Professor Brook K. Baker
Senior Policy Analyst Health GAP
As misleading as it is when drug companies say they use R&D costs, therapeutic value, or “market forces” when they set the initial price of new medicines, Big Pharma is equally duplicitous when talking about their repetitive price increases on existing medicines via their direct and indirect references to ordinary inflation rates and the consumer price index.
With respect to initial prices, two basic economic theories explain extortionate drug prices. The first is that patents and data exclusivity give drug companies monopolies on their new medicines, monopolies that they nurture and grow over time with new patents on minor variations (dosage, delivery systems, therapeutic indication, and chemical entity), that allow them to set the price at whatever the monopolistic market will bear. And, with respect to life-saving and life-enhancing medicines, the market will bear a lot given the general wealth of the country and the information insulation between prescribers, government and insurance payers, and patients. Hence, we see many new cancer medicines and many other therapies now priced at hundreds of thousands of dollars a year.
The second economic explanation is that even when there are therapeutic alternatives for treating a particular disease, the companies collude indirectly in what is best described as an oligopolist market to follow each other in ramping up prices. Given the ready availability of list prices for medicines, this tacit practice does not even need smoke-filed meetings in secret venues to accomplish regular, stepwise increases in the costs of “competing” medicines.
Drug company executives claim that their monopoly profits are needed to fund R&D into the next generation of medicines, but evidence shows that the bulk of the profits go to shareholders in the form of share buyback and dividends and in stock bonuses for executives. The sum actually spent on R&D is primarily focused on trying to evergreen existing monopolies by tweaking existing medicines or funding trials for evidence to be touted in advertising to consumer and physicians.
But, drug company robber barons also imply directly or indirectly that their single- and double-digit annual price increases should somehow be compared to the annual inflation rate because “costs go up.” The truth of the matter is that anything a normal person would call costs – the price of pharmaceutical ingredients, formulation, packaging, and labor – are a very small portion of the bloated retail price of medicines. For the typical high priced patented medicine, these costs are pennies compared to the dollar of drug prices. One example of the mark-ups over true costs are in estimates that important hepatitis C medicines can be produced for under $100 for a three-month course of treatment, but were initially priced at nearly $100,000.
If “costs” do in fact escalate, which is doubtable in many cases because of increasing economies-of-scale, true costs are only a tiny fraction of the price. Instead of raising the price of a $100,000 a year medicine by 10%, a true cost-inflation increase would typically be calculated against only 1/10 to 1/1000 of the retail price. Thus, the real rate of drug price inflation is far, far in excess of cost inflation, just another feature in the cap of the industry’s massive disinformation campaign.
