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DBL%20Hendrix%20small.png College chemistry, 1983

Derek Lowe The 2002 Model

Dbl%20new%20portrait%20B%26W.png After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: Twitter: Dereklowe

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February 12, 2004

More on Prices, High and Otherwise

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Posted by Derek

The key questions raised in the e-mail I quoted in the last post are: is it fair to fund drug research through high prices on drugs? And especially, is it fair to do so by raising prices on individual drugs, rather than across the board?

My answer to the first question, as you'd guess, is "yeah boy!" I have some disagreements with the assumptions that Nick H. is making. For one thing, the money spent on research isn't necessarily an "investment cost" in the way that some might think of it. Now, overall, it's true that we expect a return on research money, so you could classify the whole think as an investment that way. But research (unlike, say, bonds) involves a lot of sunk costs. Once spent, they can't be recovered or converted back to cash. The investment equivalent is a stock that goes to zero. A drug company's "investment portfolio" consists of a bunch of Webvans and the occasional Microsoft.

But that analogy isn't quite right, either, because it gives too much credit to the individual drugs. Microsoft can, by its own actions, try to preserve its profits indefinitely (and boy, don't they ever.) But every drug is a wasting asset, essentially. The key difference is intellectual property. A drug's patent will always expire after a few years, although companies will try every contortion they can think of to delay the day. The longer the R&D&A (A for approval!) process takes, the shorter the lifetime left on the patent. It is very common, and has been for some years now, that a drug chews up more than half of its patent life before it ever makes it to market. So every drug is born onto the market from a deep pit of sunk costs, and has a relatively short time to make them up (and pay everyone's salaries, and fund the current research projects, some of which had better pay off to keep the whole thing going.)

On to the second question. I think that Nick's main objection is that prices get raised on individual drugs, rather than across the board. His point can be illustrated by Abbott's price hike on Norvir, a drug that has (from their perspective) been underperforming. If Abbott needs more money, why should only the HIV patients pay up? (I know, they've assured Medicaid, etc., that the price hike doesn't apply to them - but some HIV patients or their health care providers are going to pay more, though. Otherwise, why raise the price? Unless it's just to make Norvir more expensive for the competition, which is one possibility that can't be shaken off.)

One answer - not the best one- would be to turn the question around: why should someone who takes one of Abbott's other drugs have to pay for the problems they've having with Norvir? This argument doesn't hold up too well, though - after all, we pass on the research costs of the whole drug portfolio to everyone. Why not pass on the sales shortfalls?

Well, in a larger sense, we do. But I'd say that companies - and not just drug companies - raise prices where they think that they can, when they think they can. A company may decide that it's feasible to raise prices in one market, and not another. To use Nick's supermarket analogy from the previous post, should we require all the products in a supermarket to have the same profit margin? I would actually expect a supermarket to raise its profits by increasing prices on the items it thought would be most likely to bring in the most increased revenue. (That probably wouldn't be the bread and flour, though.)

This is what the marketing types call "pricing power," and it varies a lot. A drug company has quite a bit of it, during that time its drug are patent protected. Countering that, of course, is the negotiating clout of Medicare, HMOs, and other bulk purchasers. That's the general tug-of-war of the market (making some allowances for Medicare.) Really countering a company's pricing power, outside the US, is the governmental price-setting ability of national health plans. That's where the market mechanism is breaking down, to my eyes. Many people see intellectual property laws as a thumb on the scale in favor of the drug companies. But at least patent protection goes away.

(There's a lot of interesting e-mail coming in on this subject, and I'll bring up some of the points people raise in another post. I should mention that Nick, the person who starting this topic off, has a blog of his own, too.)

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