Science Discussion Series: Drug Prices

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The news cycle over the past several months has prominently featured stories about the seemingly exorbitant prices of certain pharmaceutical products. This has generated a lot of interest -- and at times outrage -- in the economic factors that determine the price of drugs. This Science Discussion Series piece attempts to lay the framework for an informed debate on the public health policies guiding the national infrastructure for drug development.

To set the stage for this discussion, there are a two points that highlight exactly what is at stake:

1. New drugs have historically created great value for patients. Since 1970, for example, the introduction of new drugs has increased the expected lifespan of the US population by between 0.75-1.00% per year. On a disease by disease basis, similar trends are observed: for instance, upwards of 60% of the dramatic improvement that we have seen in survival for cancer patients in the past decades is attributable to new pharmaceutical products. And there is no reason to expect this trend will change. Additionally, new drugs often save the healthcare system money, since patients spend less time in hospitals or other care facilities. One study, for example, found that every dollar spent on drugs was associated with two dollars in savings for Medicare. So drugs have the power to do a great deal of good -- both for individuals and society.

2. Contrastingly, a major challenge in the US healthcare system is that many people cannot afford the drugs they are prescribed. In the US, patients pay on average about 20% of drug prices out of pocket. Medical illness and the concomitant high drug prices (as well as prices associated with care) is the single most common cause of personal bankruptcy. And perhaps unsurprisingly, but no less tragically, many patients who cannot afford high priced drugs suffer worse outcomes in their treatments because they discontinue the treatment and opt for alternative, less effective therapies.

The public health policy debate that emerges then is: what is the best way to ensure a robust pipeline of new drugs for unmet patient needs in a way that benefits as many patients as possible?

Why are drugs so expensive

At least three factors contribute to the price of pharmaceutical products:

1) The need to offset the high costs of drug development.

A recent Tufts study, for example, pegs the development costs of a new drug at $2.6 billion. The report found that pre-human development costs about $430 million per successful drug; clinical development cost $965 million per successful drug; the opportunity costs (what investors could have done with their money over the ten year period required to conduct these studies) accounts for the remainder of the $2.6 billion figure. It is important to note that these figures include the costs of drugs that failed to get FDA approval – and current data suggests that 90% of new chemical entities entering clinical trials fail (and an increased failure rate is implicated in the rising costs of drugs – why and to what extent more putative drugs are failing in clinical trials is an interesting topic for conversation).

The bottom line is, if a company can’t generate more money than it spends, it will go out of business. In some ways, this helps to set the ‘floor’ for drug prices. If people are interested we can discuss these numbers in more detail in the comments (i.e. what exactly is it about research or clinical trials that costs so much money). It is also worth noting, that some groups dispute the Tufts estimate, claiming development costs are closer to several hundred million per new drug. We can also discuss discrepancies between studies in the comments as well. There is also discussion about what pharmaceutical companies should be allowed to spend money on – for example, advertising.

2) The benefit that the drug offers, relative to the next best treatment option.

For this, let’s look at an example: Gilead’s Harvoni, a $90,000 drug that essentially cures hepatitis C in most patients. In justifying the price, Gilead argues that the next best treatment for patients often involves liver transplants, extensive hospital and hospice care, and a major decline in quality of life. A liver transplant, for instance, can easily cost over $500,000 in the U.S. By using Harvoni, patients are actually saving money because they would have spent far more than $90,000 to cover all of these other medical costs. When drug companies are negotiating with payers (companies, such as Express Scripts, which foot the bills for most drugs), this is often one of the most critical points in determining price. In some ways, this sets the ‘ceiling’ for a drug’s price.

3) The temporary monopoly granted to new pharmaceutical products in the form of patents.

In most markets, price is determined by a tension between supply and demand; when the markets are operating efficiently, prices will approach marginal costs of production. It turns out manufacturing drugs is quite cheap. Harvoni, for instance, only costs several dollars per pill to make and distribute. So why don’t prices for drugs approach the marginal cost of production? Namely, because most governments choose to give new drugs an exclusive monopoly for several years after development. This allows the company to sell the drug for prices far above marginal costs. Governments allow this under the premise that this encourages innovation. The basic idea is that the only way to ensure a robust pipeline of future drugs is to offer companies a financial incentive to take on the high development costs outlined above. It is also worth noting, that once a drug goes off patent, generics enter the market offering patients similar care for a drastically reduced price. For example, consider antiretrovirals (ARVs) used to treat patients with HIV. Initially these drugs cost $10,000+ per patient per year. Now, however, ARTs are available for roughly $100 per person per year. Similar trends can be seen for cholesterol lowering medications, cancer therapeutics and many more drugs that have come off patent. Once expensive molecules are now available at prices considerably closer to the marginal cost of production and distribution.

Is this the best model for promoting a healthy stream of new, lifesaving drugs? How do companies abuse this model (i.e. evergreening or pay-to-delay deals), and what can be done about it? We can discuss these topics in the comments section if there is interest.

The goal of this write-up was to promote a thoughtful examination of what goes into determining the price of a drug. It is my hope that this enables intelligent conversations about how best to manage an expensive, but critical piece of the national health infrastructure. My personal opinion is that pharmaceutical companies have the potential to do a great deal of good for humanity. And quite often they live up to this ambition. That is why I am happy to work for one. Certainly, there are despicable people like Martin Shkreli who abuse loopholes in legislation to extort value from the system, rather than add to it. But we need to understand how the selective actions of a few criminals do not represent the work of an entire industry. Thanks for reading.

TL;DR: The need to offset development costs sets the floor for drug pricing; the marginal benefit provided by the drug over the next best treatment option sets the ceiling. Patents give drug companies temporary monopolies, allowing them to realize profits. Finding a way to balance the need for new drugs in the future versus their costs today is critical public health challenge.

Some final notes/further reading:

• A slightly different take on the issue from Jack Scannell.

• A WSJ piece on why drugs in America are more expensive than elsewhere in the world.

">Science Discussion Series: Drug Prices