elements in the drug price negotiation process, including the manufacturer specific data elements that it will review in potential adjusting its view of the appropriate price. 

While other data elements also deserve manufacturers’ attention, CMS’s approach to accounting for manufacturer costs associated with research, development and manufacturing will have profound implications for biopharmaceutical manufacturers. The agency’s proposed factors omit substantial investments while improperly treating others as sunk costs. As innovators prepare to comment on CMS’s guidance, they will want to convey the need for more fulsome consideration of these investments in the upcoming negotiations.

CMS Inadequately Considers Manufacturers’ Capital Costs

Typically, drug manufacturers make substantial outlays for research and development that include operating research laboratories, enrolling patients in and operating clinical trials, building and running manufacturing facilities, acquiring a vast array of raw materials, establishing production lines, and the acquisition and regular maintenance of often highly specialized, technical equipment used to manufacture and produce drugs and biologics.

Before defining the scope of research and development costs that will be considered in establishing a “maximum fair price,” CMS arbitrarily caps the annual cost of manufacturer capital at 8.1 percent, with no method of accounting for future interest rate increases or inflation. This will result in an almost automatic, unjustified financial penalty for manufacturers. Industry trends have not been favorable for innovators as drug development success rates have declined and costs of development and clinical trials have increased dramatically. Indeed, a Congressional Budget Office report showed that research and development costs increased 8.5% year over year for a decade and that, when adjusted for inflation, industry is spending 10 times as much on research and development as it did in the 1980s.

The R&D Cost Lens Needs to be Widened

The reality of the modern biopharmaceutical paradigm is that innovation is an enterprise-wide investment—an investment that CMS does not recognize fully in a number of respects.  It seeks to exclude costs of ongoing research and, while studies have recognized that R&D costs are significant for international roll-outs and line extensions, the guidance credits only studies for FDA purposes.  At the same time, in calculating the recoupment of these US costs, it uses global to total lifetime net revenue.

CMS does allow manufacturers to include the costs associated with abandoned or failed drugs in the same therapeutic class when negotiating the price of a drug that eventually received FDA approval. But limiting failed and abandoned drugs to the same line as the successful drug overlooks the many drugs that switch therapeutic classes during development, or manufacturer efforts that were abandoned.

Acquisition Cost Exclusion is Incongruent with the Current Paradigm

While CMS acknowledges acquisition costs associated with one biopharmaceutical firm acquiring another as an aspect of new drug development, it explicitly excludes these acquisition costs from the definition of research and development.

Many smaller, startup developers do not have the financial resources to perform advanced clinical trials or go to market on their own, but they are often engines of novel drug and biologic

development. Both large and small innovators and manufacturers embrace this paradigm of unlocking R&D productivity within the industry. Joint ventures, in-licensing and other forms of acquisition of capabilities allow complementary technologies in therapies, reduce risk and accelerate access.

By relying on an outdated industry paradigm in its concept of the four corners of R&D costs, CMS may discourage such R&D productivity enhancing arrangements and reduce the number of future innovative therapies.

CMS Fails to Account for Investment in Platform Technologies

A particular area where these limitations could hamper innovation is development of platform technologies. For example, biotechnology companies use genetic information driven foundational technologies to develop DNA, RNA and cell-based therapies.

Biomolecular platform technologies improve access speed, efficiency and quality, but nonetheless require substantial investment.  As it further develops its approach to R&D costs, CMS should not fail to recognize that the costs of developing and accessing these platform technologies must be recognized and that they are not NDA/BLA or single manufacturer specific.

Indirect Costs Are Artificially Capped

Within the definitions for basic pre-clinical research costs, CMS acknowledges that both direct research expenses—those that are specifically attributable to the discovery and development of the drug—and indirect research expenses—including administrative expenses, operating costs, expenses for clinical facilities and equipment—that are shared across multiple potential drugs are required to bring a drug to market. But indirect expenses are only allowed to be submitted in proportion to the spending for direct research on the drug selected for negotiation.   Artificially capping manufacturer’s enterprise-wide investments in the calculation of a drug’s maximum fair price could stymie innovation.

Manufacturers Will Need to Convey the Realities of Innovation to CMS

Stakeholders will have the opportunity to comment on CMS’s guidance prior to its April 14, 2023, deadline and subsequently when it publishes an ICR on the Negotiation Data Elements. This is an opportunity to help CMS avoid a relatively narrow cost accounting paradigm that fails to adequately account for the investment realities underlying the innovative therapies of today and tomorrow.

Failure to broaden the lens to fully account for the development contributions of the full range of a drug or biologic’s antecedents, acquired assets, and platform technologies threatens unnecessary harm to innovation. This will inevitably shift available capital away from areas of need and diminish the range of therapies available.