A pharma inflection point is around the corner

Geirge Merck had declared that medicine was for the people and not for the profits. Today’s pharmaceutical companies bear little resemblance to the chemicals-based organizations on which the sector was originally founded. The way they make money can be extremely convoluted to understand.

Normally manufacturers price a product for the value it is supposed to represent. Customers either agree or reject, and eventually in a successful transaction, prices are set that both sides can live with. But not in branded pharmaceuticals. It is astonishing that a 100-year old drug like the insulin has seen prices rise steadily, to the point at which one study found that obtaining the life-saving drug was an extreme financial burden to a vast number of people – 14 per cent of Americans for instance.

Why? Partly, the drug companies are granted patents on treatments, essentially a temporary monopoly to let them recoup their R&D investments. Those temporary monopolies are very sweet, prompting lots of strategies to extend them through a variety of practices that have come under heavy criticism.

Drug pricing in America where most of the new discoveries occur is the product of decades of convoluted dealmaking, beginning with the manufacturers, who argue that they need high prices to pay for the R&D that creates miracle drugs. There are essentially no regulations around what a pharma firm can charge for a new drug, leading to eye-popping prices – Gilead Science charges USD 84,000 for a full course of its hepatitis medication, Sovaldi.

While that’s pretty high, remember that the drug cured Hepatitis-C, preventing eventual liver transplants or other expensive treatments. Gilead argued that the high price was needed to recoup the investment they made to find the cure, and a curative drug is less lucrative than a drug that has to be taken on an ongoing basis. One may argue that the company was motivated by profits, rather than providing a relief to a greater number of patients suffering from Hep-C.

In the US, things are a bit weird. There is a “list price,” but, the pharma company then negotiates extensively with Pharmacy Benefit Managers (PBM’s), who negotiate on behalf of insurers and payers. The PBMs are supposed to remove administrative burdens from insurers and the plan sponsors who actually pay for the whole system. In reality, PBMs have become incredibly powerful, making much of their money on rebates that they negotiate. To appease them, many manufacturers raise the “list” price and offer a bigger rebate, which is unfortunate for those who actually do have to pay the list price. This is a totally different system than that of most other developed countries, in which national health systems do the negotiation.

The new Inflation Reduction Act in the US essentially ends the most favoured customer clause on a few drugs, granting the health ministry to negotiate prescription drug prices for Medicare patients. Another shift embedded in the Act is that the government can begin to negotiate pricing for drugs after a window of exclusivity (9 years for so-called small-molecule drugs and 13 years for large-molecule drugs). The lifecycle to enjoy like a monopoly will be truncated.

This means in short, plans and programmes with a shorter exclusive “expiry date” are likely to be de-emphasised by pharma decision-makers, which is problematic as these drugs are often more convenient for patients and are easier to deliver.

The other question is whether these manufacturers try to make up for the losses in the most lucrative market by pricing higher in rest of the world? Remember, despite all this, pharma sector is doing very well, with higher profitability than in other industries.

But a new challenge will come from payers like Caterpillar, that has decided not to be at the mercy of PBMs and has been able to tame the growing cost of prescription medicines. This could create a watershed for payers, who seem to have the least amount of control over the system, despite the fact that they are the ones footing the bill.

One major aspect of healthcare costs is the waste in the system. In many developing economies, there seems to have a collusion of sorts between pharma, healthcare providers and medical insurance providers. The costs are inflated when a patient is under insurance.

It will be interesting to watch how manufacturers respond to this shift in governmental policy, in terms of which drugs get the green light. As they make portfolio decisions, perhaps it would do everybody good to remember Merck’s admonition that medicine is for the people, not the profits.

Rita McGrath is professor at Columbia Business School and founder of Valize, and Dr M Muneer is Fortune-500 adviser, startup investor and co-founder of the non-profit Medici Institute for Innovation. Twitter @MuneerMuh

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