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Drug Prices

A Look At Drug Pricing

The Wall Street Journal ran a long look yesterday at drug pricing in the US, and it’s hard to argue with this summary:

The upshot is Americans fund much of the global drug industry’s earnings, and its efforts to find new medicines. . .The reasons the U.S. pays more are rooted in philosophical and practical differences in the way its health system provides benefits, in the drug industry’s political clout and in many Americans’ deep aversion to the notion of rationing.

The fact that US prescription drug prices are higher than the rest of the world isn’t exactly news. The article compares US prices to Canada, England, Norway and other countries, and also goes into detail about how Norway’s national health care system negotiates prices. It’s a good example: the Norwegian authorities and the various drug companies fight it out over cost/benefit arguments until a price is reached (which is sometimes not disclosed).

So the natural assumption is to wonder why the US doesn’t do the same. One reason the industry fights so hard to keep that from happening is that the reason that drug companies are willing to get less for their products in the rest of the world is because they’re getting more for them in the largest single market, the US. It’s worth restating that point: people look at the lower prices in Canada and Europe and say therefore drug companies should charge the same prices in the US. They’re not thinking it through: prices are lower there because the prices are higher here.

Prices would rise in other countries if (say) Medicare were to be able to negotiate prices, a fact that many European governments are well aware of. They’re not going to publicly cheer on the position of the drug industry in the US, but economically, it’s clear that that’s what allows their own pricing levels. (That’s not to say that this would be a complete zero-sum situation: drug industry profits would surely go down overall if the US suddenly became more Norwegian. But Norwegian prices, and others, would see pressure that they certainly don’t now).

Those profits are what drive the industry in its current form – the funding of new drug projects, the incentive for many smaller companies to keep up their own programs (in the hopes that larger firms will use some of those profits to buy them out), and the incentives for startups to get venture capital in the first place. As it stands, these various gears and pulleys all go back to the main drive wheel of US-based drug pricing. It’s fine to think of ways in which this could be different, but any plans in this line have to begin with an understanding of just what the current system is and how it works, rather than (say) “Wouldn’t it be great if we could stick it to those evil drug companies?”, which is a common starting point.

One thing that the article doesn’t go on the mention, though, is that things change greatly once a drug goes off-patent. Generic drug prices are generally quite a bit lower in the US than the rest of the world; that’s the flip side of our higher prescription drug prices. (And that’s one of the things that upsets me about the Valeants and T*rings of the world, who are finding ways to make even those older drugs more expensive). I’ve said this before, but this is a good place to say it again: I think that pricing power should belong to the companies that are taking the risks and spending the money to discover and develop new drugs. That’s what patents are for; a reward system for just that risk-taking. In return, you disclose your inventions to the public, and you agree that after a set time period that temporary monopoly will expire, and prices should, at that point, be up to whoever can deliver the compound most cheaply and efficiently.

If instead we allow generic prices to ratchet upwards, the whole system we have now (like it or hate it) is in danger of collapsing. It’s not the firmest edifice in sight even as it stands. If we’re going to replace it, I’d rather we do so by thinking hard about it, rather than watching it disintegrate for reasons that we didn’t intend and didn’t expect.

33 comments on “A Look At Drug Pricing”

  1. Rob says:

    I note that the WSJ article suggests: “The higher U.S. prices also help drug makers afford hefty marketing budgets that in the U.S. include consumer advertising—something Europe doesn’t allow.”

    I think they have that the wrong way round – hefty marketing budgets for drugs in the US leads to higher prices. Take out the marketing budgets and prices will be much closer.

    1. Derek Lowe says:

      Ah, but those marketing budgets are expected to pay for themselves (and more) with increased sales. That’s not just money thrown into a ditch. If you’re not making more profit because of your marketing, you’re doing your marketing the wrong way.

      1. biotechtoreador says:

        “Ah, but those marketing budgets are expected to pay for themselves (and more) with increased sales. ”

        The problem with this, similar to R&D, is the old saw “I know half my marketing works, I just don’t know which half”.

        I don’t think pharmers have a clue what returns they get on marketing. Even as a ruthless capitalist I find it disheartening that healthcare costs go to pay ad agencies.

      2. T says:

        Marketing can pay with higher sales, but also with higher prices.

    2. Mark Thorson says:

      The AMA thinks so, and they’re calling for a ban on direct-to-consumer pharmaceutical advertising.

      1. RM says:

        Notice that nowhere in the press release you link is it claimed that the marketing spending of pharmaceutical companies is the cause of higher drug prices, at least on an individual prescription level basis. (aka “If they spent less on marketing, prices will be cheaper.”) Instead, the AMA is concerned about prescription drug marketing because it drives unwarranted demand for high price drugs. Basically, the AMA is saying that ads drive up aggregate health care costs because people who don’t need the drugs will ask for them anyway or they’ll be induced to use an advertised name-brand when a cheaper generic or older drug would be just as effective. – Or in other words, the AMA supports banning advertising not to make Nexium cheaper, but to get people to use Rolaids or omeprazole instead.

        1. Hap says:

          I could also be cynical and say that doctors would rather someone else’s salaries be cut to make health care less expensive, but that’s just me.

          It might be in pharma’s interest to stop direct-to-consumer advertising. They sell more (in theory), but they pay more in fines (though probably not enough). Of course, the goodwill they had didn’t make them money, but the lack of trust they have probably makes making drugs more expensive (because the trials have to be more complex and explicit to get a drug approved), which doesn’t help if you can’t get enough drugs for what you are spending already. On the other hand, ads make money now, which works if either you think pharma’s business model is unsustainable and can’t change it, or you get paid bonuses for short-term performance and don’t care about the long term.

  2. McChemist says:

    “They’re not thinking it through: prices are lower there because the prices are higher here.”

    I think this is flawed logic, and you’re implying that pharma companies aren’t seeking to maximize profit. If a company has leverage to negotiate higher prices from European countries, they can do this *in addition* to keeping prices as high as they can in the U.S. I can’t envision any possible mechanism where lowered prices in the U.S. lead to higher prices in the rest of the developed world.

    The point about profit from the U.S. providing incentives for drug discovery are correct, But claiming that drug prices between the U.S. and Europe are going to be inversely correlated? I ain’t buying it.

    1. Hap says:

      If pharma has an easier way to generate money, they’re going to do it. Negotiating against governments is hard, and spending more on it (being willing to give up money now to potentially make more later, spending more on lobbyists, etc.) might not get them the same yields as spending it on stuff that enables them to raise prices in the US. If they didn’t have the opportunity to raise the money in the US, they would be more likely to fight for the money elsewhere, which would drive the prices elsewhere up.

      I don’t think cutting advertising would lower US prices so much – while it would minimize the irrational reasons why people might advocate for a drug, pharma spends money on advertising because it brings in more money (and perhaps even at a higher rate of return) than other things pharma can do with the money. They’d have to make it up somewhere, and since they have more pricing leverage here, that’s probably where it’s going to happen.

    2. Derek Lowe says:

      Drug companies certainly try to get the best prices they can. But their negotiating positions might well shift in the absence of the high profits in the US market – the smaller markets would become more important, and more worth fighting about.

    3. z says:

      There’s a couple that I can think of-

      As the individual European markets are much smaller than the US, they probably have less people/lobbying/etc. supporting those negotiations.

      A number of drugs/medication would stop becoming cost effective to produce or research with a smaller US market, so Europeans would have to decide between increasing prices or losing the drug entirely. Hard to prove point though. For those “risked” drugs, the limitation for production might be more dependent on scale rather than production cost.

      There are a number of “write-offs” and otherwise free or heavily reduced priced drugs that the companies might supply for non-profit reasons (HR, marketing, etc.). With a reduced profit margin, they may decide to lean off on some of those.

      And lastly, if there is some change in the US market, European markets/governments would understand and possible “sympathize” with the reduced profit leading to higher drug costs (ex. understanding that a bad corn yield would increase prices in meat as it’s a common animal feed). Or in this case, renegotiation for drug price increases.

  3. Anon says:

    What’s more is that US drug price increases account for more than 200% of US branded sales growth while prescription volumes are falling, and 40% of US generic sales growth, even as prescription volumes rise. If it wasn’t for US price increases, the entire industry would collapse.

    And so it will, because these price rises are unsustainable, and also unjustified as incremental benefits are diminishing with every new drug.

  4. biotechtoreador says:

    “So the natural assumption is to wonder why the US doesn’t do the same. One reason the industry fights so hard to keep that from happening…”

    One wonders why pretty much EVERY other government in the world has succeeded in winning this fight while the government of the mightiest nation the world has every seen (apologies to any ancient Romans) fails. For me it seems that the US taxpayers ought to mount a WTO challenge to, what amounts to, unfair subsidies on drugs in the rest of the world.

    Be careful what you ask for, though. If the golden goose of Americans paying higher prices for drugs stops laying eggs there will be precious fewer incentives for American (and other) pharmaceutical companies to keep risking billions of dollars a year to discover new medicines. This will be bad for pharma employees and for sick patients hoping for new drugs.

    It would be great is someone could explain what an acceptable profit margin on a drug, generic or otherwise, is. So far, the best argument I’ve seen is “I can’t define it but I know it when I see it”.

    1. Mark Thorson says:

      If we kill that golden goose, it will be mostly Irish companies that suffer, not American. Ah, those greedy Irish!

    2. Andre says:

      This is not quite true, Switzerland does not fix nation-wide drug prices. As a consequence, we entertain the second highest drug-prices in the world after the US. As the US, we have a strong pharmaceutical industry (Novartis, Roche, Actelion, etc.). This would support Derek’s thesis about the correlation between high drug prices and the presence of a strong pharma industry. Are there any examples to counter the thesis: Low drug pricing, but a vibrant pharma industry?

      1. David Cockburn says:

        The obvious example to look at would be the UK. It had an important drug industry: Glaxo, Wellcome, Zeneca, Fisons, and quite a few significant drugs were developed here, propanolol, cimetidine, sildenafil. Since governments have been more aggressive about negotiating prices we have seen a significant contraction of the industry and researchers closing down their UK sites. Of course correlation is not cause but it is suspicious.

  5. Some idiot says:

    I agree with McChemist… Generally speaking, the European countries pay what they do for drugs because that’s what they think they are worth, in terms of patient outcomes (yes, I know I am skating over a lot of details, but it is the big picture which is relevant here). So if prices in the US were pushed down, this would not mean that the European countries would think that drugs were suddenly worth more.

    Sure, there would probably be a lot of hard lobbying done by the drug companies to try to raise prices, but I can’t believe that there isn’t a lot of hard ball being played now. There have been instances of original producers deciding not to sell products in some European countries because they felt they could not get a fair price for it. And if that’s not hard ball, I don’t know what is…

  6. watcher says:

    biotechtoreador: A big reason why the US Congress has not done very much to control drug prices has been simply politics, money flowing to candidates from Pharma and individual companies, and the lobbying intended to cause concern / fear that lower prices would prevent new drug research and lower access to medicines when we need / want them. (Have a virus infection, take an antibiotic.) To me, this is not much different from the lack of progress on many other issues facing the country which Congress does not address (refrain listing to avoid more debate off topic) yet Bill and Hillary tried. As much as anything, the problem lies in the fear of people to changing to something new, different that they don’t understand, don’t trust. And consider this, if prices would not have been set at “market value”, would we now have HIV drugs that extend lives for decades, new Hep C life altering and saving medications that eradicate the virus in a few weeks, novel cancer and lymphoma treatments that are making inroads not thought possible just 20 years ago? Important to remember the old adage to “be careful for what you wish for”.

  7. Vader says:

    Drug research is high-stakes gambling.

    Norway is offering to pay part of the cost of the lottery ticket, but only on those tickets that have already won.

    The U.S. is paying part of the cost of the winning tickets and all the costs of the losing tickets.

    This situation arises because Norway has claimed monopoly power over drug sales within its borders, and the U.S. does not.

    It would be fascinating to compare the behavior of the drug market with the behavior, say, of the military arms market. Here the U.S. does claim monopoly powers, at least over the more expensive arms that private citizens are prohibited from owning. Alas, I know little about that market.

    1. Old Pump Kicker says:

      I do know the military arms market. (I kicked shipboard pumps. Not chem process pumps, as you may have assumed.) Not much different. Post-cold war, we also played the mergers & downsizing game.
      For any weapon complex enough to be called a “system”, the number of vendors and number of weapons systems addressing each required capability (equivalent to “number of drugs approved for each diagnosis”) has never been enough for the seller side to be a free market.
      There are differences:
      * For the complex stuff, the U.S. is paying ALL of the cost of the winning tickets (development and purchase). It may pay certain development costs for losing tickets (on big-ticket competitions).
      * Weapon systems don’t go generic. System complexity makes it uneconomical to achieve and prove equivalency. (DOD insists on proof by test, just like FDA. They’ll even provide the soldiers and empty land required for their version of Phase III.)
      * The Government takes the risk that the system won’t meet military requirements or budget projections. They will accept poorly-performing systems (when the alternative capability gap is worse) and fund development of a fix. Pharma companies/shareholders take the $ risk that sunk R&D costs and toxicity lawsuit costs (always $, never jail time) can’t be recouped. The patient has all the health risk that (a) there are no approved drugs, (b) there are no good drugs, (c) the drug price is too rich for the health plan/wallet, or (d) the drug is toxic.

  8. Shanedorf says:

    Agree with many of the comments in here and will add one more
    In my experience, the US pays their employees higher wages than their EU counterparts
    Americans earn more and pay more (and can somewhat afford to do so)
    EU workers earn less and pay less. Want cheaper meds ?
    Try moving to Norway…and earning less
    The net net likely isn’t as big a gap as some might initially believe. Clearly politics, lobbying, marketing, innovation etc all play a role and so does the relative spend for consumers/patients. My German counterparts earned 1/2 of the salary that we Americans earned. But please don’t tell them, it won’t go over well.

  9. oxa says:

    I think the difficult truth is that pharma is in an economic bubble. Prices for new drugs are increasing even though most do not provide societal value equivalent to the profits that are being made. Obviously there are more factors to pricing than that, but I think it’s very safe to say that there is far more profit in the industry than there is value created and that it cannot continue forever. Increasing prices, M & A and overloading the US health system with extremely expensive, non-curative cancer drugs are not sustainable practices.

  10. biotechtoreador says:

    “I think it’s very safe to say that there is far more profit in the industry than there is value created ”

    I would strongly disagree with that: HArvoni would be the perfect example of value created with Soliris, Strensiq, any of GENZ’s drugs, as prime examples. Where this argument becomes less clear cut is drugs that provide marginal benefit but, even there, I’m pretty sure if I were the patient living an extra X months with disease Y at a cost of $Z I’d think it worth it.

    Your second point “that it cannot continue forever” is an issue. At its current rate of growth healthcare will, I think in a few decades, comprise the entire economy. There may be some issues associated with that. Hopefully we have better treatments for submental fullness soon….

    1. Anon says:

      Distracting attention from big picture economics to focus on the success of one drug as an example, is a rubbish way to make an argument. It’s like saying that it’s worth playing the lottery because Mrs Tibbs in Texas won (even though everyone else who played lost, and overall, people lost 80% of their stake on average).

      Bottom line is that new drugs aren’t worth what they cost, because they are only marginally (10-20%) better than generics which are 10-100 times cheaper.

      1. Eric says:

        “Bottom line is that new drugs aren’t worth what they cost, because they are only marginally (10-20%) better than generics which are 10-100 times cheaper.”

        I think this is bit short-sighted. Even the marginal improvements can be beneficial to society over the long haul. Think of metformin – available in the UK since the ’50s, dirt cheap now, and currently the most prescribed diabetes drug in the world. It works well for diabetes but causes gastric issues in some patients. If you could develop metformin 2.0 that didn’t have gastric issues it would be great for a subset of patients but would probably be too expensive for the general population as you noted. That’s only true however for the near term. 50 years from now metformin 2.0 would be generic and dirt cheap.

        If we are only willing to swing for home runs it is going to be hard to make improvements in health care. Sometimes incremental improvements are worthwhile. This vast cornucopia of generic drugs that is being created will still be available 50, 75, 100 years into the future.

  11. Scott Stewart says:

    This goes to the heart of the drug pricing issue. Why am I (as a US taxpayer and insurance consumer) expected to finance the drug development and profit for the entire world?


  12. nytimes says:

    Health Spending in U.S. Topped $3 Trillion Last Year

    “Retail spending on prescription drugs increased sharply last year, rising 12.2 percent to $297.7 billion, the administration said in its report, published in the journal Health Affairs… This rapid increase, which was the highest rate since 2002, was in part due to the introduction of new drug treatments for hepatitis C, as well as of those used to treat cancer and multiple sclerosis, the (US) administration said. The new treatments for hepatitis C, which are highly effective, accounted for $11.3 billion in new spending…”

  13. The WSJ article does a reasonable job of identifying the root cause, which makes it odd that so much of the discussion here gets distracted by peripheral issues.

    A few quotes to emphasize the central matter:
    “many Americans’ deep aversion to the notion of rationing”
    “Companies know Norway will sometimes deny coverage”
    “After Norway’s rejection, Amgen and Glaxo lowered Prolia’s price”

    These are the foundations of the negotiating power in Europe. It’s a fundamental cultural difference between the US and Europe: a willingness to forgo new medicines if necessary. It would take enormous social and political change in Americans’ outlook to grant themselves the same negotiating power.

    So no, European countries wouldn’t start to pay more if the US found a way to curb drug prices. European payers have already made the decision that there is a maximum acceptable price, and as a consequence the citizens of those countries must sometimes go without. That’s an accepted trade-off in these countries (accepted on a societal level; there may still be vociferous objection by some patient groups).

    Thus, since the US does indeed subsidize drug discovery for the rest of the world, the consequences of lower US prices would be diminished profits (but not no profits), diminished investment, severe contraction of the industry, and fewer novel drugs.

    Any effect on the prices that Europe is prepared to pay would take decades to be seen. Connecting price controls with a reduced flow of new drugs would be a slow process. And reacting to the absence of new drugs would be even slower, despite the inevitable hand-wringing that would occur (one need only look at antibiotic drug discovery to get a sense of the difficulty of accepting a pricing level that would support the desired output of new drugs).

    Even once the drying up of new drugs has been fully recognized, many would still be comfortable with the trade-off. Not every nation believes as wholeheartedly as the US that novel drugs are the central pillar supporting improved healthcare.

  14. dearieme says:

    I suspect your whole medical system falls between two stools. It benefits neither from free market competition, nor from centralised government purchasing. It’s a mess of cartels and monopolies with added governmental incompetence.

  15. Fourier says:

    There is a large economics literature on US drug pricing, foreign drug pricing, and the availability of new drugs that answers some of the questions raised here.

    There are a number of results that suggest that government control of the pharmaceutical industry, whether directly or via monopsony pricing may make patients worse off. One is that profit oriented companies allocate more drugs to countries that pay more. This means that US patients get new drugs first. New drugs save lives. New drugs often reduce side effects. This is good. One paper even looked at the effect of information dissemination from drug marketing. Its authors concluded that, in general, the effects were positive because it produced better informed patients and clinicians.

    When governments control pricing they also tend to demand prices based on production cost without regard for capital cost. Over decades, the capital plant and knowledge base decays because the low prices make it not worth the continuing investment. You get shortages. You get less innovation. You get the VA drug list, Medicaid formularies, and a shortage of sterile saline solution.

    What if the prices of new drugs are a well worth it? Health spending is rising precisely because more can be done to extend people’s lives and make them better off. What should people spend their money on? Bigger houses? Better video games? Fancier data plans for their cell phones?

    1. Eric says:

      “What should people spend their money on? Bigger houses? Better video games? Fancier data plans for their cell phones?”

      I’ve often asked this same question. In a free market, some industry will end up being the most profitable whether it’s automobiles, finance, pharmaceuticals, etc. Doesn’t it make sense for pharmaceuticals to be near the top of the heap – or would it be better if the financial services sector was the big winner? Why is health care the one industry where everyone wants the best possible care but doesn’t want to pay for it? I wish I could do that in other industries, I’d gladly trade my Nissan for a Ferrari.

  16. zero says:

    Warning: I have no actual experience to support the following.

    Purely from a cost perspective, based on what I have read here and elsewhere clinical trials are perhaps the largest share of a drug’s cost. If we in the US want to reduce the price of drugs, why don’t we hand over clinical trials to the NIH (along with sufficient funding)? Follow me through this for a minute:

    – Drug companies would not have to bear the cost of trials, saving money.
    – Perverse incentives to falsify or statistically mangle data would be reduced (but could be increased at earlier stages like screens).
    – Trials would be run in a standardized way using a nationwide pool of volunteers. Using a central agency instead of a patchwork of internal departments, contractors and other third parties would reduce costs.
    – Trials for drugs that clearly don’t work or are unsafe would be ended, rather than continued or re-run with different endpoints until the sponsoring company ultimately implodes.
    – In exchange for free trials, pharma companies would require permission to export their patented material (including exporting manufacture). This would be done as a standard contract rather than a law, with room for both sides to negotiate the details if necessary.
    – The NIH would require that a country pay a flat fee to help support the cost of development of a drug. After that fee is paid (by the country, by the company or waived as part of an aid package), the company is allowed to sell there.
    – If the company disagrees with the results of an NIH trial then they are free to pay for their own trials. They are also free to pay for their own trials from the beginning, just as they are today.
    – Funding to support this activity would come partly as a discount for all drugs purchased by medicare/medicaid and partly as a tax on new drugs that expires along with the patent (or after a set period for new generics or compound formulations).

    Some people think that government is always inefficient, yet those same people think that mergers lead to improved efficiency by eliminating redundancy. You can’t have both. I submit that centralizing the practice of clinical trials under a government organization would improve efficiency, safety and reliability. Funding for this massive endeavor would come from the industry as a whole; one way to do it might be an industry organization with dues, while another might be a combination of medicare discounts, new drug taxes and export fees.

    There are many advantages to this approach other than cost. Trials would be conducted in a standardized way. All data would be stored in one place and accessible to researchers. Volunteers would only need to sign up once and would be offered a variety of studies for which they are suitable. Reliability problems with third-party providers (some might choose to say outright fraud) would be eliminated. Tests would be performed at cost and would be subject to statistical analysis to verify their reliability. Promising candidates would be pursued even when the sponsoring company could not have afforded a suitable trial; this could even reduce the incidence of companies spending outrageous sums for candidates at phase 1 or 2 only to lose their shirts when the candidate fails in phase 3. Beyond that, drug candidates which are the product of government-funded research would now have a path to clinical trials and beyond without involving for-profit companies; these efforts could end up with the government and the researcher or university in joint ownership of patent over new drugs that could then be sold cheaply or be held in reserve (such as new last-resort antibiotics). Startups with promising candidates but not enough cash for trials would be able to push their candidates further through the process; rather than early buy-outs with sometimes outrageous dollar signs they could focus on developing an actual product and decide to join with an established pharma on more even terms later for help with distribution. This in particular, a way out of the startup lottery game, could be a significant force for improving the quality of work from startups and getting more quality drug candidates into the pipeline instead of focusing on hype and headlines in hopes of a massive early payoff.

    There would be problems. People working in third-party clinical trial companies would lose jobs. Some of them would shift to new positions in the agency. I’d like to think that negotiating for US manufacturing of drugs could make up some or all of that number with different jobs in the US, but that is not guaranteed. Politically speaking it would be a divisive issue with strong Republican opposition and lukewarm Democratic support. Internationally speaking it means the US government would suddenly be in a position of power over foreign medical programs; this would almost certainly be used to reward allies and punish enemies in addition to extracting funds for further research. Even though direct costs to patients should go down it’s not guaranteed to reduce costs overall. Because of the standardized nature of the program, some types of ‘long-shot’ or rule-violating molecules may not make the cut for testing; care must be taken to avoid prejudice and address molecules on the merits.

  17. Anon says:

    So wait. Pharma has not optimized drug prices in Norway because of drug prices in the U.S.? These seem like independent variables in different markets. I expect Pharma is charging much closer to what the market will bear than you think.

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