Government regulation lengthens the process for bringing new pharmaceuticals to market and restricts the drugs sector to protect public safety. Governments create incentives for particular behaviors and encourage the development of safe and effective drugs. Pharmaceutical companies are heavily regulated to ensure they are in compliance with federal safety laws. In the United States, the Food and Drug Administration (FDA) ensures that new drugs are rigorously tested for safety, efficacy and minimal side effects.

As a result of this testing, most new drugs are researched and investigated for 10 to 15 years before they are brought to market. Drugs must undergo human trials that are intended to discover potential side effects and treatment efficacy. At any point in the multi-phase testing process, new drugs may fail to show effectiveness or may have unreasonable side effects. If either of these occurs, the company may research it further in the lab at its own expense but will not receive permission to release it to the market until the product yields positive results in human trials.

Throughout this period of research and development, pharmaceutical companies must have dependable sources of financing. Typically, this financing is in the form of either investments and loans or revenue from sales of other products. Government regulation gives a distinct competitive advantage to companies large enough to maintain secure funding. Major drug manufacturers with profitable products already in the market usually do not require the ongoing fundraising and venture capital that startups do.

This process is a significant barrier to entry in the pharmaceutical industry. As a result, mergers and acquisitions (M&As) are common. New companies and larger companies both benefit from mergers. Big companies take advantage of opportunities to acquire profitable new products and small companies benefit from the financial boost and expertise of a large partner. Because of the regulatory expense, companies have a strong incentive to offer support to only the most promising drugs. M&As usually happen only after new drugs begin to show promise in trials.

Some drugs benefit from additional government incentives. Orphan drugs receive special consideration from the FDA in order to encourage pharmaceutical companies to develop treatments for rare diseases. Incentives for the development of orphan drugs include quicker approval time and potential financial assistance for development. Companies are often permitted to charge substantial prices for orphan drugs, making them more profitable than they would be without government intervention. As a result, the development of orphan drugs continues to grow at a faster rate than the development of traditional pharmaceuticals.

Overall, government regulation of the drug sector has resulted in a longer, more-expensive product development process that favors treatments for rare illnesses. All approved drugs have been rigorously tested by the FDA to protect consumers from harmful or ineffective treatments. This process is designed to occur over a long period of time to ensure that only the safest and most effective drugs arrive on the market.

  1. What is the drugs sector?

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  2. What are the major barriers to entry for new companies in the drugs sector?

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  3. What are the primary factors that drive share prices in the drugs sector?

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  4. What factors make the drug sector good for value investing?

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  5. What does it mean that an investor faces binary outcomes when investing in drug companies?

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  6. How does the drug sector benefit from the growth of emerging markets?

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  1. Orphan Drug Credit

    A federal tax credit that provides an incentive for pharmaceutical ...
  2. New Drug

    A new medication or therapy that has not been used before in ...
  3. Drug

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  5. Food And Drug Administration - FDA

    A government agency established in 1906 with the passage of the ...
  6. New Drug Application (NDA)

    The final step formally taken by a drug sponsor, wherein it applies ...
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