Recently, I attended an oncology medical conference that reminded me about the importance of understanding the role of drug pricing policy.

Needless to say, there was a lot of discussion about the high cost of cancer drugs.

Everybody thinks drugs cost too much.

It’s no secret that health insurance companies (i.e., payers) are some of the most vocal about high drug prices.  After all, they pay the majority of the bill.

At the conference, a Senior Vice President (SVP) at a major national US payer offered an analogy to illustrate his frustration about drug pricing practices.

Specifically, this executive suggested that pricing penicillin (PCN) the way cancer drugs are priced would make it cost $2,000,000.

If drugs are truly priced on the value they deliver over a lifetime, PCN curing infant returns decades of economic return. The hypothetical patient generally returns millions to society in terms of direct dollars (e.g., income, spending, taxes) an indirect dollars (e.g., employment that supports societal business development and income).

His analogy was certainly effective in positioning that something is broken with how drugs are currently priced.

Clearly, no one would agree that paying such a high price for PCN is digestible or desirable. However, drug companies are pricing in terms of value they deliver – both to individuals and society at large.

So where is the disconnect?

The answer lies in drug pricing policy. Here’s what’s really going on…

The Apples to Oranges Comparison

The first breakdown in the SVP’s analogy is the apples to oranges comparison he was making.

Specifically, the payer compared prices of novel oncology agents to generic PCN.

Such a comparison is inappropriate based on market principles inherent in the pharmaceutical industry – notably, artificial monopolies (discussed below in detail).

Generally, novel oncologic drugs are in the very early stages of the product life-cycle curve. In this phase of product development, companies are looking to recoup years and millions of dollars of investment. Furthermore, the clock is ticking. Their exclusive right to sell their invention has an expiration date in the form of a patent with a limited term.

In contrast, PCN is way past the late stages of its original product life-cycle curve.  As such, the original company that brought PCN to the market no longer has exclusive rights to market the product. A flurry of other manufacturers produce generic PCN and compete solely on price – driving prices downward.

A more appropriate comparison in the analogy may have been PCN’s price when it was initially launched. However, PCN had such unique roots – multiple manufacturers, war-time effort for mass distribution, etc – that the comparison is impossible.[1. ACS. Discovery and Development of Penicillin. Available at: Accessed April 2016] In fact, PCN had generic-type pricing from its start moving from $20.00 to less than $0.10 per 100,000 units from 1943 to 1949. That’s equivalent to $810.30 to $4.05 in 2016 dollars, respectively.

Drug Pricing Policy: Artificial Monopolies

The second breakdown in the analogy is rooted in the economic principles of public goods and artificial monopolies.

Public Goods

Before we talk specifically about the pricing monopolies in the drug industry, it is helpful to review the concept of a “public good.”

“Public good” is an economics term that is defined as follows: a commodity or service that is provided without profit to all members of a society, either by the government or a private individual or organization.

It can be more simply thought of as something that, once created, is available to the whole of society. Books, songs, artwork, movies, and yes, even drugs, are all examples of public goods. They are available for use in society from the moment they are produced and no one can put them “back in the box,” in theory.

Consider that the ideas presented in any given book are available to all from the day they are printed. They are available for others to duplicate and/or use in their own way. (That’s the power of good books, especially when they take years to develop but can be consumed in days or weeks :))

Now let’s consider the concept of public good in the context of drugs.

Once a drug compound is created or discovered and commercialized, it becomes available for all of society. PCN, for example, is a drug that has been available to generation after generation since its initial discovery and commercialization in the 1940’s.

We witness a similar phenomenon when looking at cancer drugs. Dozens of cancer drugs have been developed over the last few decades. These cancer drugs are not only available to us today, but will continue to be available to our kids and grand-kids. A new drug becomes another facet in the overall advancement of medical science and progress for the world.

These are pretty big societal benefits. And that’s exactly why our society (i.e., the government) has set up systems to incentivize the invention/development of public goods. Drug pricing policy facilitates this environment for the benefits of society as a whole.

Artificial Monopolies

Recognizing the benefits of public goods to societies, governments want individuals and companies to take on activities that produce public goods.

Governments want people to take risks that will ultimately result in the next great advancements for society in many areas, including technology and medicine.

At the same time, they recognize there are risks involved for those working to generate public goods. Will this book sell? Will this drug avoid rare but deadly side effects? There are also sizable investments made in terms of time and dollars in developing public goods.

Without sufficient incentive systems in place, public goods are under-produced. Only hobbyists would donate their marginal time to generate them, mostly out of their own passion and interests.

As such, two key tools the government uses to incentivize the development of public goods are:

  1. Copyrights
  2. Patents

Copyrights and Patents create “artificial monopolies” enforced by law. Those who own them can set their prices to whatever the market will bear since they are protected from competition. It’s completely legal. This is a trade-off choice that is made by society because, quite frankly, we all may benefit greatly from the next PCN, cancer cure, iPhone, etc.

The copyright system is designed to protect original published works (e.g., articles, books, songs, computer programs) from unauthorized duplication for the life of the author plus 70 years.[2. Stanford University Libraries. Copyright Basics FAQ. Available at: Accessed April 2016] The system allows the creator to be the sole beneficiary of financial or other rewards from their creation. The creator sets the price and the market responds accordingly during the lifetime of the copyright. Of note, the copyright does not protect the ideas or facts presented, but rather the fixed, original, and creative expression of the work.

The patent system is designed to protect inventions.[3. World Intellectual Property Organization. Frequently Asked Questions: Patents. Available at: Accessed April 2016]

Novel drug compounds can be classified as inventions. As such, the drug industry relies heavily upon them to drive the risk and reward trade-off decisions involved in drug development and commercialization.

New drug compounds under investigation are patented for 20 years from the date of filing. Often, it takes 6 to 10 years to do the necessary clinical trials and paperwork to gain regulatory approval to put the drug on the market. That gives most compounds 10 to 14 years to re-coup losses incurred during the drug development process and generate profits.

Once the patent expires (i.e., “loss of exclusivity” [LOE]), generic manufacturers can copy the formula, present basic bioavailability data in place of a full efficacy and safety drug development trial program, and sell their versions of the same drug. Multiple suppliers for the same drug drives prices lower and lower as they compete with each other.

As such, the drug company has a period of 10 to 14 to take advantage of it’s artificial monopoly put in place by drug pricing policy.

Conclusion: Drug Pricing Policy Considerations

Obviously, no one wants to spend $2,000,000 for a course of PCN.

But this proposal made at a recent conference by an SVP at a major US payer highlights the level of scrutiny over drug pricing today.

Currently, the drug industry is pricing more and more on value.

At the same time, all healthcare stakeholders would benefit to consider the following elements of drug pricing policy:

  1. The importance of public goods to society, for populations and individuals
  2. The way our society has chosen to incentivize public goods to make sure they happen – specifically, artificial monopolies

We all want public goods because we and our descendants benefit from them. Society advances when inventions like PCN, cancer drugs, and the iPhone are created.

If incentives are not high enough to cover the risks and potential benefits to develop the next cancer breakthrough, individuals and companies will choose something else to pursue. Something with lower risk and higher potential pay-off.

In summary, our own government, recognizing the value of drug development for society as a whole, intentionally allows for temporary pricing monopolies. Drug pricing policy is part of the engine that is driving innovation in the pharmaceutical industry.


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