The battle over Herceptin, the drug for breast cancer that this month won preliminary approval for broader use from U.K. health regulators, was a bruising affair that focused public attention on the high price of a shot at survival. With a cost of nearly GBP 20,000 a year for a typical breast cancer patient, Herceptin underscores that cancer medicines have some of the highest prices in the industry—especially for the newest "targeted" therapies. That's partly because the R&D required for oncology drugs uses many of the most advanced biotechnologies and has a low success rate. It's also because products that truly improve survival rates are relatively scarce, and most cancer patients and their families are willing to pay whatever it costs to try to beat the disease. It all adds up to big business for drug makers and their investors.

But market forces are about to change the pricing picture for oncology drugs. Oncology is now the second-largest therapeutic area, with global sales last year of $40 billion, including supportive care drugs. It's on track to eclipse cardiovascular medicines in the next five years. Some market analysts have estimated that oncology could exceed $100 billion within 10 years. Partly as a result of their high profitability, oncology medicines have become the focus of an industry-wide rush. More than 500 compounds are currently in clinical trials—four times more than any other therapeutic area. Pharma companies, including Novartis, Roche and GlaxoSmithKline, envision a future when high-priced targeted drugs will be the first-line therapy, and not just for those patients whose cancers have progressed the furthest. That alone could increase the eligible patient base by a factor of 10. And in some cases, these drugs, like Novartis's Gleevec for leukemia, may be taken for years to stop cancers from progressing.

All that is a boon for patients, but it poses a serious challenge to pharmaceutical companies. For one thing, recent history shows that fewer than 10% of compounds that begin preclinical trials are eventually approved as oncology treatments. Moreover, the rising intensity of competition will undercut the sales potential of "me-too" drugs that are similar to existing therapies. Merrill Lynch estimates that this competition will reduce prospective revenues of most cancer medicines by 21% to 32% by 2010.

Finally, as the history of cardiovascular drugs shows, payers—whether individual patients or insurers—focus aggressively on reducing the cost of medicines in the largest therapeutic areas as soon as there are enough competitive products. This track record signals further price pressures on oncology drugs. So far, infused biological drugs, like Avastin for colon cancer, have been spared generic competition. But the clock is ticking: The U.S. Food and Drug Administration took a step in this direction with the recent approval of a follow-on protein product, Omnitrope, a recombinant human growth hormone.

The upshot is that a small number of oncology drugs will manage to maintain a high price premium, because of their remarkable impact on survival. For most other products, including some that today command the highest prices despite having modest survival benefits, it's going to be much tougher. The market for oncology medicines will be smaller than many forecasts predict, reaching about $70 billion to $80 billion in 10 years' time, according to our analysis, as payers aggressively manage down prices and limit access to new oncology therapies That's still very healthy growth of 7% to 8% per year, but success will require more than rushing a "me-too" compound to market.

First and foremost, pharma companies need to begin focusing on actual patient survival, not just on whether a compound slows the progress of a tumor. That will be the all-important differentiator that justifies not only the costs of development but the price that payers are willing to reimburse. Viewed clinically—and, some might argue, coldly—many current cancer therapies have modest impacts, adding two to 10 months to a patient's life at a cost of $40,000 to $50,000. As a result, the FDA and the European Medicines Agency have both indicated that they will increasingly turn to true survival benefits as the standard of regulatory approval. For pharma companies, that's a clear signal to stop investing in drugs in development that do not show meaningful survival benefits. Investors—and patients—will want to take note of this trend, too.

Second, the market for oncology medicines is likely to grow more fragmented, as pharma companies are forced to get better at targeting the patients most affected by their medicines. One reason payers face a large and growing bill for cancer medicines is because the drugs are prescribed so broadly. But response rates among patients vary widely. A very small percentage of the people who took the lung-cancer drug Iressa during clinical trials, for example, improved their chances of survival. But it turns out that among Asian patients who never smoked, the drug is significantly more effective. The narrowed focus is becoming increasingly important in convincing therapy-assessment agencies that specific treatments are cost effective.

To pull that off, drug makers will need targeted diagnostic tests that can spot prime candidates for a drug by recognizing the presence of the right "biomarker" in the patient's blood or DNA. That won't be easy. To date, only a few biomarkers have been isolated. Efforts to develop biomarkers and drugs in tandem represent a sharp departure from pharma's standard R&D methods. But the old mindset of rushing a new cancer drug to market—and then looking for a biomarker later—becomes an even riskier path to gaining approval and attractive reimbursement.

In other words, parallel development of a drug and the biomarker that proves its efficacy might add cost in the short term, while the science required for developing the diagnostic is being worked out. In the long run, however, it will not only increase the drug's value but, most important, save lives.

Messrs. Henske, Hueltenschmidt and Singh are partners of Bain & Co. and members of the firm's global health care practice.