From Shkreli to Sanders: Why are drugs so expensive? — The Role of Pharma

This will be a 3-part blog post on a) how pharmaceutical companies set prices for drugs in the U.S. b) the role insurance companies and Medicare/Medicaid play in this system and c) how effective the policies our presidential candidates are proposing today

I’ve seen a lot of misinformation on the news recently regarding why drug prices are so high. I don’t blame politics or the media; it’s a confusing, complex subject which can vary by drug and your definition of “price.”

In the fall of 2015, the notorious Martin Shkreli, aka “Pharma Bro,” made national headlines. He gouged prices for Daraprim, a 60 year old generic drug used by AIDS patients, by 5500% to $57,000/month*. This rightfully triggered a sweeping congressional investigation on pricing practices across the pharmaceutical industry. Other drugs such as Hepatitis C treatment Sovaldi at $84,000/year are also being dragged into the fray. Today, drug pricing has become a top talking point from Sanders to Trump at the caucuses. Let’s take a step back and see if we can break down what’s really going on behind the scenes. Why are our drug prices so high?

The Basics: Understanding Innovator vs. Generic Drugs

First, we must understand the difference between new “innovator” drugs and generic drugs. “Innovator” drugs are still patented; no one but the company that researched, developed, and marketed the drug can make it. By law, these innovator drugs lose their patents after 20 years and become “generic;” after that, any company can make it. (Aside: patents can often be refiled to extend way past 20 years, but that’s a topic for another time).

With this concept in mind, I’ll focus on “innovator” drugs, first.

Drug Pricing 101: “How much are we saving the economy?”

Back when I was involved in drug pricing, the first question I was often asked by pharmaceutical clients was:

“How much are we saving in healthcare costs?”

Surprised? This is counter-intuitive to our classic understanding of corporate, pharma greed. Well, I’m not absolving them quite yet.

I’ll begin by inventing an imaginary world where our pharma company has just discovered a miracle drug, “Drug AWESOME.” (Note: all numbers used in this example are hypothetical and merely used to highlight the thought process used in drug pricing.)

“Drug AWESOME” cures headaches for 100% of people. At the moment, the only other drug in this world to treat headaches is Advil. Now let’s assume the average individual purchases about $10 of Advil per month to deal with the regular monthly headache.

After being on the market for decades, researchers have found that Advil does not work for 50% of the population; for these people, taking it does nothing to alleviate their headaches. Perhaps these 50% of people have headaches so severe that they see a doctor because Advil isn’t working. And perhaps 20% ends up hospitalized because of how painful the headaches have become.

Based on this information, our strategy team informs us:

Headaches cost the U.S. economy $24,720 per person per year (in this hypothetical world).

Whoa! How did headaches get to cost so much money? Well, let’s see:

  • The average person purchases Advil at $10/month. This comes to $120/year ($10/month x 12 months).
  • There’s a 50% chance Advil will not work on this person. Perhaps s/he will see a doctor once a month to deal with this headache. So how much does a doctor charge? $100/visit. When accounting for the fact that there’s only a 50% chance of this happening, this comes to $600/year (50% of patients for which Advil does not work x $100/visit x 12 months).
  • Finally, there’s a 20% chance this person ends up in a hospital for every headache that occurs once a month. How much does it cost to be hospitalized? $10,000/visit. When accounting for the fact that this occurs in only 20% of patients, this comes to $24,000/year (20% of patients x $10,000/visit x 12 months).
  • Let’s sum this together: $120/year for Advil + $600/year in doctor visits + $24,000/year in hospital costs.
  • Voila! Headaches cost the U.S. economy an average of $24,720/year per person.

How do we price “Drug AWESOME”?

Our company has been raving about “Drug AWESOME.” After all, it cures headaches universally, an ailment that’s plagued people around the world for thousands of years. Finally, headaches are gone forever!

We work at a great company with strong moral integrity. Our very own corporate slogan is “Don’t be evil.” So because we’re great, nice people, we will price “Drug AWESOME” at $23,720/year. A $1,000 discount from the $24,720/year in healthcare costs. Now think, we’re saving patients and the U.S. healthcare system an average of $1000/person/year from what they would incur by taking Advil. We’ve provided a great service to the U.S. economy. Time to pat ourselves on the back.

Is Drug Pricing Really that Simple?

Yes. But before you, the reader, clamor about how unjust this system is, let’s put what happened into some context:

  • Drugs that 100% cure an ailment are very, very rare.
  • Innovator drugs are rarely that much better than what exists on the market. In this case, “Drug AWESOME” is clearly superior to Advil. However, the benefits of new drugs are not always as clear cut. In such scenarios, the price of a drug may be tied to its nearest on-market equivalent (called a ‘comparator’). Still, that doesn’t mean pharma won’t attempt the health savings strategy.
  • Competition among multiple comparators can further drive prices down.
  • Health economics data is tough to measure. Who really knows if 20% of patients end up hospitalized in the above example?
  • There are other forces in the U.S. health marketplace that can lower the price. Medicare, Medicaid, and private insurance companies that contract for drugs can all lower prices a bit.
  • Pharma companies can be decent organizations and price lower, especially if being ‘indecent’ means really bad PR.

Still, at the end of the day, these calculations fundamentally dictate how pharma approaches the price of a new, innovator, drug. How do you quantify how much better the new drug is than what exists today? How much does the drug generate in savings?

This pricing strategy is the reality of what often occurs today. Sovaldi, the $84,000/year drug I referenced earlier, is effective in curing Hepatitis C for up to 90% of patients, a cure rate that was once impossible. The newest cancer drugs coming out today face a similar set of questions (see Merck’s Keytruda or Bristol-Myer Squibb’s Opdivo). When a new drug is leaps and bounds more effective than any other that had previously existed — and theoretically saves the economy so much money — how should the company price the drug? And is it fair for that price to be constrained by society’s notion of fairness?

When Does Drug Pricing Become Morally Questionable?

Pharma and biotech companies can engage in questionable tactics to keep drug prices high:

  • Funding advantageous health economics research. Our hypothetical company might be incentivized to over-estimate how much in healthcare costs is really being saved.
  • Over-representing how good the drug is. Sketchy statistics and post-hoc analysis of existing datasets can artificially make a drug appear superior.
  • Under-representing how bad the drug is. “Drug AWESOME” might have horrible side effects, which may result in higher costs. There can be side effects that really hurt people. Or perhaps 10 years down the line, people who take the drug have higher mortality rates. We would never know of these dangers today.

When Does Drug Pricing Become Evil?

No, I haven’t forgotten. Where does our Pharma Bro friend fit into all of this?

He doesn’t.

Everything I’ve mentioned before applies to new, innovator drugs. Pharma Bro took an old generic drug and bought out every manufacturer that makes it. With this monopoly, he jacked up prices by 5500%. Why does he get away with this? Because the generics world is largely unregulated.

Capitalism teaches us that in a free market another company would just come in and make the drug at a cheaper price until we arrived back at the originally low price.

This unfortunately did not happen. It’s expensive for another company to enter and start producing a drug, and there are not enough people who use Daraprim to make it a worthwhile market to enter. Only 2,000 patients in the U.S. would take Daraprim. (Aside: such rare diseases are called orphan diseases, another interesting topic we can address in a future time).

He now claims these drug prices will lead to more money to fund research. This is an argument that pharma and biotech companies like to make: innovator drugs should be rewarded for the benefit they bring humanity. And these profits can funnel into more research. There’s some truth to this. The problem is, the drug Shkreli took was an existing, 60 year old generic drug, and he, without notice, made it vastly “unaffordable.”

Now that’s pretty evil, bro.

Is He Alone in this Practice?

No. As dishonest as it might be to excessively raise prices on older drugs, Pharma Bro isn’t alone in this practice. He just happens to like bragging about it the most (a la his Ghostface Killah rapper feud). While a 5500% increase in one day is fairly unheard of, price increases anywhere from 200%-500% — typically more gradual to attract less public attention — are commonplace.

Take Valeant Pharmaceuticals, for instance — another company that has been in the news due to congressional investigations. Valeant acquired Glumetza, a branded version of diabetes medication metformin (albeit a slow-release version) back in 2013. At that time, it cost $300/month (assuming 1 pill/day @ 1000mg). Soon after Valeant acquired the drug, it raised prices to nearly $3300/month.

However, unlike Daraprim, metformin is made by multiple manufacturers. Diabetes patients will continue to have cost-effective alternatives.

Perhaps not as evil, but still a very predatory practice.

So What Does “Unaffordable” Really Mean?

Are patients really paying up to $57,000/month for Daraprim?

Most likely not.

Insurance companies continue to cover the drug, and for those without insurance, Pharma Bro claims to have a “patient access program” which gives these individuals the drug for free.

So what’s the problem?

Although the patient isn’t paying for it, someone else is. Up next on this blog, I’ll discuss how insurance companies cover your daily drugs and how rising drug prices not only impact the patients taking the drug, but the entire U.S. population.


*Daraprim’s cost per month calculation is based on the upper range of recommended dosing from Daraprim’s product label for the treatment of Toxoplasmosis. Daraprim is $750 per 25 mg pill. Assume 75 mg daily of Daraprim for the first 21 days and 37.5 mg daily for the remaining 9 days of the month. The final value is rounded up to the nearest thousand.