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Drug Pricing Factors

As mentioned above, pharmaceutical companies are the only major health care service able to set prices for drugs. The task of pricing any pharmaceutical drug for sale to the general public in it itself is a daunting task.  Setting a high ceiling price for a new drug would be problematic as physicians would shy away from prescribing the drug because the cost would be too great for the benefit.  However, setting too low of a price implies inferiority, that the drug is too “weak” for the market.  Overall, there are many different pricing strategies and factors that go into the research and evaluation of a future drug’s price with whole departments within US pharmaceutical companies like Pfizer devoted to cost analysis.  Regardless of the pricing strategy however, one theme remains common within all factors: to maximize profits.

Drug	US	Canada	UK	Spain	Netherlands
Enbrel	$2,225	$1,646	$1,117	$1,386	$1,509
Celebrex	$225	$51	$112	$164	$112
Copaxone	$3,903	$1.400	$862	$1,191	$1,190
Cymbalta	$194	$110	$46	$71	$52
Humira	$2,246	$1,950	$1,102	$1,498	$1,489
Nexium	$215	$30	$42	$58	$23

Chart data from International Federation of Health Plans

This chart shows some discrepancies seen in the pricing of drugs in different countries.  This does not indicate, however, that the United States is more interested in profits than other countries, but rather reflects the different processes countries use to determine the price of a drug.  Different countries value drugs in a different way from the United States, and thus price them differently.  There are so many factors that affect drug prices throughout the world besides maximizing profit.  Here are some of these pricing strategies.

Research and Development

Pharmaceutical Company	Number of Drugs Approved	R&D Spending Per Drug (Millions)	Total R&D Spending from 1997-2011 (Millions)
AstraZeneca	5	11,790.93	58,955
GlaxoSmithKline	10	8,170.81	81,708
Sanofi	11	7,909.26	63,274
Roche Holding	11	7,803.77	85,841
Pfizer	14	7,273.03	108,178
Johnson & Johnson	15	5,885.65	88,285
Eli Lilly & Co.	11	4,577.04	50,347
Abbott Laboratories	8	4,496.21	35,970
Merck & Co Inc.	16	4,209.99	67,360
Bristol-Meyers Squibb Co.	11	4,152.26	45,675
Novartis	21	3,989.13	83,646
Amgen Inc.	9	3,692.14	33,229

Chart showing research and development statistics for pharmaceutical companies.

Severin Schwan, the CEO of the Swiss Pharmaceutical company Roche, reported alone that the company’s research and development costs amounted to $8.4 billion dollars, a quarter of the entire NIH budget. Given the profit driven nature of pharmaceutical companies and their astronomical research and development expenses, companies use their research and development expenses as a starting point to determine appropriate yet profitable prices.

Pharmaceutical companies spend an astronomical amount on research and development before a drug is released to an open market.  These research and development costs can be further divided into three major fields:  the discovery into the drug’s specific medical field, clinical trials, and failed drugs.

Discovery

Discovery is an area of research and development that amounts to the most amount of time and money.  The process involves scientists/researchers to determine the germs, viruses, and bacteria that cause a specific disease or illness.  This timeframe itself can range from a 3-20 years and depending on the timeframe, range between several million to tens of millions of dollars.  Once established, research teams attempt to break down disease components to find abnormal events/processes taking place in the body. Only then do scientists work on developing chemical compounds to treat these abnormalities with the aid of computer models.

After “discovery” and a creation of a chemical compound, pharmaceutical companies move forward with the Investigational New Drug (IND) Application from the FDA.  After investigation into the drug and given approval, pharmaceutical companies can move into pre-clinical trials and clinical trials.

Pre-Clinical and Clinical Trials

Pre-clinical trials focus on non-human subjection and work on animals such as rats.  This is rather the most inexpensive phase of testing.

The FDA mandates a 3 phase clinical trial testing that tests for side effects and the effectiveness of the drug with a single phase clinical trial costing upwards of $100 million.

After a drug has passed through all three phases, the pharmaceutical company can move forward with a New Drug Application from the FDA.  In 2014, the FDA charged between $1 million to $2 million for an NDA.

Failed Drugs

The processes of “discovery” and clinical trials amounts to approximately 12 years from research lab to the patient, in which about 10% of all drugs that start pre-clinical trials ever make it to actual human testing.  Each pharmaceutical company (who have hundreds of drugs moving in and out of these phases) will never recuperate the costs of “failed drugs”.  Thus, profits made from one drug need to cover the costs of previous “failed drugs”.

Relationship

Overall, research and development expenses relating to a pharmaceutical drug amount to the billions.  For example, it was reported that AstraZeneca spent upwards on average of $11 billion per drug for research and developmental purposes.  The average of $11 billion only comprises of the “discovery” costs, pre-clinical and clinical trial costs, and other expenses.  With the addition of “failed drug” costs, the $11 billion easily amounts to over $20 billion dollars in expenses.  Therefore, an appropriate figure like $60 billion dollars would be an approximate sales figure that a pharmaceutical company like AstraZeneca would aim to generate in order to cover these costs and make a profit at the same time.

Total research and development costs provide pharmaceutical companies a ballpark estimation of total expenses.  This is important in setting projected profit goals for a particular drug and thus, is one of the most basic steps pharmaceutical companies take in pricing a particular drug.

Benefits and Side Effects

Drugs are made with the intention of curing, treating, or preventing a condition, disease, or illness. This is done either by "adding" or "deleting" something within the human body.  Although all drugs incur side effects, these side effects are weighed heavily against the benefit the drug brings.  Often times, companies will examine the net gain. If there is a serious net gain, pharmaceutical companies can justifiably charge a premium. However, if the net gain is marginal, it would be unreasonable to give a drug an astronomically high price if there are serious side effects or if the benefits are not too great.

Structural formula of Lipitor (calcium astorvastatin)

The drug Lipitor (Calcium atorvastatin), renowned for lowering cholesterol levels, can cause many typical drug side effects such as constipation, diarrhea, nausea, fatigue, gas, heartburn, headache, and memory loss.  The ability to lower cholesterol levels is objectively and unmistakably worth the side effects and thus, Pfizer can charge a premium over its long term 20 year patent.

Structural formula of simvastatin

Companies can also look at these side effects and compare them to the side effects of other competitor drugs on the market. If the effects are comparatively better than a competitor, prices can rise without much penalty. However, if there are more side effects, the pharmaceutical must charge significantly less. For example, Lipitor’s competition is generic simvastatin, known to be a cheaper alternative (Lipitor sells for $1 a day without insurance while simvastatin is roughly 50 cents a day). The side effects for simvastatin are generally the same as Lipitor except that simvastatin may also induce sleep problems and even depression. Hence, simvastatin must be priced at half of Lipitor's worth as it has more deleterious side effects.

Uniqueness and Patenting

One of the most important factors that determine the cost of a drug is the uniqueness of that drug, or in other words, its exclusiveness. What is the competition from other drugs to treat the same illness/disease. Is there any other drug that treats the same thing? If so, does it do it to the same extent?  With increased competition, prices for drugs tend to be lower and with lower levels of competition, companies have more reign to control prices, thus making it easier to maximize profit. So, with this in mind, many drug companies use the existing US patent laws to their advantage.

According to Title 35 of the United States Code, a patent allows no other company to use the same procedure to make the same product for exactly 20 years.  Afterward, anyone can reproduce the exact same product at will.  The patent allows for a window of time for maximum profit, because the patent ensures that the company with the patent has the most unique product. Once that window has expired, the company will have to deal with increased levels of competition with generic drugs.  An example of this trend can be seen in the world's best-selling drug of all time, Lipitor.  This drug did something else no other cholesterol drug at the time could do, increasing levels of HDL (good cholesterol) in addition to decreasing levels of LDL (bad cholesterol) faster than any other statin on the market.^[16] Pfizer used a patent to protect this approach, and for 20 years, an enormous profit was seen.

In the graph to the right, a dramatic decrease in sales and price is seen when the patent window expires and generic drugs become introduced. However, for all the drugs shown, the sales were all tremendously high before the expiration date, so the companies must have thought that the great levels of profit outweighed the drop in revenue.  

The revenue change for Lipitor after its expiration date was dramatic.  According to The 2012 Pfizer Annual Financial Report, the total revenue decreased by a total of 59%. This is directly attributed by Pfizer to the loss of exclusivity that Lipitor experienced in the month of November in 2011.  Other drugs mentioned in the report had also experienced losses of exclusivity, Caduet, Xalatan, and Aromasin are some.  All of these drugs had revenue drops of over 35%.  This stresses the importance of the patent because it makes the profits for 20 years so great, that a 35% (or even greater) drop in revenue is acceptable for these companies. 

Stakeholders

Patients and doctors can also have some input in pricing, though indirectly.  Customers in the United States have been protesting the high prices for recent “miracle” drugs like Daraprim and Harvoni, both of which attempt to cure or treat major diseases (HIV/AIDS and Hepatitis C).  Public outcry has worked in many cases to control and even decide the pricing for some drugs. for example, there was severe backlash over Daraprim, a drug that treats toxoplasmosis. Turing Pharmaceuticals, under the leadership of Martin Shkreli, price gouged the drug 5,500% from $13.50 to $750 per pill. After denouncement from 2016 presidential candidates Hillary Clinton and Bernie Sanders, Turing Pharmaceuticals finally decided to reduce the price.

With the recent trend of price gouging, legislators have even introduced reform to curb these hikes, effectively controlling the pricing of drugs in the United States. Hillary Clinton announced a proposal to help patients with chronic and serious health conditions by placing a nationwide monthly cap of $250 on prescription out-of-pocket drugs.

Some of the reason these astronomical prices are higher research and development cost. Research for a drug that is curing something no one has ever cured before will cost much more than research for the medicine of a very common disease that has known treatments. Also, there would be more patients for a more common ailment, so prices would be lower. Take, for example, the drug Soliris. It only treats two extremely rare diseases, so the number of consumers is understandably low, making it an orphan drug. Soliris still makes money in the billions because of the high price for the drug (over $400,000 per year per patient). The benefit of this drug is immense, because it cures very rare diseases that would cost much more money to treat otherwise, which actually saves insurance companies and health agencies millions of Dollars. Hence, insurance companies and health agencies are willing to pay these prices.