• 1. Price rises are not the fundamental cause of the problem of the US drug pricing ecosystem, they are a symptom – i.e. drug prices are principally set on “what the market can bear” vs. a value based mechanism.
  • 2. Feedback from many investors is that a “what the market can bear” pricing system for drugs is justified by pointing to consumer good analogies. In our view this is not a valid analogy/the economic rules of consumer goods pricing cannot be applied to drug pricing.
  • 3. In our view it is inevitable that there will be oversight on drug prices, both launch prices and subsequent price increases. It is far better for the industry to preempt such oversight, lead and control the debate – a (public) move to value-based pricing is the best strategy.

We published our first “Strategic Analytics” report “Principled Drug Pricing Centered on Innovation and Choice: Part 1” (link) on 16th November 2016. As we highlighted at the time, the primary purpose of the report was to act as a forum for debate on this important contemporary societal issue. With this in mind, we are communicating the top 10 feedback items over the next few months post our continued interactions with both investors and corporates. Our first feedback note published on Dec 7th 2016 discussed the question of “Will drug pricing still be as big of an issue going forward with the new administration?” (link) with the bottom-line conclusion being YES!

This second feedback note concerns the topic of drug price rises in the US ecosystem, which is obviously headline grabbing central soundbite of the public’s vitriol against the industry. Dealing with the broad subject of price rises in three sections: 1. the “philosophical” implications of drug price rises, 2. our perspective, and 3. a recap of the facts on drug price rises from our original report.

1. The “philosophical” implications of high drug price rises:

The subtlety is the word “philosophical” implications. The “physical” implications of US drug price rises are the facts in the section below. The key macro facts take homes are: 1. for the overall US drug market, despite drugs being launched at over 2x the price of the rest of the comparable developed world (CDW), US drug prices on average see the highest yearly price increases at well above inflation rate (vs. CDW which generally sees drug price rise at or below inflation) – over the last 5 years the average price rise for top 20 US drugs (in totality) has been 5% per year and 2. the heterogeneity of drug price rises for individual drugs in the US is very large ranging from triple to single digit price rises.

The one key, and actually much more overlooked, philosophical implication of the egregious drug price inflation unique to the US system, is that it is the epitome of illustrating on which underlying methodology is principally used to price drugs in the US – that is “what the market can bear” (and by implication what mechanisms are not used). There can be no other reason why, for example interferons for MS were launched in the late 90’s with an average price of $8,000-$10,000 per treatment year and have risen to $60,000-$70,000 currently in the US (as a comparison in Europe they were launched also in the late 90’s at around $8,000 and are currently $30,000-35,000) – if MS interferons had risen at the CPI from launch they would be around $16,500-20,000. A similar story can be seen for many other therapeutic areas, e.g. anti-TNF’s, diabetes, etc.

One of the most interesting feedback conversations we had post our original note was around the concept of US drug prices being based on this “what the market will bear” point. The majority of companies we spoke to agreed that ultimately drug pricing was based on “what the market will bear”, although this phrase was understandably not widely used, rather phrases such as “I have a fiscal duty to shareholders, and because of future R&D investment, I must price drugs optimally”. A (large) cohort of investors were much more direct on condoning the “what the market will bear” mechanism with the justification of saying other consumer industries do this (with iPhones and the car industry being the #1 and #2 analogies) and strongly defending the right of the biopharma industry to maintain a completely free market pricing mechanism and the concept that regulated prices would be to the detriment of the industry and innovation.

From a basic economic prospective, pricing a product at “what the market can bear” is of course a widely used methodology for many goods/services – it is indeed the bedrock of consumer goods pricing. But herein lies the central problem – drugs are not consumer goods for a plethora of reasons: 1. by definition consumer goods are discretionary items; drugs are arguably a necessity (or at least a right in a modern civilized society); 2. the differential “value add”/benefit of competitive consumer goods can be assessed by the consumer (the clue was always in the name), a third party (typically physicians but not always) assesses the benefit of drugs, 3. consumer goods generally have easily switchable competition – don’t like the overall benefits of an Audi A6, then a Mercedes E-Class it is – the dynamics in the switch/choice from, for example and sticking to the multiple sclerosis therapeutic area, Avonex to Rebif is much more complex (poignantly the metal and (glyco)protein illustrations are in the same $60k price point, well except that protein examples are per year…), and 4. cost basis of consumer goods acts as the ultimate check, balance and driver of price and competition – Audi and Mercedes cannot (into perpetuity) sell cars for less than the cost to produce them and equally cannot price their cars at high multiples, in order to gain market share. The cost basis for drugs is in reality impossible to assess, not only because even the “simple” exercise of attributing R&D and SG&A costs to an individual drug is hard but mainly because the requirement to assign an accurate probability of success discount factor (to account for the majority of drugs that do not succeed) is impossible. In our view, the tentative legislative attempts to look at drug pricing based on costs of production (link) is one of the biggest dangers to the biopharma industry.

Notwithstanding our arguments above for not basing the price of drugs on cost, if society were actually to do this, many drugs could actually have a higher price. For example, Vertex is a 20 year old company with cumulative losses of $5.2B despite bringing three drugs to market (the revolutionary but short lived Incivek for hepatitis C in 2011 and the arguably even more revolutionary CF drugs Ivacaftor and Lumacaftor, launched in 2012 and 2015, respectively). Vertex is due to hit GAAP profitability for the first time in 2017 – given the time value of money, there is a strong argument (if drug prices were based on a return of investment) for higher prices for Vertex drugs (all of which have received some criticism for the level of current price). There are many more examples of Biotech companies that have launched drugs after many, many years of investment that are still not profitable and/or have very significant cumulative losses (e.g. Ironwood, Ariad, BMRN).

2. Our perspective:

Price rises are not the cause of the problem of the US drug pricing ecosystem, they are a symptom of the problem. The problem is the specific application of the free market basis of pricing drugs. We strongly advocate that drug manufacturers should be able to price drugs (vs. legislation that puts pricing power in the single government buyer hands), but with this freedom of pricing that is given to manufacturers comes responsibility. The current system of pricing drugs on what the market will bear is the wrong approach. Whilst it’s a system that has prevailed in the US drug pricing ecosystem since essentially drugs have been marketed, it now has become a major problem that should be corrected (as we flagged in our original report, with the other major problem being choice and transparency especially in the RX element of the insurance system). In our view pricing on what the system can bear is a problem because it will actually place future innovation at risk rather than encouraging it. Society into perpetuity is very unlikely to put up with “what the market will bear” pricing strategy for drugs given the “physiological” points we make above – namely drugs are a necessity and consumerism based pricing rules do not fundamentally apply to drugs. The risk for the industry is that if it persists with its current pricing methods – legislative-driven pricing measures will evolve.

Without a doubt there will be oversight on drug prices, both launch prices and subsequent price increases. It is far better for the industry to preempt such oversight, lead and control the debate than to be on the back foot. The “what the market will bear” argument to the drug pricing debate is hardly defensible. Rather the biopharma industry publicly uses blanket statements or soundbites such as “high drug prices are needed for innovation”. The problem with this soundbite-friendly statement is that it unintentionally condones the super-bad actors and put the whole industry in one bucket. In our view, and again pointing out one of the major take-homes from our original report, the ethically correct AND most defensible response to drug prices is that they are based, in some shape or form, on the value they deliver. Obviously value based pricing methodology is hard and will never be 100% accurate but it is far better option then the current “it is what it is” methodology.

3. The facts on US drug price rises:

In our original report (link) we illustrated that not only were drugs in the US launched at higher prices (2.0x on average in comparison to the comparable developed world (CDW) – Exhibits 36, 37 in our original report), but manufacturers continued to steadily increase prices in the US (Exhibits 38, 39), only to further add to the gap between US and CDW prices with current list prices for the basket of the top 20 drugs being 3.04x (Exhibit 36). Even after rebates the net price of this basket of drugs is 2.1 in the US compared to the CDW (Exhibit 33). Our proprietary analysis of the top 20 drugs based on worldwide revenues in 2015 demonstrated also that the rate of price increases varied greatly (Exhibit 38). Specifically, we demonstrated that price rises varied from 0-275% from respective launch dates to 2016 levels. Another recent survey of the most common 3,000 drug prescriptions demonstrated that prices more than doubled for 60 drugs in the last two years, and that, on average, each drug “enjoys” around 10% yearly inflation (link).

We welcome comments and questions to the coordinating author, Ravi Mehrotra ( and/or to any of the Partners at MTS.

For media inquiries please contact Argot Partners:

Andrea Rabney

Eliza Schleifstein

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