Why Some Pharmaceutical Drugs are Very Expensive?

The price of drugs is going through the roof in America. This is also the case in many developing nations. In general, people are simply unable to afford healthcare if they do not have insurance.

In developing nations, having insurance is not the norm. Hence, when patients are faced with high medical bills, some of them are not able to afford the best treatment. This can lead to several adverse outcomes including death. More often than not, these patients accuse healthcare service providers of profiteering.

In some cases, excessive prices, are in fact, charged for no reason. However a lot of times the higher prices may be justified.

To know the difference between overcharging and genuine high prices, consumers need to be well versed with basic pharma economics. Pharma economics has become a different field in its own right. It borrows principles from healthcare as well as industrial economics. In this article, we will have a closer look at the economics of drug pricing.

Conflicting Goals

Firstly, it must be understood that pharma companies are different from other companies. The very nature of the product they sell, make it imperative for them to have a service mindset.

Many of the patients with incurable diseases have no option but to buy the drug. Hence, there elasticity of demand is very less. If producers were allowed to take advantage of this, they would command a very high price for the drug. Hence, there is a need for extensive regulation of drug pricing.

For this purpose, the market has been segregated into two broad categories:

  • One segment of the market is called the branded segment. Drugs in this segment symbolize the technical advancements in pharmaceutical sciences. The government interference on price caps in this segment is non-existent.

    Whenever a pharmaceutical company produces a new drug, the research and development costs involved can be humungous. It is for this reason that these companies are given some years wherein they have monopoly over the drug. This time is given so that the companies can recoup their investments with a reasonable rate of return.

    It is important that companies be allowed to make a profit at this stage. If prices are tightly regulated and companies run into a loss, there will be no economic incentive to find a new cure for what are now considered incurable diseases

  • Once the stipulated number of years is over, the company will no longer have monopoly over the drug. This means that competitors can now copy the formula of the drug and produce it in large quantities.

    The nature of pharmaceutical drugs is such that they are very expensive to develop and test. However, once the development has been done, they can be copied cheaply. Governments all over the world regulate prices in this segment. This is done to check and even prevent the profiteering done by pharma firms.

    Hence, even though the price of the drug is high when it first developed, over a period of time it provides numerous benefits to patients who do not have the economic wherewithal.

Understanding Pricing of Branded Drugs

It is true that the patent and the monopoly are given in order to recoup the massive capital expenses that have gone into the creation of the drug. However, it must also be noted that the companies do not have to publish the quantum of capital expenses that have been incurred to create the drug.

For instance, the average cost of development of a successful drug is said to be $15 billion. The price is so high because the company spends a lot of money on research and development. However, majority of the products fail. Very few drugs successfully pass trial. Hence, the cost has to be amortized only on those drugs which have been successful. It is for this reason that successful drugs need to bring in about $1 billion per year in profits on average. This calculation is done considering a 15 to 17 year monopoly period.

The pharmaceutical companies then conservatively estimate the quantity of drugs that they are likely to sell. Based on the number of units and the target revenue, the pre unit price is decided. However, these numbers are just issued by the pharma companies. The government is not qualified to verify whether $15 billion is actually an accurate number.

Wrong Interpretation

Many observers have incorrectly accused pharma companies of profiteering from scarce drugs. The evidence cited is that the price of drugs is very high while they are sold under the branded category.

Once these drugs enter the generic category, the prices decline by 90%. If it was possible to sell drugs for 1/10th of the price then the pharma companies must be overcharging. As we have seen in this article, that is not necessarily true.

Contrary to the claims made by these critics, this two segment market is the best way for pharmaceutical companies to balance contradictory objectives. They have to provide cheap healthcare for the masses while simultaneously ensuring innovation and advances that are profitable!

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