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Management of Increasing Drug Prices in the Pharmaceutical Industry

August 19, 2017
There exists a paradox in the pharmaceutical industry. Despite the pharmaceutical sector providing some of the highest value of any industry in modern economies, the industry is almost universally viewed with suspicion and is frequently criticized.[1]

Much of this criticism is focused on the high costs that are pervasive in this industry: high research and development (R&D) costs, high prices, high profits, and high marketing costs. [2] Rising costs are a frequent trend seen across all of healthcare in the United States; annual per capita expenditure on health care has increased 6740% since 1960. In particular, prescription drug expenditure has composed a significant portion of this increase, eclipsing $1000 per capita annually for the first time in 2015. [3] Despite devoting 18% of GDP to health care costs, US health outcomes are worse than in other developed nations. [4]

Image: National expenditure on prescription drugs has increased over 7000% since 1960. Source: Center for Medicare and Medicaid Services.

Image: National expenditure on prescription drugs has increased over 7000% since 1960. Source: Center for Medicare and Medicaid Services.

Given that there is no correlation between the increased health care expenditure in the United States and improved health outcomes, why do we continue to spend so much? In the pharmaceutical industry, the unique market for prescription drugs allows significantly higher pricing than in other industries. Compared to other sectors, consumers are generally more price inelastic, given that many drugs are the main, if not only, option for treatment for certain conditions and diseases. [5] Additionally, as of 2014, the cost to bring a new drug from inception to market is estimated at $2.6 billion. [6] Because of this, significant intellectual property benefits are afforded to pharmaceutical products to encourage innovation. The Food and Drug Administration provides additional opportunities for market exclusivity, beyond the traditional twenty-year patent protection. [7]

While mechanisms for market exclusivity and protection have proven crucial to allowing pharmaceutical companies to recuperate R&D costs and earn profits that can be reinvested in future research [8], they also permit overpricing of pharmaceutical products. For example, the FDA recently approved a steroid called deflazacort to treat children with Duchenne muscular dystrophy. Despite being available in Europe and Canada at a price between $1,000 and $2,000 per year, Marathon Pharmaceuticals is charging a list price of $89,000 – a 6,000% price increase. This type of pricing is possible because of FDA policies, like the Orphan Drug Act, which provides seven additional years of market exclusivity for approved drugs for rare diseases. [9]

In a survey by the Kaiser Family Foundation, a quarter of US prescription-drug users said it was difficult to afford them. In fact, 72% of Americans feel that drug prices are unreasonable, often citing that pharmaceutical companies are putting profits before people. [10] Given that there is a disconnect between the practices of pharmaceutical companies and the needs of the American people, policy discussions are necessary to bridge interests.

One of the most prominent discussions around managing costs in healthcare is in shifting healthcare to a value-based system. In the current system, pharmaceutical companies set drug prices freely, and insurance companies then decide how much of the cost they will cover. This leaves patients to bear the rest of the burden. For many life-threatening illnesses, patients have to decide between accepting high costs and forgoing life-saving treatments. By focusing on the value provided by treatments across all health sectors and incentivizing providers to maximize the value of the treatments they provide to their patients, health care will develop a central focus on its patients, which will both improve care and reduce costs. [11]

Another opportunity to target the costs of prescription drugs is to legalize Medicare negotiation with pharmaceutical companies. Currently, Medicare, which accounts for almost one-third of national retail pharmaceutical spending, does not negotiate drug prices directly. However, 82% of the public favor including Medicare negotiation in the purview of HHS. [12] The CBO has suggested that savings would only be achieved if HHS were given the authority to establish a formulary that excluded certain drugs, like many private Medicare Part D plans do. [13]

The last growing area of policy consideration is to focus on innovative technologies that will reduce the costs of healthcare management. Employing such technologies as artificial intelligence and big data systems offers significant potential to reduce the intrinsic costs of R&D, thus allowing pharmaceutical companies to pass savings to the consumer. [14] Developing new technologies that save time, manpower, and other inputs serves as one of the best ways to systematically reduce costs and improve the issue of soaring drug costs in the United States.


  [1] Uwe E. Reinhardt, “The Pharmaceutical Sector in Health Care,” Pharmaceutical Innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective, 2007.

  [2] Frank A. Sloan, and Chee-Ruey Hsieh, eds., “Pharmaceutical Innovation: Incentives, Competition, and Cost-Benefit Analysis in International Perspective,” Cambridge University Press, 2007.

  [3] Center for Medicare and Medicaid Services, “National Health Expenditure Data: Historical,” CMS, 2016.

  [4] Hagop Kantarjian, “Does the United States Have the Best Health-Care System in the World?,” The ASCO Post, August 15, 2014.

  [5] David Henry, and Andrew Searles, “Pharmaceutical Pricing Policy,” Chapter 9 in Managing Access to Medicines and Health Technologies, Management Sciences for Health, 2012.

  [6] Ed Silverman, “What Does It Cost to Develop a New Drug? Latest Study Says $2.6 Billion,” The Wall Street Journal, November 20, 2014.

  [7] Food And Drug Administration, “Patents and Exclusivity,” FDA/CDER SBIA Chronicles, May 19, 2015.

  [8] Rebecca Eisenberg, “Patents, Product Exclusivity, and Information Dissemination: How Law Directs Biopharmaceutical Research and Development,” University of Michigan Law School Scholarship Repository, 2003.

  [9] Matthew Herper, “Why Did That Drug Price Increase 6,000%? It’s The Law,” Forbes, February 10, 2017.

  [10] Bianca DiJulio, Jamie Firth, and Mollyann Brodie, “Kaiser Health Tracking Poll: August 2015,” The Kaiser Family Foundation, August 20, 2015.

  [11] Sylvia Burwell, “Setting Value-Based Payment Goals – HHS Efforts to Improve U.S. Health Care,” The New England Journal of Medicine, 2015.

  [12] Juliette Cubanski, and Tricia Neuman, “Searching for Savings in Medicare Drug Price Negotiation, The Kaiser Family Foundation, January 23, 2017.

  [13] Congressional Budget Office, “A Detailed Description of CBO’s Cost Estimate for the Medicare Prescription Drug Benefit,” Congress of the United States, July 2004.

  [14] Jamie Cattell, Sastry Chilukuri, and Michael Levy, “How Big Data can Revolutionize Pharmaceutical R&D,” McKinsey & Company, April 2013.


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