Brian Palmer at Slate asks "why are some pharmaceuticals so expensive?" and provides pretty standard answers. One reason, he says, is "unmet need" (i.e., a new drug fills a previously unmet need by providing treatment for something that otherwise is untreatable). Mr. Palmer rightly notes that
The most expensive drugs are those that have no competitors. When a truly novel blockbuster drug hits the market, there is very little to guide manufacturers and insurers in their negotiations. The largest constraint is public perception. Insurers fear that, if they refuse to fork over the dough, their sick customers will be outraged. Manufacturers don't want the public or Congress to view them as price gougers. Negotiators eventually settle on a price between those two poles.
The first thing to note is that price is not being set in a market. This is usually a sign the price will not reflect resource costs although I suppose it might be possible that it could reflect marginal social cost if the "negotiators" were setting price to reflect externalities associated with production or consumption of the drugs. That's not likely to be the case here. "Negotiating" price is also a sign that the market is most likely not a competitive one.
Of course, "novel" and "blockbuster" don't always go together either. Novel treatments may result in blockbusters if they are for conditions that are highly prevalent in a population or if they are for conditions that a population can be persuaded are highly prevalent. (Think over the counter (OTC) Tums and Prilosec and prescription Nexium, all treatments for heartburn, for example). Of course, if a disease is highly prevalent in a population, but the population is poor and uninsured, there won't be much interest in developing a treatment for it. (Think "river blindness," which did eventually have a cure and is one of the true ethical success stories of US drugs manufacturing...ethical, but not supported by shareholders, at least at first). But "novel" can also mean "orphan drug", as in so novel that only 100 people in the entire world need it. I'll bet you can guess how much time drugs manufacturers are spending on those "novel" drugs.
But then Palmer strays a bit into what can only be regarded as wishful thinking.
Few drug makers are lucky enough to face this problem, though. Most debutant drugs find the market already crowded with similar products, and prices are set by the competition.
The use of the word "competition" in the above quote appears to be intended to convey that as the next proton-pump inhibitor is brought to market under patent, it is forced to compete with older PPIs that are now available over the counter or as generics. Unfortunately, whatever competition there is does not result in comparable prices. Given the near identical performance of under-patent, prescription Nexium ($248/month), OTC Prilosec ($24/month) and OTC Prevacid ($23/month), the difference in price is difficult to justify based on performance alone.
Why, you ask, would anyone in their right mind take, say, prescription Nexium, when they can purchase Prilosec or Prevacid without a prescription and get nearly identical relief on average? Well, several reasons. First, we tend to rely on and trust our physicians to prescribe what is best for us. Physicians often get their information about new products from pharmaceutical firm reps who are paid to increase sales of drugs that are under patent. One "solution" in a market characterized by information asymmetry is to distort credibly the information about the value of more expensive, more recently developed, still under patent close substitutes. It's called marketing.
But it isn't just that drug reps do their jobs well, it's also that insured consumers don't face the full price of the drugs still under patent. The monthly Nexium price to a consumer will be the co-payment set by their insurance company, usually on the order of $30-$60 per month, but sometimes as low as $0-$15. That, in combination with absence of information about the relative performance of the three drugs and an "animal spirit" belief that if it's new, it must be better, almost certainly dampens any competitive forces that might drive an under-patent drug price closer to that of a comparable generic or OTC substitute.
Mr. Palmer also rightly cites the high R&D costs of new drugs
You hear a lot about how expensive it is to bring a drug to market. All of that is true, especially for cancer drugs. It costs around $1.75 billion to develop the average cancer medicine. Only drugs for respiratory disorders, at $2 billion, can top that total. (AIDS drugs and anti-parasitics are the real bargains, at between $500 million and $700 million.) But there is no correlation whatsoever between the cost of developing an individual drug and its eventual price. Drug companies have to make a profit over the long term. Most of the chemicals that a company experiments with never make it to market. Of those that do, only 20 percent are ultimately profitable. They cover these losses—and then some—by squeezing as much money out of their few successes as possible.
"Squeezing as much money out of their few successes as possible?" Well, they do a pretty good job of "squeezing." It looks like they are barely eking out a living compared to other Fortune 500 firms, doesn't it?
Click here to see enlarged version.
Where's the R&D induced volatility that justifies the excessive profits? Wouldn't you expect at least one year of profits more in line with other Fortune 500 firms? But leave that aside. Surely the large profits are getting us more R&D and more new molecular entities (NME), yes?
Maybe not. For one thing, it appears that drug makers in the US spend more on advertising than they do on R&D. In 2007, the Economist reported (subscription required) that R&D was running about one fifth of revenues in the US, while marketing was running about one-third. Not really surprising given that (as the article notes) the US is the only country paying full price for pharmaceuticals.
And what about the output of new drugs?
It's no surprise really. It's true that developing a NME that fills a void tends to insulate pricing from competitive forces. The problem is that more often than not the voids that remain to be filled are 1) technologically more difficult to fill and therefore incur higher R&D costs and 2) they are often characterized by lower demand because the high demand, more lucrative voids have already been filled with "blockbuster" drugs. It's the beauty of the market and the profit motive at work. Those high prevalence, potentially high profit unmet needs gave us hormone replacement therapy, Viagra, proton pump inhibitors, statins, and a plethora of other useful, but now oft duplicated with little increment in benefit, but large increment in price, under-patent, prescription drugs.
Mr. Palmer's article also describes the rudiments of cost effectiveness analysis as practiced by the British National Health Service's "let's kill granny" National Institute for Clinical Excellence (NICE). The NHS has the quaint idea that, much as we all do when we shop for shoes or coats or beach houses, we might want to ask the question: what exactly am I getting for this expenditure? They also have the radical notion that there are probably some circumstances in which we would opt not to spend money on drugs or procedures where the costs of treatment far exceed any benefit (in terms of a longer life at some minimum of level of quality) that is likely to result.
Now, of course, if we don't actually have to pay for the treatment because our insurer pays all or most of the treatment price, it's likely to alter the trade off between costs and benefits we make when deciding whether or not to purchase treatment. If the costs exceed the expected benefit, we don't buy. If the expected benefits exceed the cost (or at least equal the cost) we do buy. It's one reason co-pays and deductibles are important components of health insurance. They cause us to pause and reflect on the financial hardship we will impose on our survivors when we purchase that extra 4 or 5 months of life at $31,000/month or even as "little" as $8,000/month. If we have to sell the home our loved ones would otherwise reside in after our near certain demise to pay for our extra four months of life, some of us (me included and I say this as a cancer survivor) will opt to preserve the welfare of our surviving loved ones and not sell the house in order to purchase treatment. (Although I might sell the beach house if I owned one.)
I know. I know. Life is priceless, just like taking your dad back to the land of your ancestors using your Mastercard. But it isn't and we all know it. Some of us get to buy more of it and some of us don't. And the more unequal the income distribution and the more uninsured there are, the cheaper life gets for some of us. Those of us with health insurance start looking a little like Wall Street bankers, helping drug makers siphon off dollars that could otherwise be spent on education or infrastructure or R&D on something really useful or anything else we might feel like buying, to buy ourselves the latest, greatest, nearly identical, but far more expensive, newly under patent, copycat drug. And driving up health care costs and our insurance premiums at a faster rate. Heads Pharma wins, tails you lose.
The result is that under-patent pharmaceuticals tend to cost a lot compared to generic and OTC substitutes, even when they're not so "new" or meeting "unmet need." Patents may help us by allowing drug makers to recover some of their R&D costs, a good thing when they're developing new molecular entities, but the value is less clear when they're re-inventing the next proton-pump inhibitor or statin or simply changing an old one enough to extend the patent a few more years.
Manufacturers' profits have been in the double digits for over 10 years with little sign of the volatility that would explain the need for persistently higher margins. In the US, they spend more on marketing than they do on R&D and the US pays more for prescription drugs than any other developed country. Instead of innovation and increased output of new molecular entities, the profit motive has tended to produce "copycat" blockbuster drugs, many of which represent very small or no improvement over already existing drugs. The profit motive also has tended to produce new drugs that fill remaining smaller voids at very high prices. Some of these buy only a few extra months of life for desperate and dying individuals. It is difficult for patients to assess the value of new treatments and they often don't face the full price of those treatments.
Having benefited in the extreme from a relatively new (and expensive) monoclonal antibody and a chemotherapy regimen that has been around for a long time, but is still expensive, I will be the last to argue that innovation should be discouraged or that profits should be eliminated altogether. But I will argue that incentives matter and, in the case of pharmaceuticals, the US would benefit from pricing that was similar to that in other developed countries and from less "patient-centered" demand for still-under-patent, marginally beneficial, copycat drugs. Unfortunately, the incentives in the current system work against this and price does not properly function as a signal of resource costs or value.
I don't have a solution, but I would feel better if we were all on the same page about this. Drug prices are high for reasons that have little to do with value even when they cure cancer.