Drug pricing - greed, necessity and the looming political battle

What an interesting couple of days. The Democratic race is increasingly leaning towards Senator Obama - a man who has placed big pharma squarely with big oil as a target for future action. We learn that PhRMA (the trade group) spent $22m lobbying last year, although it looks to have been defensively biased, and Mr Obama has made it clear what he thinks of lobbying. We also learn that drug wholesale prices for the top 50 best sellers rose last year by a rate that is almost double the overall inflation rate - and some of those products had price rises that were very substantially higher.

No doubt the industry will say that these are the headline rates and that the true price paid is usually very much lower than the list price. What with all the discounts, off-invoice rebates and so forth. Not to mention (because we're not supposed to know it goes on) the so called "portfolio marketing" that involves bundling prices across a range of products. All this means that the net realized price is much lower than list. The industry knows that there have to be price increases if they are to be able to negotiate deals that create an increase in sales - something for which they are constantly being badgered by senior management and Wall Street. The pharmaceutical industry, you see, is predominantly a fixed cost business. The proportion of total costs that are truly variable are very small; and so profit is directly a function of sales. If you don't increase sales then the only way to increase profit is to reduce fixed costs - and that means jobs, plants, and all those other unpleasant things that take ages to show through as a benefit to the p&l.

Consumer groups and anti-industry observers will, of course, highlight the headline number. An average of nearly 8% when inflation is running at 4% - how is this justified? Isn't it a perfect example of corporate greed at the expense of the sick? Well, yes - to a certain extent, but no, not entirely.

Yes the pharmaceutical companies increase prices so that they can maximize profit and, by definition, it is the sick that foot the bill. But to lay the blame for the ills of the healthcare industry at the door of the pharmaceutical industry alone is to misplace responsibility. The insurance companies are at least as much responsible if not more so - given that drugs still represent less than 15% of the total health cost in this country. Are drug co-pays actually linked to drug prices, or is there an option for the middlemen to squeeze a little more profit by getting supply discounts on the one hand and increased co-pays on the other? Of course there is.

From the political perspective there is little doubt that a future President Obama will seek to lower the prices paid for drugs. Central negotiation of Medicare drug prices seems like an obvious starting point. There is no doubt that this would improve costs to Government but it would also hit the industry very hard. One could imagine broader formularies coming into play as a result, because if prices are going to be negotiated centrally one can easily imagine a global price structure becoming a global formulary structure within Medicare, Medicaid and the VA. That is a truly unpleasant notion when viewed from the pharmaceutical industry perspective. And what (if any) role do the insurance companies play in such a process? Perhaps Senator Obama will also look at switching Part D over to a single payer scheme? It makes sense when viewed from his direction but would have dramatic consequences on the industry.

Such a view of the future suggests that a dramatically different business model will be needed. Perhaps P&G have got it right - no internal R&D, buy everything in from start-ups and discovery boutiques, and run the business accordingly. It is a very interesting and compelling approach that has its finances routed in market performance, does not carry the hugely inefficient internal research cost, and has no qualms about seeking in-licensed projects that compete with internal research silos - because there aren't any. Leave the "not invented here" ego at the door and get on with sourcing and selling good drugs. Interesting thought.

Two things I think we can be sure of; the pharma industry will continue to come under severe criticism for corporate greed so long as prices rise this fast and there continue to be stories in the press covering all manner of shady business practices - some of which may be directly linked to patient deaths. Second, the political wind is in the backs of the Democrats and that means healthcare reform. It is hard to know what this will look like but it will certainly be enough to force the pharma industry to think very seriously about what business it is really in. They should have started looking at this already, the question is whether they have enough time before the crunch hits?