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BIOTECH: Value-Based Pricing In Biotechnology

October 23rd, 2006
by James C. Robinson

The biotechnology industry has grounds for complaint. The research pipeline is disgorging breathtaking new treatments for cancer, rheumatoid arthritis, multiple sclerosis, and other once-intractable diseases. But instead of praise, or in addition to praise, the industry finds itself subjected to ever-louder criticism of its prices and earnings. America again seems to demand the best health care someone else will pay for. Let’s cut the prices and worry about it later. And if the venture capitalists don’t get repaid for their efforts, so what?

HBR CartoonSticker shock on biotech prices should hardly be unexpected. Avastin is priced at $50,000 a year for colon cancer and twice that for lung cancer, although Genentech recently announced a $55,000 annual cap on total spending from all sources for patients below an as yet undetermined income level. Erbitux for colorectal cancer comes in at $120,000 per year (although patients don’t live a year), Nexavar for kidney cancer at $50,000, and Herceptin appears a bargain at $35,000 for breast cancer.

Biotech products typically are tested and marketed for one narrow clinical indication and then are expanded into broader patient populations with different severity levels, comorbidities, and primary conditions. This “indication expansion” is just what we want from breakthrough innovation, the application to new uses of core scientific insights, but, boy, does it add to the costs. Now, after enjoying two decades being too small to be noticed by payers, the biotechnology industry [two-week free access] finds itself very much on the budgetary radar screen [two-week free access].

The traditional industry response to accusations of excessive prices has been to emphasize the high cost of research and development, the years in the laboratory and the clinic, the innumerable failures for each successful product, and the imperative to reward investors’ high risks with commensurately high returns. But the cost-based justification for high biotech prices has two nontrivial problems. First and most simply, it is not valid as a description of pricing practices; biotech companies do not base prices on costs. Second, the industry is beginning to realize that it does not want the public to think that prices are based on costs, whatever might be the short-term appeal of such thinking.

Are prices based on cost, in biotechnology or anywhere else? No, and fortunately not. In research-intensive sectors such as biotech, the biggest costs are sunk. The price for a new product must cover the incremental expenditures on manufacturing and marketing, but there is no logic to quantifying past expenditures on research and development. Rather, prices are based on what the market will bear. These prices and revenues may or may not reimburse past efforts and investments, but their social purpose is to encourage future efforts and future investments. The prices for today’s products finance research for tomorrow’s products, either directly through the retained earnings of biotechnology firms or indirectly by enriching investors who then remain attached to the sector rather than moving their money elsewhere.

Justifications of biotech pricing based on research costs offer the industry protection in the short term, but over the long term they would foster public demands for data on actual research costs, debates over who should bear the cost of failed research initiatives, definitional contests over appropriate marketing expenditures, and a cost-plus mentality more befitting a slow-moving utility sector than the science-based, entrepreneurial, venture-funded culture of biotechnology.

So biotech insiders now promote the language of “value-based pricing” for their products, which offers the virtue of honesty (away from cost-based justifications) but the vice of obscurity. No one knows how to define value in health care (it’s certainly not what the patient would be willing to pay, because the patient is not the one paying), much less how to measure it. And it’s not obvious that the biotech industry should capture the full value of its innovations anyway, compared to, say, splitting that value with consumers and the citizenry at large.

But at least the industry in engaged in the right discussion. It’s about value, not about cost. Costs have to be covered, but only for products that we value enough to pay the expenses required. The challenge facing the biotech industry is to tell its story, to define value, and to articulate a product and pricing strategy based on it. The challenge facing those who pay for biologics, including governmental programs, private insurers, and individual consumers, is to develop the ability to define value and to push the industry to ensure that their products are only used in truly high-value settings. Value-based pricing needs to be matched with value-based purchasing, the relentless search for better data on clinical and comparative efficacy, more effective clinical programs incorporating new treatments, and prices bargained down to the lowest levels needed to sustain investment and innovation.

For more research and commentary on biotechnology, see Health Affairs’ current issue, “Biotech Drugs Come of Age.”

Tomorrow on the blog: Ian Spatz on biotech pricing.

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3 Responses to “BIOTECH: Value-Based Pricing In Biotechnology”

  1. James C. Robinson Says:

    Yes the taxpayer is generous in supporting biomedical research through the NIH, but that is far from producing ready-to-use drugs and biologics. Unless the taxpayer wants to pay even more (his/her lust for further taxes is limited, I fear), we will continue to rely on private investors, including venture capital, licensing deals with big pharma, and the stock market, to pay for much of the lab research and clinical testing. And unfortunately, science is hard; most ideas prove to be losers. The biotech industry as a whole has been unprofitable since the beginning, in the sense that if you had invested in the whole sector and earned the profits from the profitable firms and suffered the losses with the unprofitable firms, you would still be in the red ink. For more color on this factoid, see the Wall Street Journal piece of a couple of years ago.

  2. LFBaltrucki Says:

    Perhaps the “loud criticism” stems from the frustration of the “business as usual” approach that the entire biotechnology industry, and our government is taking towards cancer and other diseases.

    On the one hand, many diseases are on the brink of being defined at the molecular and cellular level, (thanks to publically-funded research). On the other hand, it’s business as usual, and this is NOT going to get us to the promised land, (i.e. sustainable health care).

    I don’t have precise figures for Neil Gardner, but it is clear that much of the research that leads ultimately to biological therapeutics and other medical breakthroughs is publically-funded, through NIH grants and other mechanisms. Strictly speaking, it is the government that actually owns the experimental data, and the researchers that created it are considered inventors.

    Entrepreneurial activity is the norm between government or academic laboratories and biotech companies through a variety of relationships/mechisms that in essence results in the transfer of intellectual property rights to the companies. Next the company would need to attract investors to fund a project (and this would be a high-risk high-reward situation) but I have yet to figure out how the government or the tax-payers who funded the research in the first place, actually benefit (other than getting to pay those huge medical bills for their new drugs).

    The reality is that there is NO OVERSIGHT concerning the decisions that are made or the process that is followed where the basic science information that is owned by the public is transformed into clinical therapeutics, which are owned by the drug companies.

    I am all for innovation. I would even like to think of myself as an entrepreneur, but there is definitely something wrong wiht this picture. It is time to do something different!

    First of all, we should have a broad as well as a focused perspective. Broadly, anything that is publically funded but not clearly acting for the public good, (i.e. the biomedical research enterprise) needs to be reviewed. This should consist largely of representatives from stakeholder groups who are not engaged in biomedical research, but have made the commitment to acquire a basic knowledge of the relevant issues.

    More specifically, using new expensive technology (biologicals) to treat advanced stages of cancer is clearly not an effective long-term strategy or in the best interest of patients, health plans, or our nation. Right now, less than 5% of the NCI’s annual budget is allocated for clinical prevention trials. We deserve better. We deserve oversight and transparency, not business as usual.

    On the other hand, companies need to be profitable. (Despite the fact that drug prices are not related to development costs) there are ways to facilitate drug development that would impact those costs. We need to be creative to be competitive. We need partnerships where different components of the “health care system” are actually working together rather than against each other.

    Integrated delivery systems, (such as the VA or Kaiser Permanente) have something that is incredibly valuble to any drug or diagnostics company; a correlation data-base. In addition to the patient information itself, access to blood specimens (the most accessible tissue for banking) would important. Together with “computational biology”, and advanced screening technologies biologicals would be developed at low cost and in record time.

    This would be a partnership between the health plan / agency and the company. The specifications for the desired properties of the drug would be agreed upon up front, (i.e. oral agent, few mild side effects, etc.). Utilzation of the patient specimens and data-base for other purposes other than agreed to in the original agreement would be based on the company’s performance of the original contract.

  3. Neil Gardner Says:

    How much of this research is already supported by taxpayers through grants for research from government sources. If much of the legwork IS already funded by taxpayers, what’s up with these huge later prices?

    Check the below NIH news release out. Who will eventually make the big bucks on this taxpayer funded reseach??

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