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BIOTECH: A Road Toward Value-Based Pricing

October 25th, 2006

In his post, Jamie Robinson has raised the specter of an upside-down world of setting prices for biomedical innovations based on cost. Before we examine his serious admonition to focus on value in pricing new biotechnology drugs, let’s walk down the other trail: the argument that drugs should be pricy because they cost so darn much to discover and develop.

Robinson argues that if those who discover and develop expensive new medicines persist in this line of defense, some authority, somewhere, will take suppliers at face value and require bottoms-up cost information to calculate a “fair” price. If such a system were to take root, it would open up the oversight of biotechnology innovation to a much larger pool of managerial talent than those we rely on today. People who have excelled in the worlds of defense and aerospace contracting, for example, would be needed to maximize allowable costs at every turn in order to generate the maximum flow of cash through the enterprise.

Having managed every stage in the drug discovery and development process under our current system, I can tell you that this new world of cost-plus will also be a world of time-plus. If there is no strong and pervasive incentive to use money as efficiently as possible, there will inevitably be an expansion in the time required for every step in the innovation chain.

Maybe this explains why countries with Soviet-style planned economies have not produced a single pharmaceutical innovation with the health impact of any major blockbuster drug or vaccine. Our own system of stimulating pharmaceutical innovation has been spectacularly successful despite inefficiencies that result from segregation of key purchasing roles among those who decide (doctors), those who pay (insurance and government), and those who receive the benefit of the resulting products (patients). In the 1970s, when I first started paying attention, leaders in the field of health economics were already crying out that we would soon invent our way into an array of biomedical and technology innovations that we could never afford. The bogeymen of the time were rapidly proliferating CT scanners and pills that cost as much as one dollar a day (!).

Measuring Value: Hard, But Worth It

So what about value in biomedical innovation? Is it really so hard to measure? I argue that the actionable quantification of value of these inputs to the health care enterprise is indeed doable, it is hard to do, and it is worth the effort. The core methodologies underlying the use of quality-adjusted life-years (QALYs) as the output metric were thoroughly explored in the 1980s, including the rich gamut of moral, technical, and sociological issues that are raised by aggregating health outcomes across individuals for decision making. For over a decade, we have had league tables which array research findings from dozens of cost-effectiveness studies indicating the range of dollars per QALY we are paying in the current system for specific technologies or health care practices. The usefulness of these methodologies is not limited to some idealized single-payer system or any other form of overt rationing, but can usefully inform pricing decisions by providers, treatment decisions by doctors and their patients, and payment decisions by payers in our pluralistic system.

Clear thinking about the marginal cost of a specific use of a new technology in relation to the marginal QALY output of such use, compared with some specific alternative, is completely within our competency. What has been elusive is to put this highly informative data into the right context, where the value of new innovation is properly seen in the context of the other technologies and services for which we already pay.

It is an extremely bad idea to hold only the latest innovations to a high standard of value-for-money and leave all the rest of the drugs and devices for which we provide coverage unexamined. This approach will throttle back both the best and the not-so-best innovation in favor of the status quo. Furthermore, since improvements in drugs and medical technology often reduce the need for health care services, the context for value of innovations must be placed on a level playing field with all of the other inputs to the health care enterprise.

Maybe it’s time to reimagine how to do a better job of making decisions about medical innovation. If so, then we need to be particularly concerned about keeping the private sector interested in funding innovation in the very-long-lead-time technologies of biotechnology and pharmaceuticals. Whether or not you find the estimated billion-dollar price tag for a major new drug convincing, it’s hard to dispute the years of preclinical and clinical research and the massive capital investments in manufacturing that must be sustained before commercial products emerge.

As a full-time investor in early-stage biotechnology, I am one of many who are closely watching for signals from the CMS and the insurance industry that could hurt or help the prospects of development projects we might undertake. Policy changes will immediately impact the cost of capital the next time these money-losing start-ups raise money, and therefore the amount of dilution we experience as we take on new investors. Managers and investors focused on later-stage companies, profitable or not, are nurturing projects with enormous sunk costs and will exert commensurate political capital to protect the environment in which these portfolio decisions were made.

A Proposal for Investing in Innovation

So here is the beginning of a specific proposal: Let’s introduce a better framework for purchasing medical innovation that is set to begin enough years in the future that investors in the long-lead-time technologies can adjust to the new signals (and will not need to expend their political capital to derail these changes). This system will pave the way for wider and faster adoption of medical innovation demonstrating objective value for money that exceeds some pay-line on a cost-per-QALY yardstick that is reasonably consistent with trade-offs we make elsewhere in our economy. Let’s make sure that new innovation is not held to a higher standard than previous breakthroughs, which means that there is some system for continuous examination of value for money and a level playing field for payment decision on new and old technology. Furthermore, we need to envision a system where the other inputs to health care are evaluated and paid for on the same level playing field.

This sounds like a large undertaking, but I can’t imagine a sector of our economy or our personal quality of life where the stakes are higher and the effort more worthwhile.

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

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1 Trackback for “BIOTECH: A Road Toward Value-Based Pricing”

  1. Policy
    July 20th, 2011 at 4:48 am

4 Responses to “BIOTECH: A Road Toward Value-Based Pricing”

  1. mgoozner Says:

    How would a novelist describe the cancer patient’s quality-of-life during that quality-adjusted life year purchased for $55,000?

    Do not take this as a defense of the former eastern bloc, but there are actually plenty of examples of state-sponsored innovations that have had a tremendous impact on public health: We’re watching the emergence of artemisinin-combination therapy for malaria, a product of an initial collaboration between Mao Tse-Tung and Ho Chi Minh and the traditional Chinese medicine doctors they set in motion at the height of Mao’s cultural revolution. Go figure. How about penicillin? If the federal lab in Peoria, Ill. hadn’t come up with a method for mass fermentation, it wouldn’t have reached the troops before the end of WWII. Want to talk about biotech? Read the first chapter of my book, “The $800 Million Pill,” and I defy you to say that Amgen’s price for Epogen has anything to do with a) the cost of development; b) an incentive needed for further innovation; or c) the value it adds to patients’ lives.

    I had a few moments this evening to drop in on this new blog to see what folks had to say on this interesting subject, and I was sad to see that the health care economists who fuss over this topic never seem to grapple with two, mutually exclusive realitiies.

    First, the historical driving forces in significant medical innovation are the mutually reinforcing combination of human need (think of the AIDS crisis) and investigator drive (think of Brian Drucker and the development of Gleevec), nurtured by scientific serendipity and leavened by the difficulties of the tasks at hand (think of Alzheimer’s . . . what does it cost to develop a good AZ drug? Why, the answer is simple. Infinity. Why? Because we don’t know how to do it and any amount of money divided by zero is infinity).

    The competing reality is that the private sector responds to a completely different set of signals, which are quite legitimately set by capital markets (the supply side) and health care provider markets (the demand side). I would humbly submit that neither market sends appropriate signals for maximizing health. I am sure the sophisticated readers of this blog know the arguments of contrarians like myself, ranging from the critique of me-too drugs to the hyper-marketing of minimalist improvements (read the oct.19 NEJM for the latest installment, on Xigris). Suffice it to say for now that even while the private sector as currently organized and responding to market signals as they currently exist does occasionally deliver innovation, it delivers just as much if not more waste. Any discussion of biotech drug pricing (and health care pricing generally) that doesn’t take into account those realities will find itself on the outside looking in at the coming debate over how to create a sustainable health care system for all Americans.

  2. LFBaltrucki Says:

    (Along the same lines as what Neil Gardner has shared)

    As a nation and as a society, in addition to the specific issues under discussion we also need to answer some of the more fundamental questions.

    Examples: What diseases can be completely prevented? (i.e. primary prevention) and What diseases can be detected at early subclinical stages and effectively arrested such that they do not progess? (i.e. secondary prevention).

    I submit that the wealth of basic science knowledge that we have have about disease at the molecular and cellular level, mostly publically-funded, (but not held in the public’s trust) can be transformed into interventions that are directed at earlier stages of diseases. But who will be responsible for redirecting the resources and efforts along these lines and towards what we, the people, actually need? Big Pharma/Biotech? I don’t think so. Governmental Labs/Agencies as currently configured (up until now this occurs only in exceptional cases rather than being part of a concerted effort).

    This may not be the most appropriate forum (on this particular blog) to state this, but there is a fundamental conflict between our nation’s plan for healthy peolple and the business development strategies of Big Pharma/Biotech, and the time for an honest and open discussion about this issue is long overdue.

    As a pathologist I have been involved in cancer diagnosis for over 20 years. Also with a strong family history of colon cancer I am heavily invested in preventing colon cancer in myself and other family members. We get all of our “medicine” to prevent colon cancer from Wal-Mart and Costco (or similar stores). The evidence that supports the benefits of these vitamins and supplements has been derived from clinical trials that were funded completely by the government (NCI’s Division of Cancer Prevention) which is currently getting less than 5% of the total NCI budget. Thanks to this research, the chances of my family members actually getting colon cancer have been substantially reduced.

    What are the areas that we need to be working on right now? Just to start out, let’s make two lists; one developed by the best and brightest minds in goverment biomedical research and health care the other developed by Big Pharma/Biotech. There would need to be Congressional oversight of the process by which appropriations for research funding were matched to national health priorities. Priority areas where government and industry could work together would be identified. Oversight of the entire process would need to be more intensive and more inclusive than it is now.

    Our current strategy, (treating diseases that are fully established with newer and more xpensive) biologicals for marginal/incremental benefits, WILL NOT take us where we need to go.

  3. Neil Gardner Says:

    When I read this discussion about the top of the foodchain drug discovery process and/or selling/pricing ideas, I see an analogy coming forth. That analogy is buying a super sports car to drive on roads that only allow safe driving at 35 MPH.

    You all know the IOM report ( ) listing medical errors as one of the leading casues of death in America. You do also realize that our current system has 47 million uninsured showing a death spiral insurance paradigm coming forth to threaten everyone’s ability to eventually afford health care! In light of this, just what should we be talking first about around here: the needed infrastructure to drive at all, or the latest sports cars??

  4. James C. Robinson Says:

    Comparing the cost effectiveness of a new biologic against the range of costs and QALYs already covered, or against some cost-per-QALY benchmark (as done in Britain) is interesting and good public policy. But here the issue is price, not “cost” in the immediate sense. Biotech companies have discretion (some call it strategy, to prove they have an MBA) to set the price regardless of cost (or rather, price must cover incremental costs of manufacturing and distribution but need only make some contribution to covering research and development costs). This discretion can be used to come in at any cost-per-QALY level desired. For example, Genentech’s recent price cap for Avastin ($55,000 per patient per year) is close to the maximum cost-per-QALY guideline that is used in Britain. This does not get really at the “cost effectiveness” of the drug but does perhaps provide an (arbitrary) lid to product prices. Or not?

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