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How to Lower Drug Prices, Improve Care, and Save Pharma


Xconomy San Diego — 

I recently received a note from a longtime friend who questioned me on the issue of pharma pricing.

I answered with the always-reliable alleviating-the-scourge-of-disease-through-the-miracle-of-modern-medicine defense of “free-market pricing.”  My friend, who is not in the pharmaceutical business, responded:

The fundamental flaw in your argument centers on the notion that there is any relevance to “market efficiency” in discussing drug pricing.  The entire system of drug delivery operates outside anything resembling a free market.  … Explaining (again) the risks of price controls does not solve the problem of predatory pricing.  …[You have to] find a way to rein in the extraordinary greed shown by parts of your industry and get past the “you can’t talk about our pricing or we will simply go out of business” rejoinder.  You and your industry have a problem and you need to get out in front of it.

I prepared another volley, insisting that the threat of price controls to innovation was real.  (No one outside of pharma can really understand how difficult this business is.)  Over the next two weeks, I tried several times to send my reply, before finally deciding that I had to agree with him.  For a number of reasons, the “golden goose” defense will not save us.

First, once the public reaches the breaking point on prices, the threat of denying future drugs will not dissuade an angry populous that can’t afford the ones we have.

Second, the good intentions of a few well-meaning industry leaders to limit prices will not stop an industry addicted to price increases.  (In September prices were up 7 percent year-over-year.)

Third, price controls will work, at least in the short term.

Fourth, and most importantly, the “pricing crisis” is not about prices.

This last point is actually a good thing for the industry. If the problem were only prices, the government would have the solution.

The problem is not prices but productivity, or more precisely, lack of productivity.  Prices are a secondary effect of the industry’s inability to develop new drugs in sufficient quantities to sustain a market, to say nothing of meeting the needs of patients.  The pharmaceutical industry is failing at its principle task—making drugs.  Worse, it is reaping huge rewards for its shortcomings, which in turn compromises its ability to deal with the problem.

Pharma benefits handsomely from inadequate supply shortcomings in the form of what-the-market-will-bear pricing.  The industry proselytizes about the need for free-markets but does its best to evade them.  We talk about alleviating suffering while delivering a couple of dozen drugs each year, against even fewer targets, most of which fail in the market.  The bulk of those that “succeed”—i.e. make a lot of money—are incremental improvements at best, such as combinations of generic drugs.

Chasing quarterly profits, big pharma companies are making so much money at the expense of the health-care system (i.e. the American people) and are so bad at drug development that they literally do not know what to do with all the cash.  (Share buybacks and M&A do not benefit patients or enhance productivity.)  It is a wonder the public is as tolerant as it is.

In a free-market system, crazy pricing—pricing disconnected from value—arises from a dislocation of the market.  When either buyer or seller have no choice but to enter into the transaction, regardless of the terms, the market cannot carry out its function of matching price with value.  In the case of the pharmaceutical industry, the dislocation arises from a shortage of drugs.  With few alternatives, buyers have no choice but to pay whatever pharma asks.

As more hepatitis C medications came to market, prices dropped  to the point that drug costs in the U.S. fell below those in Europe, demonstrating that, even with proprietary products, a robust supply results in competitive pricing.  To attract buyers, suppliers have to differentiate their products based on their benefits, which aligns prices with the value of the drugs.  The most productive companies—i.e. those who produce the most value in the eyes of the consumer—grow.  Those that try to arbitrarily set prices fail.

More drugs would increase competition and provide more varied and better treatments, which would improve care.  More alternatives in the market results in greater competitive pressure, which means that pharma will have to price drugs to value—good for payers, i.e. all of us.  More cost-and-outcomes-effective treatments means healthier, more productive patients and gains for society—the reason the pharmaceutical industry exists.

Competition even brings gains for drug companies.  By improving productivity, pharma can increase revenues far beyond what they could achieve under a what-the-market-will-bear regime.  With unlimited pricing, buyers eventually run out of money, to say nothing of patience.  When industry provides more value than it takes out of the system in cost, there is over time literally no limit to growth.  That is why we have been able to build a global civilization, starting with rocks.  (Admittedly, things are complicated by short-term budgets and government accounting, but the principle is sound.)

Pharma needs a plan(s) to increase productivity, and time to carry it out;, both of which are in short supply.

As it turns out, the seeds of a solution may already be in sight.  Over the past 30 years one sector of the industry has dramatically increased its productivity.  Since Genentech introduced tPA in 1984, the biotech and small pharma sector  has grown to the point that since 2011 it has originated 65 percent of the new molecular entities (NMEs) approved by the FDA.  In the five years from 1981-85, before biotech, industry averaged 24 NMEs a year.  In the last five years, while total NME output averaged 34 per year, the top 25 companies originated only 12 of those.  The productivity gains have come largely from small companies.

However, the entrepreneurial community cannot develop drugs alone.  Almost 70 percent  of the NMEs that originated in biotech are brought to market by larger partner/acquirers.  Yet both sides face inherent limitations to growth, as I explained in an earlier blog. To meaningfully improve productivity, the pharmaceutical industry must expand large-company-small-company cooperation, not incrementally, but by orders of magnitude.

Chris Viehbacher, former CEO of Sanofi and a founder of newly minted Gurnet Point Capital, commented about the deluge of proposals they received when they announced the opening of the fund, “There will always be enough science, the supply is endless.  The limiting factor is financing.”

The limiting factor for financing is the confidence of investors that they will receive returns commensurate with risk.  For that the industry needs new models of collaboration that can support growth in the entrepreneurial community on an unprecedented scale.

Standish Fleming is a 29-year veteran of early stage, life sciences investing. He has helped raise and manage six venture funds totaling more than $500 million and served on the boards of 19 venture-backed companies, including Nereus Pharmaceuticals, Ambit Biosciences, Triangle Pharmaceuticals (acquired by Gilead Sciences) and Actigen/Corixa (now part of GSK). Follow @

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