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Derek Lowe The 2002 Model

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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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March 16, 2006

Price Gouging or Not?

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Posted by Derek

Update: More on this issue from Jim Hu here.

The New York Times ran a pretty heavy-duty article the other day on drug pricing. But for once, it wasn't the big companies that were getting pummelled. No, this time it was Ovation Pharmaceuticals getting the treatment, and I'd have to guess that most readers will have the same reaction I did: who they?

Well, they're sort of a specialty generic company. Their business model seems to be taking on ancient medications, which other companies are giving up on, but which still have a small patient population to serve. Their business model is also apparently to raise the price of said drugs, and that's what got them into the papers:

"Last August, Merck, which makes Mustargen, sold the rights to manufacture and market it and Cosmegen, another cancer drug, to Ovation Pharmaceuticals, a six-year-old company in Deerfield, Ill., that buys slow-selling medicines from big pharmaceutical companies.

The two drugs are used by fewer than 5,000 patients a year and had combined sales of about $1 million in 2004.

Now Ovation has raised the wholesale price of Mustargen roughly tenfold and that of Cosmegen even more, according to several pharmacists and patients."

Mustargen is better known to chemists as nitrogen mustard, which was basically the first chemotherapy agent ever used. Cosmegen, for its part, is the brand name for actinomycin D, which goes back almost that far itself. (To give you the idea, the first person to try it out for cancer was Sidney Farber, whose last name still turns up in cancer therapy circles.

These are drugs from the caveman days, that's for sure, and many references (that Wikipedia link to nitrogen mustards, for example, unless it's been fixed by now) will tell you that they aren't used at all any more because of their toxicity. But they're each still useful for the small group of patients the Times article mentions, generally those with very particular forms of cancer that respond well to these agents above all others. To give you the idea, five thousand patients is one fortieth the market size for what the FDA considers an orphan drug, and it's not clear if that's the patient population for both drugs put together. These are orphaned orphans.

This article is of a piece with the recent one on the price of Avastin, which I spoke about here:

The increase has stunned doctors, who say it starkly illustrates two trends in the pharmaceutical industry: the soaring price of cancer medicines and the tendency for those prices to have little relation to the cost of developing or making the drugs. . .people who analyze drug pricing say they see the Mustargen situation as emblematic of an industry trend of basing drug prices on something other than the underlying costs. After years of defending high prices as necessary to cover the cost of research or production, industry executives increasingly point to the intrinsic value of their medicines as justification for prices."

Now we're down to the real question: is this price justified, or not? Ovation is in business to make money, like any drug company, and charging a high price is about the only way to do that when you're talking about a few thousand patients. A company like Merck could carry these things on its books without much harm being done to its bottom line, because the costs of its other medicines would make up for them (not that the Times is too crazy about those other prices, either). But when a small company like Ovation takes them over, they're going to try to make them into profit centers. Over at Blogs for Industry, Jim Hu asks: "I wonder what (the Times) would be writing if Merck just dropped Mustargen and these patients weren't able to get it at all." He's got a point.

For the most part, Ovation seems to be getting the prices that they're asking. One problem is that they're selling injectable Mustagen, which is the approved form, but there's one set of patients that uses the stuff as a topical lotion (which is formulated for them by local pharmacies). It's harder to get insurance to pay for that, since it's not an approved use. (And it's hard to imagine who would be able to go to the expense of getting it approved, either, considering the subset-of-a-fraction-of-an-orphan size of the market). These people are really feeling the price increase, and the Times article accordingly spends most of its space on them. Ovation is apparently lobbying for increased insurance coverage - which is, after all, in their financial interest - but for now, things don't seem to have changed.

The downside, for Ovation and for the industry, is that this kind of thing makes it very easy to write the heartless-price-jackers article. And this is why I think the ban on Medicare using prices as a consideration is a mistake. I know that my industry lobbied hard for it, and it's no mystery why. But I'd rather have Medicare responding to (and giving out) pricing signals, and I think that (for their part) private insurance companies should do so at every opportunity. Says the Times article:

And once a company sets a price, government agencies, private insurers and patients have little choice but to pay it. The Food & Drug Administration does not regulate prices, and Medicare is banned from considering price in deciding whether to cover treatments.

While private insurers can negotiate prices, they have limited leeway to exclude drugs from coverage based on price, said C. Lee Blansett, a partner at DaVinci Healthcare Partners, which works with drug makers on pricing and marketing.

"Price is simply not included in whether or not to cover a drug," Mr. Blansett said.

But why not? It's included as a factor in decisions to pay for all sorts of other things. If that quote were talking about anything other than pharmaceuticals, it would sound weirdly obvious. The same goes for that earlier excerpt: all sorts of things are priced considering factors other than their intrinsic costs. (What the market will pay, for example). Competing on price sounds heartless at first, but consider: if Ovation's raising their prices too high, that should open the door for someone else to step in and undercut them. Pricing signals go both ways. . .

Comments (9) + TrackBacks (1) | Category: Cancer | Drug Prices


1. RKN on March 17, 2006 8:54 AM writes...

You'll correct me if I'm wrong, but given its relatively simple structure mustine appears to be a straightforward synthesis. If so, isn't the cost of government (FDA) regulation in this area the primary barrier to entry? I can otherwise imagine that a small lab with lower overhead than either Ovation or Merck might manufacture and sell this drug much more cheaply. Or even a lab outside the US. But heaven forbid the government should allow fixed-income Texans from buying their drugs from overseas!

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2. Timothy on March 17, 2006 9:40 AM writes...

This is econ 101 stuff, really. Companies set prices at the profit maximizing level: for Merck that was apparently 10x less than the price Ovation is charging now. Merck has other products to cover any loss, and the bad PR from an "evil price jackers" story is going to hurt them. A lot.

There are also probably some wrinkles like the inelastic nature of the demand curve and a likely discontinuity in supply (IE below a certain price it just isn't worth Ovation's money to produce).

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3. MikeT on March 17, 2006 10:28 AM writes...

Or, we could have the government tax us 10% more and they could make it for us. Ya, right, then we'll pay for it with the euro.

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4. P. K. Scott on March 17, 2006 12:58 PM writes...

How is pricing a drug used by only a small population of patients any different than the pricing of technical books that are only bought by a small group of professionals. I'm sure the book I bought on nonlinear regression analysis didn't cost more to publish than the latest Stephen King novel so why did it cost $120 for hardcover versus $25 for the hardcover novel? It did because a lot more people will buy the Stephen King novel over the book on nonlinear regression analysis. The same principle holds true for the drugs you are discussing.

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5. anon on March 17, 2006 1:36 PM writes...

Hard to assess how prices should be set for any drugs (even though I'm a veteran of Big Pharma). As far as Cosmegen goes, actnomycin-D is one of the most common Streptomycetes products. Yes it's a toxic compound, but otherwise should be straightforward to produce in bulk. It's certainly available from chemical houses, eg. Sigma (although not in a form fit for humans). I'm surprised Merck didn't decide to give it away - as they did for ivermectin.

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6. TFox on March 18, 2006 9:31 AM writes...

Jim Hu says the barrier to entry for generics is infinite, due to the ethical issues with proving bioequivalence on healthy volunteers. That can't an issue exclusive to this compound, though: lots of drugs have side effects which would be unacceptable unless you were sick. Does anyone know how bioequivalence of toxic compounds gets demonstrated?

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7. Bill on March 20, 2006 7:43 PM writes...

Thanks for posting. This might be the first clue to why my dog's chemotherapy sessions (he has canine lymphoma) skyrocketed from $300 a session to more than $1700! He's taking Cosmogen (actinomycin-D), which my vet said just went up from $108 a vial to more than $1500.

Did Merck also make the canine form of the drug and sell it to Ovation (my vet hinted that the manufacturer did just sell out) or was it a different manufacturer? I have a news reporter who's looking into this.


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8. Dustin James on March 22, 2006 6:37 PM writes...

I once interviewed for a job at a large lab chemical supply company and was asked "what price should we charge for our chemicals?" I had always assumed that this particular company charged about 10 times what the chemical cost in bulk, so that's what I answered. WRONG! I was told that you charge "whatever the customer will pay." The difference between a good salesperson and a great salesperson is finding out what the customer will pay before setting the price.

Of course, the pharmaceutical industry is pretty complex, and it not really a free market due to insurance subsidies (to the customers) and government price controls, so it is difficult to really determine "what the customer will pay". However, Ovation appears to be making a stab at it.

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9. guy on May 27, 2006 11:14 PM writes...

"sold the rights" seems to mean that your comment about "someone else" stepping in "and undercut(ing) them" wouldn't work, no? No one else would be allowed to, it's an exclusive market then, no? The question is, what rights? This is a basic chemical, used for 60 years, patents don't last that long... what rights were sold? The brand? 5000 customers doesn't make it sound like a valuable brand, and the only thing keeping Ted the chemist from making and selling this is... regulations...

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Listed below are links to weblogs that reference Price Gouging or Not?:

Hold the Mustard from blogs for industry
Derek Lowe (thanks for the link!), Nick Anthis (in the context of energy deregulation), Ron Bailey at Hit and Run, and others note the Mustargen price hike story. Even though Ovation has an effective monopoly on branded Mustargen, the price it can... [Read More]

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