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BIOTECH: The Myth of Value-Based Pricing – So Far



February 20th, 2007

At last policymakers and readers are being set straight that the prices of drugs are not related to the immense costs of research and development but to “what the market will bear,” as James Robinson put it in his Health Affairs Blog post last fall. Never mind that pharmaceutical executives told Congress and everyone else the opposite for 50 years to wrest government protections from the normal price competition. Apparently we’ve all been duped since the Kefauver hearings over 45 years ago, and industry-supported analysts keep issuing ever higher estimates of $1.2 billion and $1.7 billion R&D cost per average new drug. Since industry data show full recovery of R&D costs, with strong profits, year after year, does this mean these estimates are exercises in false rhetoric?

How can the market know what it will bear if pricing is usually covert and value unknown? Why does the “free market” in the United States result in the highest prices in the world, according to the recent report by the Congressional Budget Office? Do those prices reflect true value? This is impossible because, as Robinson writes, “No one knows how to define value in health care,…much less how to measure it.” Thus biotech and pharmaceutical prices cannot be based on value.

Meantime, the sellers are busy recruiting and supporting health economists to define value, measure it, and produce articles “proving” that the value of their drugs is two to four times greater than current prices. In their hands, the value of a life-year has quadrupled in the past five years, thus inflating the value of products. So far then, “value-based pricing” means the sellers define and measure value, tell us how valuable their products are, and provide the basis for still higher prices.

Is this why Robinson writes that we should not feel sticker shock when companies charge $35,000 per year for Herceptin, $50,000 for Avastin, or $120,000 for Erbitux? We now know that such prices are not based on sunk R&D costs. And we’ve learned they can’t be based on undefined and unmeasured value; so what are these prices based on? Many physicians and patients feel they are based on the exertion of pure power by drug companies who have the drugs that people need.

One common answer by economists is that price is related to expected R&D costs, but then expected costs can be whatever the seller says they are, like the $1.2 billion estimate, which is based on trial costs about 12 times greater than companies report to the IRS in audited statements and trial sizes 4 times greater than independent sources like the FDA. Divide the industry-claimed costs by 12 and then 4 and you get cost-estimates 1/48th as large. For biotech companies and investors, the best indication that future R&D is worth the cost and risk is how rapidly and profitably they recover their past investments in R&D. But that brings us full circle back to what we are told prices are not based on, and it’s a completely different argument than value pricing. More important, pharmaceutical and biotech companies never provide figures to show how prices or revenues are actually related, either to past or future R&D costs. This is the beauty of using theories to describe how reality works! The advantage of economic sociology is that it starts with detailed description and draws empirical conclusions.

For these reasons, “value-based pricing” is a myth, at least so far. To make it a reality we would need at least something like the tables in Consumer Reports Best Buy Drugs. They compare effectiveness, safety and price for different classes of drugs. Take statins for people with a mild cholesterol problem who want to lower their LDL cholesterol less than 30% without changing their lifestyle. Several drugs are rated as equally effective and safe. Patients or their plan could buy Lovastatin 40mg for $58 a month. Or for 59% more they could pay $92 for Lipitor and achieve comparable results. The price for an equivalent supply of Zocor is 79% higher ($104), and for Mevacor the price is 164% higher ($153). But Mevacor 40 is just Lovastatin 40 with a brand name. Apparently the name is worth $95 more.

If we compare how much physicians prescribe each of these five statins, we will get an indication of how far we are from buying on value, even when comparing price and value is simple. Something quite different is going on. It’s time to forget arguments based on theory and look closely at the organization and dynamics of the multi-level, segmented markets involved.

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2 Responses to “BIOTECH: The Myth of Value-Based Pricing – So Far”

  1. Hank Kearney Says:

    The “Myth of Value Based Pricing – So Far” further illustrates the challenge the entire pharma industry has in justifying an out of date pricing model.

    Patent maximization, or driving the highest per unit price based on market interference (e.g. the patent) requires a delicate balance between the price, volume, and value, or more correctly, the perceived value. But the pharma industry has for some time now decided to weigh the balance in favor of a maximized per unit price.

    Countries like India long ago realized the need to increase volume, e.g. access, even at the expense of the patent.

  2. Ian Spatz Says:

    Light writes that “At last policymakers and readers are being set straight that the prices of drugs are not related to the immense costs of research and development”? Not so.

    One example is a speech, widely-reported at the time, by Merck’s then-CEO, Ray Gilmartin, in which he said:

    “The price of medicines isn’t determined by their research costs. Instead, it is determined by their value in preventing and treating disease. Whether Merck spends $500 million or $1 billion developing a medicine, it is the doctor, the patient and those paying for our medicines who will determine its true value. Those medicines that deliver the best value – in terms of true medical advances – will command prices commensurate with that value. Those medicines that represent marginal or no improvement over existing therapies will gain little respect in an increasingly demanding marketplace.”

    See the entire speech at http://www.merck.com/newsroom/executive_speeches/113001.html

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