Another explanation why meds cost so much; this ties into the GIK valuation issue

This post will be deep background on the GIK valuation issue. I won’t connect the dots to the international versus US pricing issue, just lay out a few pieces of the puzzle.

One of many fascinating things I’ve learned about pharmaceuticals while blogging about mebendazol and the related valuation issues is the dramatic disparity of the prices for meds in the US and overseas. There is also a huge gap between branded and generics.

I’ve looked for data on the difference in consumption of meds and costs paid here in the US versus the rest of the world. Can’t find what I’m looking for. Somewhere sometime I saw a comment that we in the US consume 10% of all prescription meds but pay 50% of the costs. Can’t support that with anything other than hazy memory. I am fairly comfortable that the disproportionate relationship exists, even if the numbers are off.

Why does that disparity exist? Is it, perhaps, a good thing?

The underlying economic model is US residents pay for all the astoundingly huge development costs of brand new wonder drugs and the rest of the world pays the incremental costs of making another pill.

What that model does is recover the billions of dollars needed to find a new drug and motivates big pharma to look for another blockbuster.

Megan McArdle explains the issue much more clearly in her article Would you Pay $84,000 for a New Liver?

At issue is a new drug that cures around 90% of patients with hepatitis C in a 12 week regimen. The alternative is a 6 month to year regimen that causes most people severe side effects and cures only 40% to 80% yet still leaves large numbers of people with cirrhosis of the liver, a liver transplant, or liver cancer in their future. Which would you prefer?

The problem?

The 90% cure drug costs $84K, or $1,000 a day for 12 weeks.  That is substantially less expensive than the not-as-effective regimen; perhaps 20% or so less expensive. For those headed towards a liver transplant the cost is several hundred thousand just for the surgery.

Ms. McArdle explains the dynamics of drug research and pricing:

As always in the development of pharmaceuticals, we have once again washed up on the shoals of marginal versus average cost pricing. Drug development has a very high fixed cost, thanks to all the research needed to find drugs and bring them to market. The cost of actually making the pills, on the other hand, is trivial. So the optimal pricing strategy — for everyone, not just pharmaceutical companies — is to charge rich countries a lot and sell the drug at near-marginal cost in poor countries (emphasis added).

That gets the drug in as many hands as possible while still providing the incentive, and the cash flow, to research new drugs. This is one reason we shouldn’t be that unhappy that the U.S. shoulders a disproportionate share of the cost of drug development. (emphasis added)

Yet when I look at it, Sovaldi seems like a bargain. Here’s a drug that likely cost hundreds of millions to develop and bring to market. It has a 10-year patent life to recoup its costs and make some money for the developers.  (emphasis added)

It looks to me like the actual costs are between $4 billion and $11 billion to develop one new drug and get it to market. Those big pharma companies may be out five or ten billion bucks before they sell the first pill.

The consequence if people in rich countries demand to buy meds at the marginal cost? Big pharma won’t recover even a fraction of their development costs and they won’t look for new drugs. Ms. McArdle’s comment:

If the rich countries insist that they should also get the drug near-marginal cost, then they benefit in the short-term. But over the long run, the company loses money on its products, and then we don’t get any new drugs.

Let me create a simple illustration. Please know I’m making up these numbers. Here’s the cost structure for a new wonder drug:

  • $4,000,000,000.00 – cost of the first pill from the production line.
  • $                   0.05 – cost to make every pill after that.

How do you price that med to recover all the costs and make a small profit? Don’t forget that for every drug that gets to market, another drug or two failed in the research or testing stage. Have to recover those costs too.

If you are doing good, you should work for free

The article closes with a discussion of why so many in our society expect people who develop new drugs or work in nonprofits to pay their mortgages and buy food for their children with only the good wishes and appreciation of people they helped.

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