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Jack Scannell Talks Loads of Sense on Drug Pricing

Jack Scannell (the person who coined the phrase “Eroom’s law” for the rise of drug discovery expenses) has a long piece up at Forbes on drug pricing, and it’s terrific.  He goes over the various rationales for high drug prices in turn, with extensive comment. First off is the “recouping costs” argument, which he doesn’t have much time for:

Cost covering is a palatable spiel to make if one is trying to sell an expensive drug. In fact, the cost of production story has been repeated so many times for so long, that it has become plausible to lots of people who should know better. I still read in health policy papers that drug companies need to “recoup their costs.” This is nonsense. Sunk costs are sunk. If companies are going to spend on R&D they need to believe there are decent odds that they will make a good return on investment, but this is a different thing to recouping anyone’s historic R&D costs.

Next is pricing based on value – what this drug can do for you – which gets a more sympathetic hearing, but is also rejected in the end. One of the biggest problems is that it’s very hard to assign the real value to a drug, especially at first. This is especially tricky for the national heath services that are trying to do cost/benefit analysis:

Nobody knows for sure at the point of launch which drugs will transform medicine, which will turn out to be duds, and which will poison people. Drug companies and Wall Street analysts are hopeless at forecasting drug sales, even when most of the clinical trial data have been collected. I would be surprised if national health economic agencies have clairvoyant powers that the companies and the analyst lack. Therefore, rushing to do technical health economic analyses to come up with what will often be the wrong value-based price, which may be ignored by the drug company if it is lower than other countries’ wrong numbers, seems somewhat futile.

Arguing drug costs based on value, Scannell says, is also an invitation to exaggeration and salesmanship, which the industry does not need any more invitations to. As he notes, the UK is backing off the whole value-based pricing model, which is something to think about.

After that comes pricing power, since patents after all grant someone a temporary monopoly. Emphasis on “temporary”, because this does collapse when the patent expires and the drug goes generic. (At least it should – the recent furor over T*ring Pharmaceuticals and their ilk is largely about keeping this from happening and putting ancient generic drugs into the as-high-as-it-will-go category). But when the system works, it’s something to see. As Scannell says: “I would guess that one can buy today, at rock bottom generic prices, a set of small-molecule drugs that has greater medical utility than the entire set available to anyone, anywhere, at any price in 1995.” This is, as he says, a tough sell, but it may be one of the best drug-price arguments out there.

And finally comes the prize-winning lottery-playing aspect of drug research, and if anyone would like to deny that as a factor, I will gladly meet them in person to hit them over the head. After 26 years of drug research, that’s one thing I’m sure of: money, hard work, and brains are essential to success in this business, but are in themselves still insufficient. Time and chance happeneth to them all, folks, and equally smart and hard-working teams will come up with different results, sometimes dramatically jackpot-winning or job-losing different, and there is (so far) not a whole lot we can do about it. Here’s Scannell:

Only someone lacking ambition would play the lottery hoping to “recoup” their costs. . .the R&D lottery is expensive to play, most games are a bust, and the rare wins take a long time to pay out. Investors and drug companies choose their games (cancer, Alzheimer’s, obesity, etc.) by guessing at the value of the monopoly, the cost of the R&D, and the odds of success.

. . .It takes luck. It’s not fair. Roughly nine out of ten drug candidates that enter clinical trials in man are never launched. Even for the few drugs that are ultimately approved, the winnings are skewed. The most successful 10% of approved drugs, only 1% of those that entered clinical trials, maybe 3 new drugs each year, generate half of the profits of the entire drug industry.

He does not wrap up with a big list of suggestions that will fix everything – he has some ideas, which I’ll send people over to his post to read, but the big take-home is that this is a hard problem and there is almost certainly no way to make everyone happy about it. Along the way, he has a lot of excellent points about the various estimates of the costs of drug discovery and development, about the relationships of US prices to European prices, and many more topics. You really should read the whole thing. A lot of us have been making many of these points for a long time, but it’s really great to see everything wrapped up in one big package – instead of sending people to my my last dozen years of blog posts on drug pricing, I’m going to start sending them to this piece instead. Things like this prompt me to do so:

A mistake that many critics of the drug industry make is to imagine that because new drugs are very expensive, the industry is systematically cheating, there must be a lot of slack in the system, and if only the slack were removed, we would have a flow of good cheap new drugs. I think that the truth is much worse: The industry is trying hard to discover and develop things to sell; it is charging as much as the market will bear; even First World health systems are baulking; access to the newest drugs is problematic; but outside of a select few disease areas the financial returns on R&D investment are poor; and without the private sector investors, there would be vanishingly few new drugs.

Sounds easy to fix, doesn’t it? Gosh, if only all those folks running for office could just get their hands on the levers; they’d have things straightened out in no time. Despite all the political fireworks, Scannell says that “a likely outcome is that things grind slowly along their current trajectories”. I’d take that over some of the other possibilities, believe me.

18 comments on “Jack Scannell Talks Loads of Sense on Drug Pricing”

  1. blogceutico says:

    The original article is a great reading but his writing is confusing in some parts, especially for a non-native english speaker. I found this post of yours much more clear and transparent! Thanks!

  2. Steve says:

    NY Attorney General’s office has apparently opened an antitrust investigation of T**ing Pharmaceuticals:

  3. Eric says:

    I too thought it was a very good summary of drug pricing. It would be nice to see a similar review of other medical pricing paradigms – how do hospitals, clinical labs, doctors, etc. come up with their pricing? Drug prices are often the focal point which, in my opinion, ignores the broader issues in healthcare costs.

    1. Mucco says:

      Hospital costs would be interesting. Even the latest economics Nobel couldn’t establish the cost of his hip operation in advance:
      Trying to be a good hip op consumer

  4. AQR says:

    The public tends to think of the money that spent on patented drugs strictly as a cost. It seems to me that it is more properly considered as an investment. A company spends money on research to discover and develop a new drug. Only if that investment is successful in leading to a drug is the company able to offer this innovation to the public. The exclusivity offered by the patent allows the company to price it at a rate that will hopefully allow it to stay in the business of discovering new drugs. However, this exclusivity lasts only for a limited period of time and, once the product goes off patent, competitors can enter the market and the drug’s price drops. In essence, the money that is spent by the innovative companies and “repayed” by payers during the period of patent exclusivity, is an investment that has been made by society which, at patent expiry, makes that therapy available into perpetuity at a relatively cheap cost.
    This situation contrasts dramatically with other health care expenditures. The cost of things like open heart surgery, angioplasty, pacemakers and dental work are high and will only increase going into the future.

    When viewed from this perspective, the money spent on innovative drugs offers a distinct public health advantage over expenditures on other forms of therapy.

  5. Andy II says:

    This may be a little off the topic but is a link to an interesting pricing process in Japan. or
    It is a very confusing. And, drug price in Japan decreases over years, which is different from US. BTW. Roche had a success to set their HepC drug high at about $515 per daily dose but the government pays $43,000 (12 week dose) per patient who pays $335 for the full regimen.

  6. Richard W says:

    It was an excellent article. Most notably was that no ones’s country methodology in drug pricing was overall better than anyone else’s. IMO, the free market is still the prefer method, but it needs to be more transparent so that the buyers can “shop” properly. Towards that transparency, barriers that are due to regulation and the ones that companies put up to prevent generics from entering the market have to be dealt with. Quid pro quo: patent protection and cheap generics.

  7. diverdude says:

    “One of the best books about the drug industry is about the movie industry; William Goldman’s Adventures in the Screen Trade. Goldman wrote that: “Nobody knows anything… Not one person in the entire motion picture field knows for a certainty what’s going to work. Every time out it’s a guess and, if you’re lucky, an educated one.””

    Best. Drug. Development. Quote. Ever.

  8. petros says:

    Some interesting points

    Note the appalling track record of AD trials 99.4% failure rate in 441 trials of over 200 drugs

    And highlights the market failure with respect to new antibiotics

  9. RM says:

    I can’t help but feel that his “Cost” arguments are a strawman. When people (at least knowledgeable people) talk about recovering costs in R&D, they’re not talking about recovering costs *for that particular drug*. It’s always talking about the general costs across all R&D efforts, including the ones which didn’t produce any usable drugs.

    I also think talking about the sunk cost fallacy in this context is disingenuous. It may be a sunk cost at the point in time when the drug exists, but it isn’t when the actual R&D spending occurs. By moving at which point you make the argument, you can void almost any transaction. “Vending machine ate your dollar? Why do you expect to get it back, it’s now a sunk cost.” “You should have no expectation to be allowed in to the theater, as your ticket purchase is a sunk cost.” “You put money into a bank account? You should have no expectation of getting it back – it’s a sunk cost.” — Take the “sunk cost” theory to its logical conclusion, and all transactions are reduced to “one, two, three, shoot!” and a mad grab for the money/goods.

    His last point (“Prizes”) deals with these issues, but with a (I think) needlessly pejorative word choice. “Prizes”/”lottery” convey a cynicism about things that a term like “investment” does not. We wouldn’t say the restaurant owner who remodels to add more tables is “playing the lottery”, nor would we say that the manufacturer who buys a new machine to increase capacity is “hoping for a prize”. I don’t think that applying such terms in the context of R&D spending is appropriate. (Granted, there is a “lottery” aspect to blockbuster drug pricing, but it’s unfair and disingenuous to lump that aspect of the situation in with fulfilling expected ROI on speculative R&D spending.)

  10. exGlaxoid says:

    We wouldn’t say the restaurant owner who remodels to add more tables is “playing the lottery”. Anyone who has owner a business knows that every decision to spend more money is a gamble that the investment will pay itself off. Many restaurants spend money to expand or renovate and then find that the economy falters (like in 2008) and the spending is never recovered. So in that sense, every dollar spend on R & D is a gamble that any discovered drug might make more money that the average cost of finding/developing it.

    Ford and GM include the cost of designing new cars (including crashing some them to test safety) into the cost of their new cars, I don’t see why pharma companies shouldn’t do the same. Ultimately, a few models and brands make most money for them as well, buy it does not mean that you can demand that they sell you a car for the cost of the steel and plastic it is made from. The cost of the design, tooling, factories, training, and labor are all included in the final cost, not the cost of the materials in it. Drugs are ever more risky to develop, so the profit from the best drugs needs to be high enough to encourage more research.

    But buying a generic company or drug and then jacking up the price by 1000% is not spending on R & D or innovating. It is just an attempt to extort money from people based on loopholes in generic laws. The FDA and/or Congree should fix those loopholes, and the practice would stop, as once a “cheap to make” drug goes generic, the extorting company would loose and go bankrupt, and that practice will go away.

  11. Brandon Berg says:

    I think he gives the “value” argument short shrift. Yes, it’s hard to judge the true value, but ultimately you can’t get people to pay more for a drug than they actually think it’s worth. Or, rather, in most cases, more than their insurance companies or governments think it’s worth.

    Of course, this is subject to the constraints of their limited ability to engage in price discrimination. It’s worth different things to different people, and they can’t charge everyone exactly what they’re willing to pay.

    Monopoly power matters quite a bit, of course, but it’s still constrained by perceived value. Monopoly or not, it doesn’t make sense to charge a $90,000 for a course of cold medicine, because all but a handful of the world’s richest would rather endure a cold than pay $90,000. For a cure to a terminal disease like Hepatitis C, it’s a reasonable pricing strategy. Because a cure for a terminal disease has much greater perceived value than a cure for a common cold.

  12. Robert says:

    As long as the CEOs of drug companies receive U$ 10 million bonuses, we can be certain the price of drugs are inflated.

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