Glimpse at the complexity of drug prices

Glimpse at the complexity of drug prices

I feel that there is considerable confusion about drug prices amongst industry outsiders. Until I started looking into the topic, I had no idea how complex it was.

Drug prices incorporate several components along the supply chain from manufacturer to sales outlet. There is also a distinction to be made between the retail price set by industry and the reimbursement price set by healthcare payers.

In 2017 European pharmaceutical retail prices were composed as follows:

Manufacturer 67%
Wholesaler 5%
Pharmacist 18%
State (VAT, other taxes) 10%

Exclusivity – A double-edged word

Pharmaceutical firms enjoy two levels of exclusivity protection through intellectual property and regulatory provisions. These are meant as incentives to stimulate innovation but also allow them to set high retail prices at whichever level the market will tolerate. It appears that market analysis rather than development costs factor heavily in pricing decisions. In the USA, 10% of prescription drugs are brand-name pharmaceuticals, yet they account for 72% of drug expenditure. Prices drop thanks to competition when generics (essentially copies of the original drugs) enter the market after the exclusivity period. However, this does not appear to be the case in some countries where list prices of generics can be higher than those of branded drugs.

Payers may use their negotiating power to lower reimbursement prices during the exclusivity period. However, their influence is especially limited in the USA as compared to some other countries. The financial burden is then shifted to patients’ out-of-pocket contributions. This not only means that expensive treatments become selectively available to people who can afford them. It also leads to avoidable consequential healthcare costs due to non-compliance with treatment regimens. Patients will either not follow their physician’s advice properly or not at all. As a result, they will require treatment for ailments (e.g. co-morbidities) that could have been managed or even prevented had the original treatment been followed.

Who sets reimbursement prices?

Three main strategies are used to set reimbursement prices:

  • determination by manufacturers
  • determination by the government
  • external price referencing (EPR), i.e. basing domestic prices on foreign ones

The latter two are common across Europe, but their implementation is heterogeneous and stark price differences exist between countries. From mid-2020 Canada is supposed to stop referring to US and Swiss prices in an attempt to lower healthcare costs. The USA’s adherence to the first strategy may be one reason why US drug prices are generally higher than in other industrialised countries. However, US adoption of EPR has been debated.

EPR is not without drawbacks. Countries might overprice drugs by basing their decisions on list prices, not confidentially discounted actual prices. Changes in reference countries affect domestic prices, and manufacturers might launch drugs strategically by starting with countries that can bear higher charges. Whilst some countries have successfully reduced price levels using appraisal or control measures, a tendency towards increasing launch prices has been described in OECD countries (Organisation for Economic Cooperation and Development).

Obviously, elevated prices help firms generate sufficient profitability for investors to tolerate the high R&D risk and incentivise the financing of future developments. Of note, net US prices of branded drugs increased by only 0.3% in 2018, and major publicly listed industry players lost market value due to various investor concerns.

One may be tempted to tar and feather the greedy pharmaceutical industry for hiking prices. However, the economic complexity of drug development must be acknowledged. The current antibiotics crisis discussed in a previous post is but one example for the consequences of drug development becoming unviable for industry players. A sustainable balance between manufacturers and healthcare payers is needed. Novel ways of financing should also be envisaged. One suggestion involves healthcare derivatives, which I have explored in my 2019 MSc dissertation.


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