“Value-Pricing” of Drugs and Pharmaceutical Innovation

In a fascinating paper on drug pricing, Ana D. Vega and her five co-authors trace increases in the price of brand-name and generic drugs in the U.S. during the period 2012-15, using the national average drug acquisition costs (NADAC) data made public by the Centers for Medicare and Medicaid Services (CMS). These acquisition costs are the prices that retail community pharmacies pay to acquire medicines, usually from a wholesaler.

The tables in the paper show that the top 50 increases in the price of generic drugs over the three-year period ranged from a “low” of 448% to a high of 18,808%. For branded drugs the increases over the period ranged from a “low” of 63% to a high of 391%.

The paper also presents data on the wholesale acquisition costs (WAC) differences between first-in-class drugs and subsequent me-too-drugs, the latter usually costing much more than the first-in-class drugs, although they typically involve only small molecular changes. Here the price differentials varied from a low of -2.3% (the sole case me-too-drug actually being cheaper than the first-in-class drug) to a high of 61,259%.

It is rare to find such transparency on drug prices in this country, presumably because the data are in possession of a public agency, the CMS. By contrast, the private sector usually confronts both patients and researchers with contemptuous opacity. The pharmaceutical benefit management industry (PBMs) is particularly opaque on drug pricing, and private insurers and employers have gone along with it.

Price increases of the sort reported by Vera et al. usually are defended on two distinct grounds.

The first is what has come to be called “value pricing’ the idea that the price of a drug should be pegged on the value that drug has to patients or to society at large, in their eyes. For life-saving drugs or pain-killing drugs, that value can be very high.
Another defense of the ever rising prices of drugs is that they are needed to provide the incentives for new drug development.

Value Pricing

In my presentations on drug pricing, I often use the following metaphor to convey the central point of this concept.
Picture, then, a man somewhere in the Sahara desert close to dying of thirst.

Along comes a camel caravan for tourists, loaded with bottles of water. Assume the chap on the first camel is a private equity manager who knows a thing or two about “value creation” through “value pricing.” Assume the lady on the camel behind the first is a corporate lawyer.

Jumping off the camel, the private-equity chap approaches the dying man and, water bottle in hand, queries the dying man thus:

“How much would you pay me for this fresh bottle of water?”

“Everything I own,“ moans the dying man. “My house, my car, my bank account – all my possessions.”

“Done deal,” responds the private equity chap.

Swiftly the corporate lawyer jumps off her camel, draws up an airtight contract and presents it to the dying man, who promptly signs it.

He gets his water and gulps it down, thus purchasing a whole lot more “quality-adjusted life years” (QALYs).

The private equity chap and the lawyer are beaming.

End of story.

What should we call this transaction? What should we think of it?
The answer to the first question is “value pricing,” because the price for the life-saving water was pegged on the value that water had in the eyes of the dying man in the desert.

What to think of it is quite another matter.

Economists would call the deal “efficient” and unambiguously “social-welfare enhancing,” because both parties to the deal are better off consummating it than they would be if the transaction had not taken place.

Non-economists, however, may view the transaction as a form of price gouging and exploitation of a person in dire circumstances.
What do you, the reader, think?

The metaphor should be of interest to health-policy experts, because more than a few members of the pharmaceutical industry appear in recent years to have slouched more and more toward the Sahara model of “value pricing” their products.

Whatever economists might say in defense of this practice “value pricing” in health care, the general public and those who represent them, members of Congress, do not seem to buy into the economist’s rationale. It is by now well known that at the opening of his very first news conference, newly elected President Donald Trump stated that in their pricing policies drug companies are “getting away with murder.”

Incentives for R&D in Pharmaceuticals

On the surface, the arguments that high drug prices today pave the way for new-drug development by the pharmaceutical industry has intuitive appeal.

Pharmaceutical companies tend to spend anywhere between 15% to 20% of their revenues on R&D, a ratio that varies by company and over time. It is certainly less than is spent on marketing and administration.

So the argument may be that if increases bin drug prices raises revenues, some 15% to 20% of that increase may trickle down to R&D.

Perhaps so. An alternative hypothesis, however, might be that if it is so easy to raise drug prices, even for older generic drugs, why bother to sweat over the uncertainty surrounding R&D? On this theory, the great facility with which drug manufacturers can ram huge price increases down the throat of the health insurance industry and patients may actually be a barrier to more fervent search for truly innovative drugs.

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  1. This post mentions the increases in the price of brand name and generic drugs in the U.S. during the period from 2012-2015, using data from the national average drug acquisition costs data. The paper cites numbers of top increases in the price of generic drugs from 448% to a high of 1808% and for branded drugs the increases were from 63% to 391%. Specialty brand inflation and increased utilization are also major contributors. 10% as been commonly cited as the amount of price increase in 2014 but this number does not take into account the discounts and coupons. A 5% increase has been reported by Schumock et. al which takes those discounts into account. The substantial portion of increases can be attributed to brand inflation and specialty brand inflation while modest proportions can be attributed to generic inflation and increased utilization under the Affordable Care Act. The price increases can be seen as a result of the monopolization of the pharmaceutical industry and the imbalance of power favoring the pharmaceutical industry over the payer. Over the last few years there has been little that the payers can do to combat the increases as they have little negotiating power due to not having a large unified group of payers. That could now be changing with the new startup companies such as Blink Health. This is a company that provides online services and purchasing power to the payer. Essentially allowing the payer to purchase through them with up to 95% savings. Blink health is able to unify a large amount of payers to bring a better negotiating presence to the table. There will be more companies like Blink Health come along to further empower the payer.

    This article also mentions value based pricing and the moral considerations to such a system. These are concerns not to be taken lightly as we are essentially talking about raising the prices for conditions that can most benefit from a treatment. However the argument can be made with respect to long term benefits and the number of people benefitted. Price increases on those who need a drug the most seems to be cruel. However if the objective of value based pricing can be met in having a sustainable system that perpetuates innovation and development to benefit the population as whole, then certainly this would be a moral system. So the question is does value based pricing work and how?

    Value based pricing assumes the premise that there is a right price for each customer, product, and transaction. An assumption that carries the tedious tasks of determining the right price for the seemingly endless range of patient-drug scenarios, clinical outcomes, risk and benefits, and additional benefits for patients and families. Not only do these scenarios have to be defined, also the next best alternative needs to be defined to truly determine the value of the drug in question. To do this one must ask how is the price different from the alternative and how is it better than the alternative. The necessary measures would need to include such concepts as cost-minimization, cost benefit, cost-effectiveness, and cost utility analysis of both the drug and next best alternative. Economists believe this can be quantified into quality adjusted life years for which a price tag could be placed. Using these measurements economist think that a price tag of $100,000-$150,000 per quality adjusted life year would be the correct number for impact of a drug treatment in the U.S. Again this assumes that this can be quantified for each scenario which would surely be time consuming or inaccurate, or both. While certain algorithms could be in place to accomplish the bulk of quantifying for objective categories such as medical conditions, other measurements are not as easily quantifiable such as what is important to the patient. For example, someone who is sick has a very different value of the drug as to someone who is healthy. The elderly would have a different value of a quality life year compared to the young. This seems to be a major pitfall of a value based system.

    With the price increases that might accompany a value based system it would be necessary to think about the short- term budget impact of the states since our health care system is different from state to state with differing effects of each new drug policy. Every dollar that is over budget of the state’s healthcare system is a dollar that is cut from public safety, housing, education, etc. It would be necessary to make projections of the states future budgets and gdp growth so that drug prices did not become a burden that is not sustainable without compromising on other public interests. Economists believe that this might be accomplished by setting a budgetary number that would serve as an alarm bell to cut down on costs so that states did not get into trouble. However, there are a lot of moving parts in a budgetary system and constantly adjusting to this system would only make a value based system more complex. And when you take into account the amount of differences at the state level the situation becomes even more complex.

    The best solution still seems to be the capping of drug prices such as is in the Canadian model in which a board determines the maximum price for all drugs. While this system would certainly lower costs, it does so at the cost of innovation with companies not being as motivated for large profits.

  2. Reports like these raise several questions: are pharmaceutical companies pricing drugs reasonably, or simply taking advantage of consumers to make large profits? Are they charging the highest price they can get away with? An article from Forbes Magazine entitled “Is Big Pharma to Blame for Soaring Health Costs?” highlights the ways in which Big Pharma is incomparable to other industries, such as pharmaceutical companies’ added level of risk, in addition to the presence of entry barriers (Forbes, 2016). There are also certain cases in which more spending is worth it, increasing innovation and leading to breakthroughs in treatment, as with Hepatitis C. Hepatitis C drugs were initially very expensive, but the introduction of two new drugs into the market led to a fall in drug prices by 40-60% in under one year (Forbes, 2016). These drugs cure Hepatitis C in eight to twelve weeks (Forbes, 2016). The market entry of generics means more competition, and prices drop even further.

    The blog post also references a new paper on drug pricing written by Ana D. Vega et. al. The paper analyzed trends in drug price increases between 2012-2015 using National Average Drug Acquisition Costs (NADAC) data published by the Centers for Medicare & Medicaid Services to identify branded products and their generic or “me-too” competitors with the highest percentage increases in price (D. Vega et. al, 2016). The results were shocking. According to D. Vega and authors, “The top 50 generic drug price increases ranged from 474% to over 18,000% from December 2012 to July 2015” while the top 50 brand-name drugs increased between 63% to 391% (D. Vega et. al, 2016). Potential explanations for these variations in price increases include factors such as manufacturer competition, generic drug entry, and the consolidation or monopolization of the pharmaceutical industry.

    One specific example of arbitrarily high pricing of a treatment is Mylan’s spike in price of the EpiPen, a crucial and life-saving allergy treatment which dominates the market with virtually no competition. (Lipton and Abrams, 2016). The article claims that “The retail price for the standard two-pack has jumped nearly fivefold since 2010, hitting $608 this [2016]” (Lipton and Abrams, 2016). The profits made by Mylan went largely to fund administration and travel, and the EpiPen price increase was largely masked by health insurance coverage, since insurance companies negotiate directly with Mylan (Lipton and Abrams, 2016). This is a common theme which complicates the value-based pricing model—insurers and employers have more bargaining power than individual patients or consumers who just pay a monthly premium and/or small copays for each visit. This leaves individuals unaware of the “true cost” of prescriptions or treatments and decreases price transparency. The situation is exacerbated by the FDA’s involvement. The brand-name EpiPen’s monopoly of the market is a result of the FDA setting restrictions on competitor products, despite the existence of scientific evidence regarding the active ingredient: epinephrine. This points to the lobbying power Mylan has in government.

    In drug pricing, it is also important to note the extreme lobbying power from pharmaceutical companies in Congress. This perspective claims the system has been built this way in order to extract the most money from consumers as possible for drugs with little consideration of the overall public good. One interesting solution for rising drug prices is Blink Health, a biotech startup company or “disruptor” that combats rising drug prices by targeting generic drugs. Blink’s free app helps consumers save up to 90 percent on generic drugs by using its large subscriber pool to gain negotiating power with pharmacies and get cheaper prices for users. GoodRX has a similar model, pooling the purchasing power of consumers to get coupons or discounts on drugs. Drug pricing transparency is another issue altogether, especially among private pharmaceutical companies, and sectors like the pharmaceutical benefit management industry (PBMs). Deals made between private pharmaceutical companies and generics can be enormous, and are often kept secret. Patients also often pay cash for drugs for privacy reasons or due to their insurance plan’s high deductible rate, which leads to more opacity in regards to drug pricing and profit.

    I envision several changes to be made regarding this issue of value-based drug pricing and innovation. One change to implement would be to place price caps on drugs at the federal level, modelled after the Swiss health system. The FDA would determine a maximum allowable amount for each drug that is on the market, and only include drugs which are both effective and cost-effective (Emanuel, 2015). Price caps would be determined or weighted based on QALYs or other objective measures of value (Emanuel, 2015). These price caps would create a ceiling to ensure price stability and promote competition. This intervention, though it limits the profit of pharmaceutical companies, would have minimal negative impact on medical innovation. Another smaller-scale, more immediate solution would be to implement therapeutic interchange programs. This means replacing a patient’s original prescription medication with a chemically different medication (AMCP, 2017). These medications are often of greater value to the patient and are more affordable.

    Value is the root issue, not pricing. Drugs that cure are preferred to drugs that treat. For example, someone with a new HIV-positive diagnosis must take ART therapy every day for the rest of their lives, while other drugs like Gilead’s Sovaldi virtually cure Hepatitis C infection. Similarly, the survival time for people on some cancer drugs is on a much smaller scale, adding just weeks or months to a patient’s life. Regardless, the ultimate question is: how much do we value an individual life?

  3. “The supply side of the US health system, which pretty much owns the Congress and, with Congress’ help, has built a health system over the years that allows it to extract the maximum revenue from the rest of society…”

    Absolutely right. And given this, it seems nutty to expect Congress to do anything to address the most significant problems of health care quality or cost. Do you disagree?

  4. The real problem is the effect of government intervention on the free marketplace. Government intervention has been poorly managed because instead of government using measures that least affect the free market place they used measures that caused distortions all over the marketplace.

  5. Charlie –

    It is very difficult to price a drug for Hep C per the patient clinical need. Transplants are not super relevant because recurrence rate is 95% because the disease is present in the bloodstream and re infects the new organ. Sovaldi is a “breakthrough drug.” This is an important distinction. Sovaldi was a cure of sorts with an efficacy of 94-97% in a disease affecting 150 million worldwide. The value is simply the value. It is not “more” valuable to one patient than another. All 150 million with Hepatitis C benefit from a medication that is curative.

    I am no fan of pharmaceutical companies (I cannot emphasize this enough) and it is astounding that Gilead was able to recoup the purchase price of Pharmasett (11.2 billion) in the first year of Sovaldi sales where they profited $12.4 billion. Their only expense after purchasing was 50-100 million for the Phase 3 clinical trials as the NIH paid for Phase 2. However, innovation is a large part of the pharmaceutical industry drive. Its not like they are watching patients die from these diseases, so they just care about the money.

    Joe Flower turned me on to the idea of external benchmarking using Pricing Power Parity as I discussed in a previous email, using various OECD countries to compare and then set a top price. Yes, it is a form of price control however it is set by the world stage. For example, Canada pays 55k, Germany 75K, UK 55K, and France 70K. If you average just those countries alone and then add 10%, the top price paid would be 70K for a 12 week course of Sovaldi. This was part of a presentation I just gave in Washington DC. The National Physicians’ Council for Healthcare Policy added this strategy to their list of “asks” that went to Tom Price, MD. He may not listen but it is a worthy compromise between warring factions.

    According to Liverpool University researchers the cost to produce a 12 week course of Sovaldi is $68-136 total. So if we set some level of control at a reasonable amount, the pharmaceutical industry (who has the ear of Congress) would be happy. The costs would slowly come down, and savings could be realized.

    This whole discussion about lowering drug costs must be about rational economic policy. Sovaldi is not exactly the best example, but Epi pen makes a better case. In Canada $57, UK, it is $69, France $75, and Germany $200. For us, using this method it would cost $110 in the US. Straightforward, simple, and effective.

    It isn’t really about negotiation. This should be about what the world is paying for this medication and how we fit into that picture while balancing the needs for innovation and investment for pharmaceutical companies. Look, I love to hate them too, but they are profiting off of making disease better. Right now, Hospitals are a bigger problem as they are being incentivized by the government to provide crappy care in small areas and are harming vulnerable people.

    I still like Uwe’s analogy overall. And I love Roberts suggestion to slit the throat of the guy and take off with the camel. That is obviously my style as well.

  6. What you say has to be understood clearly. These systems are far away from what we would call market-based system.

    The supply side of the US health system, which pretty much owns the Congress and, with Congress’ help, has built a health system over the years that allows it to extract the maximum revenue from the rest of society, would never allow the Swiss or German setup. It would limit revenues. As to Singapore, see here http://www.bmj.com/content/347/bmj.f4797

    Still, it was good of Reggie and her colleagues to have written the JAMA piece because it tells us so clearly what it takes to attain universal health insurance on the principle of social solidarity.

    See here https://www.youtube.com/watch?v=VYV5SrofmjU also and here https://www.youtube.com/watch?v=XV8jDc0kufM

  7. Every single time people pontificate about the “private” markets in Singapore, Switzerland and now Germany, I want to scream…
    Why? Because they all leave out the two things that make these “competitive” “markets” work: prices of medical products and services are negotiated and controlled by the respective governments, and insurers, which are essentially utilities, are not allowed to extract profits from the mandatory benefits basket. So let me know when we’re ready to do that, and it will all be rainbows and unicorns…. not to mention artesian fountains every 200 feet in the Sahara…

  8. Adrian,

    Don’t you want to add pharma, the lobbyists who work for all of the companies (including device makers), providers, LTCs, and of course the gov’t using healthcare as a boggieman to fool the foolish and redistribute funds from the poor to the very rich?

    I realize these would have a different position if there were single payer….but that position would not be orthogonal and they would still be players

  9. The diagnosis is a lack of universal coverage driving the politics of employer vs. private vs. government vs. uninsured. This malady seems to be localized to the US and isn’t spreading as far as I can tell.

  10. The list is of symptoms and nothing on list is a cause in my view and ranking would be waste of time. Your view of the reality you want us back to is a false one. We are missing the diagnosis and that discussion might be useful endeavor.

  11. Adrian, Your list is wonderful. Thank you. Rather than ranking them, however, I think it would be more valuable to seek to determine the cost of each to the nation. (That would rank them anyway….but with powerful evidence)>

  12. Charlie, Thanks for bringing this thread back to reality. The byzantine relationship of the various parties makes my head spin:

    – Blink Health has raised $165 Million already
    – I’m not sure who’s side the PBMs are working for except themselves
    – Coupon sites like GoodRx are out there
    – Importation looms in the background
    – Patent issues, especially around biologics, are likely to get worse
    – Direct-to-consumer advertising plays a role that could grow
    – Insurance company prior authorization programs will be automated and probably extended
    – Deductibles and privacy often drive people to pay cash
    – The deals between branded pharma and generics are massive and typically secret
    – Powerful branches of our government payers are out for themselves and don’t necessarily work to support the overall public good

  13. I’m sure there are a few that I missed in my list but if Uwe and others in our august group wanted to help, they should start by trying to rank order the list above in terms of relevance to drug pricing and payment reform in general before making analogies.

  14. All analogies have their limits, and I don’t want to be unduly critical of this one. But I don’t think it helps one understand “value pricing.” Uwe says that it shows that “the price for the life-saving water was pegged on the value that water had in the eyes of the dying man in the desert.” This isn’t how value pricing works in practice, however. (If it did, I would find it less objectionable.)

    Consider Sovaldi, Gilead’s treatment for hep C. Gilead initially priced it at $1000/pill or $84,000 for an entire course of treatment. The price wasn’t pegged to the value that hep C sufferers placed on the drug. Had it been, prices would have varied from consumer to consumer and, for some, would have been low. For example, persons newly infected with hep C might not have been willing to pay very much, their symptoms being minor.

    This is one thing the analogy obscures. Not all drug users are like the fellow crawling through the desert who is about to die of thirst. Some are in more dire need than others. The general point is that the analogy wrongly suggests that pharma companies engage in price discrimination.

    The analogy also focuses attention on the wrong variable: the intensity of consumers’ needs. Gilead didn’t peg Sovaldi’s price to the intensity of any hep C sufferer’s needs or even to the average intensity of need across consumers. It tried to figure out the maximum price it could squeeze out of payers. This is another thing the analogy obscures. The demand side of the market for prescription drugs is controlled by insurers, PBMs, and other payers, not by consumers. Consequently, manufacturers don’t think about consumers when setting prices. Sovaldi’s price makes this obvious. Few hep C sufferers had $84,000 to shell out for the drug.

    In Uwe’s story, there is no insurer accompanying the fellow crawling through the desert. This is an important omission because it suggests a ceiling on drug prices (consumers’ wealth) that, in reality, does not exist. There are surely thousands of people, perhaps millions, who are receiving drugs (or other treatments) whose cost exceeds their total net wealth.

    In a better story, the thirsty guy would hand the camel driver his BCBS card along with a $10 bill and say, “Here’s my copay. Charge them whatever you want.”

    Finally, when Gilead was pressed to justify Sovaldi’s price, it didn’t cite the value the drug had for consumers. It argued that, even at $1,000/pill, Sovaldi was cheaper than the liver transplants that hep C sufferers would eventually need as the disease ran its course. The drug was value-priced, then, because it was cheaper than other therapies. This was a phony and terrible justification, obviously, but it still had nothing to do with the amounts that consumers would willingly pay when using their own money.

  15. Bob — I agree with your comment about price gouging on certain low volume generic drugs. My preferred solution is for the FDA to simplify its drug approval process to reduce costs and shrink the time needed to approve a new competitive offering. When the incumbent’s price rises beyond a defined threshold, a new competitor should be moved to the head of the line in the backlog so its application can be approved as quickly as possible. I’m uncomfortable with direct price control but I am comfortable with QALY metrics or other rational bases to exclude overpriced drugs from a formulary.

  16. Barry I am not expert on pharma, but I do have two opinions that may be of value:

    1. Some of the worst price gouging (albeit in smaller dollar amounts) has taken place in the last few years on older drugs –which are bought up if they have even a small population dependent upon them.

    The gouging could be stopped tomorrow and not have the slightest impact on medical innovation.

    America needs a Pharmacy Price Review Board like Canada’s, with veto power over monopoly gouging. We could also use less powers for the FDA, which slows up competition for these drugs.

    2. The decisions on how much to spend on one life are agonizing, but more than drugs are involved. Friends of mine had a child born with a defective liver, and with all his treatments the cost has been over $3 million. Two health plans have had huge rate shocks, and the parents are divorced and bankrupt.

    I have two ideas to relieve this horrible strain:

    a. Price controls on drugs and hospitals, which does not remove the decision but kind of postpones it ….in the sense that a cost of $100,000 is easier to debate than a cost of $500,000.

    b. My last idea will never happen, but here it is. Have insurers refuse to pay enormous sums, and turn the decision over to the doctors and hospitals.

    If they want to devote their own time to the patient and save their life, wonderful.
    If not, so it goes.

  17. Robert, the Brooks Brothers dude owns the camel. Not only that but he voluntarily allowed the water carriers to use his camels earlier on, in the hope that if he ever gets stuck so in the Sahara, they will bring water. There was a compact here, made in good faith by the Brooks Brothers idiot. What is missing in this incident is the Sahara Patrol trooper(which Brooksie pays for as well) to arrest the entire caravan and put them in jail forever.

  18. When it comes to pricing brand name and specialty drugs, most drug companies think in terms of maximizing shareholder value which, I think, is unfortunate. While it’s necessary for investors to earn a satisfactory risk-adjusted return on their capital to sustain medical innovation, there is or at least should be such a thing as striking a reasonable balance among all stakeholders including patients and payers. Most drug companies want patients to pay little or nothing for their drugs but they want payers to pay through the nose. Too many drug companies raise prices well in excess of inflation year after year because they can but just because they can doesn’t mean that they should. I wonder how some of these folks who set drug prices would feel if they were on the receiving end of the bills.

    Another thing that is unique to the drug industry is using per capita GDP as a proxy for ability to pay so they charge what the market will bear in the unfettered U.S. market and considerably less in other first world countries. Importing drugs into the U.S. from other countries is easier said than done even if there are no safety issues. It’s not like Canadian pharmacies, for example, can buy as much of a given drug as they want in order to export it back to the U.S. The manufacturers will place limits on how much they will sell based on prior patient demand within the country. If the U.S. tried to control prices like other first world countries do, there would likely be a significant adverse impact on medical innovation. Price controls work in other countries because drug companies can shift costs back to the U.S. just as Medicare and Medicaid can pay relatively low reimbursement rates because providers can shift costs to commercial insurers and self-funded employers.

    In the end, society has to make some judgments as to how much it is prepared to pay to keep one person alive. That’s a mighty tough call when you’re dealing with a child or young adult. It should be a considerably easier call when you’re dealing with an older person who has already lived a normal lifespan and then some. People should always be free to spend their own money if they have it but most people don’t have it when it comes to very expensive specialty drugs especially. Specialty drugs account for only 1% of prescriptions written in any given year and only 2% of patients need them but they account for one-third of drug costs and that percentage continues to drift up. We have to draw the line somewhere.

  19. Obviously, we have a huge drug price problem that reduces access (although they still amount to about 10% of health care costs and are the most important treatments for almost all chronic illnesses.) We should seek other price concessions as well (hospitals come to mind).

    Also, I am not an economist. But it is still correct that we can’t price drugs at the level of a poor African country. Isn’t it true that cos price discriminate (very low prices in countries that can only afford those prices). Obviously, prices need to be higher in the US and Europe to offset such low prices. I stand to be corrected. But I don’t think prices can ever be the same all over the world. S

  20. What amazes me about this “problem” is that American lives seem to have infinitely more “value” than European lives, Canadian lives, Asian lives, African lives…..

    And the “solutions” are priceless. Since we are a principled capitalist “free market” country, we would never impose price controls on businesses, but we are innocently proposing to turn around and “re-import” the same darn drug from a “socialist” country that dares do just that. If that’s not hypocrisy, I don’t know what it is….

    In this case the parched desert is the mirage…..

  21. Great discussion, but want to raise a contrary view.

    First, Uve, thank you. I loved reading your work as editor and enjoy your insights. However, I think your teaching analogy should be discarded. It is giving a wrong message, but in doing so it shows the nonsense of the three words, “value-based pricing”,

    My point. You make an incorrect assumption(s) in the analogy. You assume the water has value. It really has no value to this Brook’s Brother clad desert (misspelled on purpose) dweller. He will spend his fortune, get 12 oz of purified water and then die of thirst. The real value in the depiction is the camel. I would slit the throat of the person offering the overpriced, valueless water and take their camel.

    Think for a moment of the word, “value”. What is it? Is it a measurable, hence, understandable concept? No. We have some who think we should spend hours talking about things we don’t know anything about to provide for a future of better discussions decades in advance, and ask others to pay for our time. I think my insurer owes me a BMW for my back pain. Without a concept of value, we can’t study it and trying to use it to explain drug pricing is not helpful in my view. For sure, no economist, physician, insurer, pharma head should decide value, only patients should.

    The sometimes fun and descriptive terms of economics don’t help us in medical care. Porter is right; there is no economics of health care because we have no shared value of value. Sticky economics, value-based, needs for R and D, are buzzwords that don’t explain anything. So, I want to offer my economic principles of medical care. If I was at the UC, I would like get a Nobel. First, they charge more because they can, and, most important, the less value something has, the more we will charge for it.

  22. “I often use the following metaphor to convey the central point of this concept. Picture, then, a man somewhere in the Sahara desert close to dying of thirst….”

    Uwe, one of the problems with healthcare policy is that such metaphors are frequently used, but they don’t lead to good policy formation. If Churchill during WW2 used that type of thinking WW2 could have been lost.

    David Dranove rightly brings up liquidity constraint something that has been mentioned in various ways before. It demonstrates that the policy makers have created much of the problem they now intend to find solutions for.

    I would like to add another aspect, contract law. There is such a thing as a contract of adhesion which this metaphor seems to create. The courts might later hold the contract to be unenforceable due to its unconscionability. Wouldn’t such an agreement “shock the conscience” (Rochin v. California)?

  23. I’m genuinely confused by the pharma industry’s use of “value-based pricing” when it comes to life-saving drugs. The value to the consumer is a strange metric to use in these instances because we’re talking about someone’s very existence. If we’re to buy the conceit that “life is priceless” – a proposition that makes sense given that life and death are generally pretty binary – then would that justify a drug’s value being uncapped. Would pharmaceutical companies advocate that emergency rooms refuse to treat unless the injured deed over their first-born as well?

    I would be more sympathetic to value-based pricing if pharmaceutical companies didn’t regularly demonstrate that they’d rather spend in marketing and administration than R&D (as noted by Uwe Reinhardt). The reality is that pharma executives know that there are enormous (and understandable!) barriers to entry – institutionally (FDA approval process), economically (manufacturing and distribution costs) and legally (IP litigation) – which prevent a true free market from determining fair rates. And they take advantage of it. Given these highly imperfect conditions for competition, consumers must be protected by Congress in the form of regulation on costs or, at the very least, on transparency of prices.

  24. This paper http://www.nber.org/papers/w22353 might be of interest…it is a bit technical but most can skip the nasty bits.

    The main points: Liquidity caps pricing (you can charge more than what people have). Insurance breaks the liquidity constraint, but then you can’t charge so much that the insurance is unaffordable. Medicare Part D rules make it all but impossible to exclude many protected classes of drugs. Industry fragmentation encourages each firm to ignore the industry’s long run interests. Thus, it is not surprising that the spike in pricing coincides with the passage of Part D and the tremendous increase in fragmentation.


  25. Uwe-

    I love your analogy. It really is quite an eloquent way to describe a terribly imbalanced situation. Obviously, the pharmaceutical industry has no reason to comply with demand for “water” until there are more “drinking options” available. We can either pipe in “water” from foreign sources (quite safe), allow external benchmarking (ie use median OECD price + X% or benchmark with France, Canada, Germany, and the UK + X% ) to set the prices, or tie after-market price increases to something like inflation. But all of these options are considered negotiation and everyone knows there is no room for negotiation when one will die without the “water” and there is no chance to simply “walk away.”

    The public should be made aware of the price gouging going on as much as possible. We need to help patients obtain drugs from outside the country while still protecting our licenses. We should push, imho, for external benchmarking prices as a future standard. It is a reasonable solution from which pharma and patients would benefit.