Column: Pharmaceutical Pricing

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Pharmaceutical pricing is a topic rife with contradictions:

  • Pills that cost pennies to produce may cost thousands of dollars to purchase
  • Two pills with identical ingredients, but different names, may vary in price by a factor of five
  • In the United States, the price of the same drug may vary by two times or more compared to what it
    costs in other countries

However, these bewildering characteristics of pharmacy prices are not unexplainable. Pharmaceutical pricing is a natural consequence of the way pharmaceutical products are researched, manufactured, and paid for. Understanding the details and complexities of this pricing is a necessary first step in supporting the creation of potential cost-saving approaches. This paper will briefly explore the structure of the pharmaceutical industry, investigate the layers of pricing between manufacturers and consumers, and highlight various approaches to managing drug prices in both the United States and throughout the world. Throughout the paper, the drug Lipitor will help illuminate the path of a drug from the laboratory to the pharmacy.

Pharmaceutical Profits

Two unique aspects of the pharmaceutical industry are (1) the amount of research and development (R&D) investment and (2) the patent system. In 2016, the top 10 largest pharmaceutical companies spent just over 17% of their revenue on research. This is compared to 3% in Aerospace and Defense, 9% in Computing and Electronics and 12% in Healthcare overall. This huge investment in R&D is necessary for a pharmaceutical company to be able to finance the development of future drugs. During the development process, many potential drugs have ineffective clinical outcomes or serious side effects. Including the cost of drugs that were not approved, the cost of developing a single FDA approved medication was recently estimated at $2.87 billion dollars (in 2013 dollars). This large upfront outlay and considerable uncertainty in the drug development process means that a very high return is sought by investors in drug companies to compensate for these risks.

The pharmaceutical industry routinely appears at the top of “most profitable industry” lists. The large profits associated with the pharmaceutical industry are also related to the second unique aspect of this sector, the patents which protect drug discoveries. The major impetus driving research and development spending is the prospect of developing a blockbuster drug (i.e., an innovative drug that treats a serious condition with a large number of patients in economically-advanced countries). Such a drug recoups its large R&D expense many times over, which then funds less-successful drugs and provides profit to drive future investments. In 2015, 12 drugs had sales of over $5 billion a year. The two most successful had sales in excess of $10 billion. Patent protection ensures multiple years of exclusive
access to market these medications to a large population.

Continue reading the column here.