On the Wondrous U.S. Market For Prescription Drugs

Citing a recent report in the Los Angeles Times, an article in FirecePharma entitled “Some generic drug prices soar despite heavy competition” rises questions on the ability of market forces to reign in drug prices – for example, on the idea that the price of Mylan NV’s EpiPen would not have risen to $614 per 2-pack from about $100 per 2-pack or less in 2007 if the Food and Drug Administration (FDA) had not prevented Sanofi’s and a new product by Teva to come on market, leaving Mylan NV in full monopolistic control, of this blockbuster market.

According to data assembled by the Los Angeles Times, prices of generic drugs can rise sharply even if multiple manufacturers compete for market share. As an illustration, the article cites the generic drug ursodiol for gall stones, produced by no less than 8 manufacturers. “Several years ago, the wholesale price ran as low as 45 cents a capsule. In May 2014, Lannett Co. ($LCI) bumped its price for ursodiol to $5.10 a capsule, a price hike of more than 1,000%. Rather than keeping their own generic versions of ursodiol low to steal market share, each competitor followed Lannett’s lead and priced their versions the same or close.”

I doubt that many economists would have predicted this outcome, although it must be added that economists have very few theories that reliably predict the future. For the most part we have shelves full of theories one of which usually can explain, ex post, how a particular outcome might have come about.

In this case, for example, we might drag from the shelf the price-leadership model in an oligopolistic market, that is, one usually thought to have only 3 to 5 or so competitors with differentiated products. If in such a market structure there is a dominant producer of a product who raises the price of the product, other competitors may just follow to do the same, rather than go for greater market share. It is an implicit but legal form of collusion. I rather doubt, however, that many economists would apply this model to a market with 8 competitors selling a virtually identical product.

It seems fair to ask members of the health insurance industry and their agents, the pharmaceutical benefits industry, what role they play in this market.

Specifically, if as their agents in the market of health care you cannot manage to exploit to the advantage of your principals – ultimately patients and the insured public— a market with 8 competitors selling a virtually identical product, what can you do for us? How is it that, in real life, the makers or, say, ursodiol can raises prices by 1000% in the face of the putative competition of which economic theorists can wax so mushy? Did you not have enough countervailing market power to put a lower limit to that increase? Why not?

You may respond with what I have come to call the “All-American Knee-Jerk CEO Response (AAKJCR).” It is an almost instinctive reaction by CEOs whenever there is untoward behavior in the private sector. Somehow it always ends up government’s fault. I have heard it hundreds of times from CEOs over the years – and, of course, from many economists — to the point that I now simply anticipate it. (Somehow, for example, it was the government’s fault when AIG sold bond insurance with a potential liability of over $500 billion without setting aside adequate cash reserves to cover claims on that insurance. It’s a bit like going out into a snows storm without gloves, blaming your mother or your wife for the fact that your hands are freezing, because she did not tell you to wear gloves.) So perhaps government is at fault again in the ursodiol case, even though I cannot think in what way. Can you explain why it might be government’s fault?

You may also respond that you actually do not pay the prices that the Los Angeles Times reports, that you in fact do use your market moxie to extract from the manufacturers sizeable discounts and ex-post rebates on top of discounts, so that the net prices you paid the manufacturers actually did decline in the face of competition. Fair enough. But then explain to us what prices patients are made to pay, when they still are under a deductible on their insurance policy or pay coinsurance? Is it the manufacturer’s list price, is it the discounted price prior to rebates, or is it the net price you actually pay, net of rebates which, in my view, would be the most decent approach?
In fact, how is it that actual transaction prices, net of rebates, in the market for health care goods and services are kept so opaque from those who ultimately have to pay for these goods and services? Why, for example, is the market for drugs such an impenetrable mess from the patient’s perspective?
In the meantime, a major lesson for non-economists from the market of generic drugs – and from health care in general — is that when economists assure the public that competition in health care will take care of cost control in health care, it may be a good time to run for the hills, a form of “safe zone.”

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18 replies »

  1. I suggest the following exercise. Take your average tax rate and add the percentage of income spend on insurance premiums and out of pocket expenses – I’ll bet the result is fairly well distributed around 50% for a majority of Americans.

  2. Ahh yes, those pesky social determinants of health. Reminds me of past discussions of cause and effect – if you want to alter the effect, go after the cause. We are spending far too much time trying to lower health care costs without focusing on the true causes of sickness in our country.

  3. Middle class Americans aren’t willing to pay 50% of their income in taxes to support a comprehensive social safety net. Europeans are. Different culture, different values.

  4. Carnivorous capitalism effects nominally aside, Bradley and Taylor:

    “…Improving access will have positive effects, but by itself is unlikely to address fundamental causes of the American paradox of high costs and poor outcomes. Extensive literature suggests that health care has relatively less impact on health than these social determinants of health, begging the question of whether past health care reforms have been too narrow to have an effect.

    If we view the national expenditure data while keeping the social determinants of health in mind, the United States’ spend more, get less paradox begins to unravel. The United States is spending an extraordinary amount on health care as narrowly defined by the OECD, and a substantial amount of time, energy, and money reforming the way in which this health care is paid for and delivered. But the United States is not spending as much as other industrialized countries on fortifying crucial social services that help make people healthy. For instance, it spends less than 10 percent of its GDP on social services, while France, Sweden, Austria, Switzerland, Denmark, and Italy all spend about 20 percent of their GDP on social services (see Figure 1.3); the inclusion of the US nonprofit sector in the analysis does not begin to close this gap. When researchers look at how the United States is doing in these other areas— providing reliable housing, ensuring nutritious food sufficiency, and safeguarding against harmful exposures— they find the performance lackluster…”

    Bradley, Elizabeth H.; Taylor, Lauren A. (2013-11-05). The American Health Care Paradox: Why Spending More is Getting Us Less (Kindle Locations 399-410). PublicAffairs. Kindle Edition.

  5. Healthcare systems throughout the world tend to be a reflection of the countries culture and ethos. Americans are capitalist and hence we call out free market competition as the solution to all problems. However, healthcare does not follow free market principles. We have no choice when we’re sick, and value is veiled as mentioned by the author. The trick moving forward will be to incentivize innovation (the cry from pharma whenever regulation is mentioned) while still caring for people. I don’t have the answer, but the current inability for CMS to regulate drug pricing seems out of balance with the need to cut our healthcare spend in half.

  6. “I favor the competitive model, but that model will work only when there is complete price and quality transparency”

    And, some things are true even when asserted by economists; to wit, that transparency is inversely correlated with margin (how could it be otherwise?). Moreover, and in that light, our most notable Silicon Valley digerati assert that capitalism and competition are antithetical — e.g., no lesser a light than Peter Thiel unabashedly argues lovingly for monopoly. Read his book “Zero to One.” Keyword search “monopoly.” 64 hits.

    “Monopolies drive progress because the promise of years or even decades of monopoly profits provides a powerful incentive to innovate. Then monopolies can keep innovating because profits enable them to make the long-term plans and to finance the ambitious research projects that firms locked in competition can’t dream of.

    So why are economists obsessed with competition as an ideal state? It’s a relic of history. Economists copied their mathematics from the work of 19th-century physicists: they see individuals and businesses as interchangeable atoms, not as unique creators. Their theories describe an equilibrium state of perfect competition because that’s what’s easy to model, not because it represents the best of business. But it’s worth recalling that the long-run equilibrium predicted by 19th-century physics was a state in which all energy is evenly distributed and everything comes to rest— also known as the heat death of the universe. Whatever your views on thermodynamics, it’s a powerful metaphor: in business, equilibrium means stasis, and stasis means death. If your industry is in a competitive equilibrium, the death of your business won’t matter to the world; some other undifferentiated competitor will always be ready to take your place…”

    Thiel, Peter; Masters, Blake (2014-09-16). Zero to One: Notes on Startups, or How to Build the Future (pp. 33-34). Crown Publishing Group. Kindle Edition.

  7. Learn how to protect yourself with powerful health effects and fulfill your life with happiness.

  8. Ewe, I think this phenomenon is because Ursodiol is not a very effective drug and the demand for it is weak and, in this low price range, is inelastic. It is only useful if the gall stone is pure cholesterol in nature (rare), and are small stones, and it takes several years to dissolve the stone…..so you have a situation where the suppliers are not afraid that price elasticity will reduce demand. In fact, within this low price range, demand is probably very low to begin with and quite inelastic, willy nilly the price being .45$ or $5.10. so it is like raising the price of a cheap ball point pen from 25 cents to a $1.50. No one notices or cares, but the folks who want the pen are going to buy it regardless of price.

  9. There was an editorial in the NYimes 3 years ago that sought to explain the problems of exorbitant pricing of generic drugs.


    It places blame on GPO’s and the anti-kickback law’s exemptions in 1987. The conclusion of the editorial states: “The Obama administration and Congress must protect patients by repealing the anti-kickback safe harbor and restoring free-market competition to the hospital purchasing industry.”

  10. We seem to be concluding that the competitive model does not work in healthcare quite as expected. First of all, the competitive model is by definition random, being subject to whatever market forces that exist then and there. And it changes over time. But add to that the byzantine structure of healthcare financing, and it’s no wonder that the competitive model has hiccups. Even so, I’d not throw out the baby with the bathwater. I favor the competitive model, but that model will work only when there is complete price and quality transparency available to purchasers who care about what they’re buying (unlike individual insureds who have paid premiums and the price is now being paid by insurers). It would seem that in the instance of ursodiol, those payors who were aware of the increase (transparency) would demand that one or more manufacturers dramatically drop their price or they would not be customers. Why that did not happen is puzzling, but again, there’s randomness.

    Interesting article Uwe, and good comments.

  11. Barry,
    Yes, that is the rationale for why we supposedly need legions of bureaucrats and central planners and certificate of need laws to manage all of this. The argument is often made and sounds reasonable, but in all markets (health care and any other product or service you can think of) where it is tried it never works very well…..even when the planners have fancy degrees and Ivy educations…..and often good intentions.

  12. Dr. Reinhardt appropriately points out that simply allowing more competition isn’t enough to allow for the most efficient pricing of drugs. I should point out, though, that the presence of multiple ursodiol manufacturers is likely why the price is $5 and not $500. The enemy of good is perfect – certainly preventing regulatory monopolies would seem to be low lying fruit. Tackling our 3rd party payment model which is why ursodiol is $5 and no $.50 would seem to be a larger mountain to climb at this stage.

  13. I listened to a story on NPR last week about this huge increase in Epipen’s pricing. Interestingly, when asked why the company thought this was a fair thing to do, they explained “because people have insurance with which to pay for it” (which of course, many don’t, or many have large co-pays).

  14. Uwe, no-one believes the free market is safe from abuse. Paraphrasing Churchill by changing a word.

    No one pretends that the free market is perfect or all-wise. Indeed, it has been said that free market is the worst type of economy except all those other types that have been tried from time to time.”

  15. While one would think the prospect of lower prices that an ambulatory surgical center offers should be welcomed by the health insurers, by employers, and by patients, there are potential adverse consequences too. For example, suppose the ASC’s skim off most of the well insured, easy, low risk cases. Then the hospital(s) occupancy rate may shrink to an uneconomic level and its payer mix will probably deteriorate as the ASC’s aren’t likely to accept Medicaid patients or the uninsured. There are services, tests, and procedures that can only be done on an inpatient basis. Will the hospital have to drastically increase its prices for those and how will that impact healthcare costs overall that insurers and patients have to pay for? Hospitals have to cover their costs, including capital costs, to stay in business. No margin, no mission.

    That all said, the secular trend is toward less need for inpatient beds as better surgical techniques make it possible to do more surgical procedures on an outpatient basis and those that still need to be done in the hospital may have shorter recovery times. Better drugs to manage chronic diseases and conditions help to keep more patients out of the hospital for longer periods in the first place. Hospitals need a minimum critical mass of business to remain economically viable. If there are only one or two hospitals in a large area, government subsidies or higher reimbursement rates or both may be necessary to keep them in business if ASC’s skim off too much of their previously profitable revenue.

  16. Interesting post, though I don’t find the contention that increasing competition isn’t very powerful in reducing costs/improving quality convincing. Can one find cases where it doesn’t work? Of cource…but that doesn’t disprove the general principle.

    Re why insurers don’t always focus on getting the price lower (“Specifically, if as their agents in the market of health care you cannot manage to exploit to the advantage of your principals – ultimately patients and the insured public— a market with 8 competitors selling a virtually identical product, what can you do for us?”)……..when I joined the Board of a dominant regional health insurance company I took it for granted that the non profit was acting as employer/employee agents to control costs of health insurance….I was puzzled that was not the case. The insurers don’t see that as their primary role. When they have dominant market share (in my case over 60%) they see themselves as the chief czar/central planner of the regional health system…and in my case working to keep out lower cost ambulatory surgery centers to protect the hospital revenues. I was shocked, and argued that when an ambulatory surgery center was going to reduce costs per procedure by 50-60% the health insurer should not be fighting it.
    One of Jim Purcell’s (ex non profit healh insurer CEO) posts on THCB was excellent in that it explained the multiple forces/constraints and pressures that take priority over controlling costs.
    Note: many, perhaps most health insurance markets in the US are oligarchic in structure…..a few insurers and one that is dominant. Opening up the barriers to entry is an important way to dislodge the complacency of the health insurers.

  17. In a perfect drug company world, patients would pay nothing or very little for drugs and insurers would pay through the nose. Of course the impact on insurance premiums or employers’ ability to raise wages after paying for rising healthcare costs is not their concern. For them, it’s all about maximizing the stock price and the potential for executives to amass great wealth through stock options and restricted stock awards.

    In the case of ursodiol, I wonder how large the total market opportunity is. I suspect it’s quite small and the generic manufacturers are taking advantage of what one might call the importance of being unimportant within the total market for prescription drugs. Why doesn’t this happen with statin or hypertension drugs which millions of patients have to take for the rest of their lives? Multiple manufacturers make those and the generic drugs in those therapeutic classes remain quite inexpensive, at least for the most part. Moreover, when the blood thinker, Plavix went off patent, the price dropped 96% in short order. How come?