The increasing problem of drug shortages (see chart, click to enlarge) has received much recent attention, including a Presidential executive order moving to address the problem. A large number of drugs, including a number of agents ranging from electrolytes to anti-neoplastic agents have been the subject of supply interruptions creating drug shortages. If a drug has only one or a very few producers, then action by even a single firm can sharply curtail the drug supply. The more complex and capital intense the production process, the higher the barrier to entry of new sources of supply, then the longer a shortage is likely to persist.

Although individual medical health care institutions and providers have considered strategies to cope with shortages on the demand side (by maintaining individual drug reserves, aggressive preordering from their regular suppliers, and/or buying at high cost from other than their regular suppliers) they generally lack the ability to ameliorate the fundamental problems upstream on the supply side of the equation. In fact, while efforts to hoard drug are an economically rational response by each individual user to protect themselves from an imminent anticipated shortage, the cumulative effect will be to exacerbate the shortage’s impact on all users.

The shortages have created economic distortions, with inflated prices for drugs marked up by middlemen, opportunities for stolen or fraudulent drugs to enter the supply chain, and disruptions of patients’ treatments. There has been some legislative discussion both in the U.S. and elsewhere about how to provide for more notice of impending drug shortages, but even if such a proposal were enacted, notice alone would not prevent a shortage.

While the FDA has broad authority to interrupt drug production — such as when the manufacturer is not following good manufacturing practice — the FDA under its current scope of authority cannot compel a manufacturer to continue production of a drug if the manufacturer makes a business decision to cease production. As an FDA representative made clear at a September 26, 2011 Drug Shortage Workshop (page 21), that agency relies heavily on voluntary cooperation with industry to ameliorate potential shortages.

When a drug has market exclusivity, the manufacturer has considerable flexibility in setting prices, and the FDA generally has not sought to intervene to bring down prices. For a typical drug on market exclusivity, the marginal cost of producing extra doses will be low compared to the drug’s wholesale price. The manufacturer has an incentive to have enough product on hand to reliably meet the demand for their product at the set price, even if they have a transient interruption in their manufacturing output.

A perverse side effect of drug shortages is that they can facilitate making it necessary, feasible and ethical to study practice strategies that decrease use of the drug in question. The study results may produce data that help future patients, but hurt the economic interests of the drug manufacturer. In particular, the drug manufacturer does not wish prescribers to be forced by a drug shortage to look for therapeutic alternatives to their drug, for fear that the prescriber may develop a permanent new practice pattern that decreases or no longer includes the manufacturer’s product.

In the case of many pharmaceuticals there is a high initial fixed cost (research and development, obtaining regulatory approval, setting up a production line with good manufacturing practice) to bring the first dose to market, but very often a rather low marginal cost for producing additional doses thereafter. This drop in marginal cost in part explains why, once a drug’s market exclusivity period expires, both the initial manufacturer and competing manufacturers can profitably produce the generic drug at a price point much below the price at which the initially exclusive manufacturer had first sold it.

If the market price falls so far that it is close to the marginal cost of manufacturing the drug, then the several generic drug manufacturers may each be unwilling to produce drug quantities beyond what they can sell in the immediate future as their share of the overall market for that drug. Despite there being several manufacturers, they paradoxically may be less likely to produce an excess capacity for drug production than was the initial exclusive manufacturer when the drug was still on patent.

Patients can suffer if a shortage results from a mismatch between a great societal need to maintain an uninterrupted availability of critical drugs — like injectable generic chemotherapy agents — from some source on the one hand, and on the other hand a lack of any particular actor who has both a strong incentive to maintain the supply and the means to effectuate that result. This mismatch has produced increasingly frequent drug shortages, often lasting up to a year and sometimes longer.

How Reserve Stockpiles Of Critical Drugs Might Work

One might consider a proposal to have the drug manufacturer use this low cost marginal capacity to produce a reserve of extra drug some time before the end of the period of market exclusivity. One might compensate the manufacturer directly for producing this additional drug, by paying them their marginal production cost plus a modest profit.

An additional or alternative route to create a stockpile would be to allow generic drug manufacturers to participate in the process. This would strengthen capacity not only of the stockpile itself but of the potential manufacturing base, to insure that multiple drug sources will be available as a drug transitions off of its period of market exclusivity at the end of a patent term. One might consider offering generic drug manufacturers the opportunity to bid competitively during the last year of market exclusivity to produce say a twelve month supply of a critically needed drug for stockpiling just after the exclusivity period ends. One need not do this for “me-too” drugs that have ready therapeutic alternatives, but only for those drugs for which a future shortage would actually be of clinical importance.

In either case the stockpile could be maintained as a right owned by the federal government to the number of purchased doses, which could be drawn upon, for example, if the later generic supply of the drug should be interrupted for some reason. The stockpiled inventory would be the property of the government, but for administrative convenience might well be physically stored onsite at the manufacturer’s warehouse.

If the stockpiled drugs have a limited shelf life, one could readily have a rotational system (first into inventory, first out of inventory) where aging drugs are removed from the stockpile to satisfy current patient needs and replaced with newly manufactured drug. If at a later point the federal government (as represented perhaps by the Secretary of the Department of Health and Human Services) decides that maintenance of a stockpile of that drug is no longer essential, then the government might simply deplete that stockpile to meet ongoing federal pharmaceutical needs of the VA and the Department of Defense.

The societal costs of this proposal would consist of the cost of maintaining and rotating drug stockpile as well as the potential that at some later date the contents of the inventory would lose their value, whether because the inventory spoils or more likely because the particular pharmaceutical falls out of regular clinical use. In any case, the costs are likely to be relatively modest compared to the health benefits of avoiding therapy interruptions for patients and the economic benefits of discouraging price gouging during unexpected drug shortages.

Editor’s note: For more on drug shortages and efforts to address them, see Duff Wilson’s Entry Point article in the February issue of Health Affairs.