Prescription drug pricing has become a very hot topic in the last year. The public policy debate began in earnest with the market launch of Gilead’s Hepatitis C cure, Sovaldi, in 2014, sparking a Congressional investigation. Most recently, the price of Sanofi’s chronic care cholesterol lowering agent, Praluent, is a source of discussion. Senator Ron Wyden (D-OR), the ranking member on the Senate Finance Committee, has called for reform of how Medicare and Medicaid pay for drugs.

To have a better and more productive policy debate about drug pricing, we need to have a better understanding of how the market landscape—and the market risks—have shifted for the branded biopharmaceutical business in recent years. Today, fast-paced changes in the health care economy affect price by creating new financial risks once a product has already made it through the development process and is on the market. This ‘in-market’ financial risk is a relatively recent phenomena and is, arguably, as significant as the financial risk of the pre-market clinical development process.

What follows is a brief analysis of changes in the U.S. health care marketplace and how they may affect drug launch prices. The author takes no position on the merits of current launch prices, but simply intends to level-set an understanding about the biopharma business model in general, with the caveat that the general analysis will not apply to all companies or all products uniformly.

The Role Of Incremental Innovation In The Biopharmaceutical Business Model

As much as companies would prefer to bring to market only world-changing medical treatments, the reality is that scientific progress is usually incremental. The sum of the increments over time, however, constitutes radical improvement.

This is true for medicine and other scientific fields, such as information technology (IT). While we welcome incremental IT advances, we tend not to have patience for the step-by-step improvements in pharmacologics. However, these incremental clinical improvements benefit patients and lead to big changes over time. Just as important, incremental innovation is also what keeps the lights on for the research and development enterprise.

There are many skeptics about the value of incremental innovation, and an even larger pool of people who find the launch prices of incremental innovations unjustified or irrational, seeing little alignment between value and price. It is important to acknowledge that price and value are not always the same. It may be helpful for the policy discussion to think of a drug’s value as the clinical performance and patient outcomes, while the price reflects both the value and the growing uncertainty around in-market risks of market consolidation and restricted access, branded therapeutic competition, mandatory discounts, and restrictive coverage policy.

Health Care Market Consolidation In The US

One of the in-market risks for biopharma is consolidation among payers, providers, or suppliers. A 2014 survey by KPMG indicates that health care executives believe the most significant driver of merger/acquisition activity in 2015 will be the Affordable Care Act (ACA).

In this multi-sector survey, health care is reported to have the highest level of merger and acquisition activity, with hospitals expected to be the most active players. Hospitals look to consolidations to expand their reach into community/outpatient services to balance the reduction in inpatient census, to increase their market share relative to peers, and to increase their market leverage relative to payers.

Competition between and among all health care sectors has become particularly acute, partly due to policies in the ACA. As competition heats up, each sector and each entity strives to reduce input costs and maintain or improve prices — and consolidation can be an important tool to accomplish these goals. It is currently a subject of public debate about whether hospital and other types of consolidation will be helpful or harmful to cost containment.

Specific to biopharma, consolidation strengthens payers’ and providers’ ability to press for drug discounts that are contractual, proprietary, and confidential. Payers and providers achieve such discounts/rebates/price concessions by using tools to drive use of preferred products and discourage use of non-preferred therapies. These tools include lists of covered drugs (formularies), cost-sharing tiers, and utilization management, such as step therapy and prior authorization. All of this puts pressure on the revenues of the biopharma industry, and that pressure can be reflected in the publicly available, “list,” or “catalogue” price.

In a recent issue of Health Affairs, Berndt and colleagues highlighted how net lifetime revenues of new biopharma therapies declined from profitability in the late 1990s to slightly negative profitability by the end of the first decade of 21st century. Payer policy and practice such as greater control on patient access through tiering, step therapy, and prior authorization, all drive down utilization and potentially drive up manufacturer price concessions. Berndt found that market risks affect lifetime product revenue, essentially identifying the impact on price of in-market risks.

Diminished Market Exclusivity/Increased Competition

In addition to cross-sector market competition through payer and provider consolidation, there is growing intra-sectorial competition among generics, biosimilars, and branded therapeutic alternatives. This competition creates market uncertainty and risk and can affect launch pricing.

First, generics are now almost 90 percent of all prescriptions today and take almost all of the brand market share quickly at patent expiry. Grabowski and colleagues found that 82 percent of all 2012 patent expiries were subject to generic manufacturer patent challenges before the expiration. The growth of generic competition and the speed of the brand loss of market share is another newer market risk that affects biopharma costs and revenues.

An average therapy has 12 to13 years of patent life remaining once it is approved for sale, before a generic substitute can come to market (although it can be as little as seven years). However, DiMasi and Faden reported in 2011 that, on average, a first-in-class therapy has a little more than a year before a branded therapeutic alternative comes to market.

The important point here is that the patent can be irrelevant to a therapeutic alternative coming to market. The time period between the first in class branded product and the second in class branded therapeutic alternative declined from an average of 13.5 years in the 1960s, to 2.7 years in the 1990s, to just over one year in the early 2000s. Branded competition can increase pressure for price concessions to payers and providers for both the first product and the new branded competitor/therapeutic alternate. Uncertainty about branded competition is potentially a much more significant risk than generic entry post-patent. A company cannot know for certain if a therapeutic alternate will make it to market, how effective a competitor it will be, or how market share or revenues will be affected. Here again, this market uncertainty can affect pricing.

A fine example of this in-market risk was the late 2014-early 2015 market positioning of Gilead’s Harvoni and AbbVie’s Viekira Pak — both important new cures for Hepatitis C. Although priced similarly, once AbbVie’s therapeutic alternative came to market, both companies scrambled for market share through contracted rebates and discounts (which reached almost to 50 percent based on records of Gilead’s first quarter 2015 shareholder meeting).

It appears that Gilead and its shareholders did not anticipate the need for this level of discount, which affected revenues and the stock price in ways that were not clearly anticipated in the years of development preceding market approval. While the level of the discounts in this example may be somewhat unique, the provision of price discounts/rebates is common. Importantly, proprietary, contracted discounts do not change the ‘list’ price of a drug, which is the price upon which the policy debate is focused.

Mandatory Discounts And Price Concessions

We should not underestimate the potential effect of mandatory price discounts on drug launch prices. There are several programs that require significant discounts for large populations. First, by law, pharmaceutical manufacturers must give Medicaid programs a 23.1 percent discount off the average of all commercial market discounted prices provided by a manufacturer. (Recent changes to the formula by which the average of all market discount prices is calculated effectively raised the discount rate higher). There is also a price increase penalty rebate in the Medicaid formula, which requires additional rebates when a drug price increases faster than the rate of inflation.

Next, the 340B Drug Discount program gives certain purchasers Medicaid-level discounts. This program is projected to affect up to 8 percent of brand sales in the near future. Finally the Medicare Part D 50 percent point of sale discount for beneficiaries, and the Veteran’s Administration federal discount affect revenues. Taken together, the populations covered by these national programs are greater than the populations of Germany, Great Britain, or Canada which all have drug price controls. Furthering market uncertainty, these U.S. programs have undergone major changes and expansions in just the past few years — creating new and unknown in-market risks for the biopharma industry. These are significant market events to which the industry is still adjusting.

Restrictive Coverage Policy

Finally, Medicare, creates significant in-market risks for the industry through coverage policy — or, decisions regarding what services and technologies it will and will not cover. Recent analysis shows that Medicare coverage policy has become more restrictive in recent years. In addition, another recent analysis shows that Europe moves more quickly and more often to facilitate access to new technologies through reimbursement policy than does Medicare. All of these trends affect the biopharma industry somewhat uniquely in the health care marketplace.

Looking Forward

In-market risks for biopharma are very significant today. Because of rapid changes in the market environment (many related to the ACA), revenue expectations established when the decision is made to proceed with product development can be very different than actual revenue several years later when a product is launched.

These dynamics have already significantly impacted biopharmaceutical pricing. However, the Congressional Budget Office and other analysts anticipate that there are limits to the industry’s strategy of raising launch prices to account for in-market risks. In fact, the strategy may be more limited than it was five years ago for a variety of reasons:

  • Payer and provider consolidation creates more market leverage in discount negotiations with biopharma, so the launch price might rise, but so will the actual amount of discounts;
  • Payer cost-shifting to consumers limits the effectiveness of launch price increases and can limit patient access and sales;
  • Competition among brands in crowded therapeutic classes is increasing payer and purchaser ability to extract non-public price concessions that make the launch price less and less relevant; and,
  • As launch prices rise in response to market uncertainties, payer, policymakers, and patient disapproval becomes louder.

The current set of market dynamics creates almost a cognitive dissonance — we see more approvals for products that we consider incremental innovation, coming to market at ever higher prices that do not seem to reflect their value. However, because of the biopharma business model and the changing business models throughout the health care sector, a new product launch is not a sure bet anymore. The variable by which a company seeks to minimize in-market risk is price.

While there are potentially many ways to address drug pricing issues, a series of actions on the part of the industry could help considerably: do a better job at defining the value of a product; be more open to discussion about how pre-market and in-market risks affect product pricing; and, when possible, align price and value more closely. Until we all understand the complications of this market in more detail, and until the manufacturers start to address the information gap, we will continue a potentially unproductive cycle of drug introduction, outrage, and limitations on patient access.