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FourReasonsDrugsAreExpensive,Of
WhichTwoAreFalse
GUESTPOSTWRITTENBY

JackScannell

InnogenAssociate,Innogen
Institute,&AssociateFellow,
CASMI

Editorsnote:WhenJackScannell,theguywhocoinedthe
termEroomsLaw(MooresLawbackwards)todescribe
theexponentialincreaseinthecostofdevelopinganew
drugbetween1950and2010,tellsyouhewantstotellyou
everythinghethinksaboutdrugprices,youlisten.What
followsislongat10,000words,itsmorethantripleyour
averageForbescoverstorybutIthinkitrewardsalook.
Takeitaway,Jack.
IfIofferedtobuyyourshoesyouwouldthinkIwasstrange,
butwecouldprobablyhaggleaprice.IfIofferedtobuyyour
children,wewouldnotgettothehagglingstage.The
differencebetweentradingshoesandchildrenisnotmerely
legal.Itisalsomoral.Peoplefinditunpalatable,eventaboo,
toputpricesonthingsthatwetreatasabsoluteslife,liberty,
orhealth.Peoplehavemoralqualmsaboutthecostof
medicinesforthesickordying,butnotaboutthecostof
Botoxorliposuction.
Yetlifesavingmedicinesdonotexistinaparallelmoral
universe,freefromeconomics.Taxesarepaid,asarehealth
insurancepremiumshealthcarebudgetsaresetdoctors
earnmoney,oftenindirectproportiontothequantityof
treatmenttheyprovideprofessorsseekrichesasbiotech
entrepreneursventurecapitalistsgambleotherpeoples
moneyontheprofessorsideasdrugcompaniespaywagesto

employeesanddividendstoshareholdersandformerhedge
fundmanagerssetupfirmstoplaypharmaceuticalarbitrage,
buyingdrugslowthensellingthemhigh.
Arecentuptickincommercialdrugdiscoveryindiseases
suchascancer,hepatitisC,andmultiplesclerosismeansthat
thepriceofdrugsisfirmlyaFirstWorldProblemnotmerely
somethingthattroublespoorpeopleinfarawaycountries.
Thisarticlefocusesontheeconomicsoftheproblem.The
aimistoexplainwhymanydrugsaresoexpensivethateven
FirstWorldhealthsystemsstruggletopayforthem.
Afterall,totheuninitiated,drugpricingdoesnotmake
obvioussense.Foraroundthepriceofacappuccino,UNICEF
canbuyvaccinetoimmunizeachildagainstpolio.In
contrast,inthe4yearsbeforeherdeathfrommetastatic
breastcancer,over5coursesoftreatment,anAmerican
womanmightconsumedrugsthatcostmorethan$200,000
yetofferzeroprospectofcure.TheEnglishNationalHealth
Service(NHS)mightspendonly$75,000onsimilardrugs
forasimilarpatientnotbecausethedrugsaremuchcheaper
intheUK,butbecausethedrugstendtostopwhenfurther
treatmentisunlikelytobecosteffective.
Someantibioticsthatkillbacteriaaresocheapthattheyare
manufacturedbythetonandaddedtoanimalfeed,sopigs
getfatandsausagesarecheaper.YettheAmericanhealth
systemwillpay$150,000to$700,000perpatientperyear
forvariousdrugsthatmitigaterareconditionssuchas
GaucherDisease,HunterSyndrome,orparoxysmal
nocturnalhemoglobinuria.TheEnglishNHSpaysaboutthe
samebut,incontrasttothebreastcancerexample,rarely
limitsaccessonthegroundsofcosteffectiveness.Lifesaving
insulin,fordiabeticpatients,isbetween100and1000times
cheaper,costingbetween$1and$20perday,dependingon
thedosingregimen,thecountry,andthebrand.
Fiveyearsago,drugspricedat$50,000intheUScuredjust
over1outof3patientswithahepatitisCinfection,atacost
percurenear$140,000.Twoyearsago,anewdrug,Sovaldi,
waslaunchedatapricearound$85,000.Itcured95%of
patients,atacostpercurenear$90,000.ThepriceofSovaldi
hascausedintercontinentalapoplexy,butthecostpercure
hasfallen,andSovaldiischeaperthanmanydrugsthatnever
cureanyone.
Itisnotonlypricesthatareapuzzle.Thedrugindustryhas
higherprofitmarginsandhigherR&Dintensitythanany
otherindustry.Butsomestockmarketanalysts(me,for
example)spentthelastdecadebelievingthatmuchdrug
R&Dwasawasteofshareholdersmoney,andifdrug
companiesputtheirshareholdersfirst,theywouldbe
shuttinglabs,firingscientists,andpayingbiggerdividends.A
fewdrugcompanies,Valeantforexample,overtlyagreed.
Downsizingelsewhereshowsothercompaniescovertly
agreed.The11biggestdrugcompaniesemployedaround
140,000fewerpeoplein2013versus2008.
Sowhatisgoingon?
Cost,value,powerandprizesarefourwaysthat
peoplethink,talkorwriteaboutthemechanismbywhich
drugsarepriced.Costreferstocostbasedpricingtheidea
thatthepriceofgoodsisbasedonhowmuchitcostto
producethem.Valuereferstovaluebasedpricingtheidea
thatthepriceofgoodsreflectstheirvaluetothebuyer.

Poweristheexerciseofintellectualpropertyrights,to
createscarcityandtofindthemaximumpricethatthe
marketwillbear.Prizesaretheincentivesprovidedby
profittomorrow,madecrediblebyprofittoday,forinvestors
gamblingontheR&Dthatmightcreatetomorrowsdrugs.
Inwhatfollows,Istartwithmorefamiliarbutlesstruthful
explanationsofdrugpricing,costandvalue,beforemoving
tomoretruthfulbutlesspalatableonespowerandprizes.

Reason1:Cost(False)
Honestly,wearenottakingadvantageofyoujustbecause
wehaveamonopolyontheonlydrugthatcansaveyou
fromanearlyandpainfuldeath.Wewouldliketocharge
youless,butsadlywecant.Yousee,thisdrugtookahuge
amountoftimeandmoneytodiscoveranditisreallyhard
tomanufacture.Ifwedidntchargeyouahighprice,we
wouldneverrecoupwhatwespentonit,whichwouldbea
disasterforeveryone.
NorthKoreaandthedrugindustryarethelastbastionsof
Marxism.IheardthisfromProfessorMartinMichel,
formerlyanacademicpharmacologistandnowworkingin
thedrugindustryatBoehringerIngelheim.
Iwontpushtheideatoofar.Afterall,itwasMartinMichels
joke.MostofusarefamiliarwithMarxandcommunism,but
fewofusknowMarxsworkonvalueandpricing.Itisasa
pricingeconomist,notasacommunist,thatMarxwouldfeel
athomeinthedrugindustry.Hebelievedthattheeconomic
valueofsomething,suchanewmedicine,isdeterminedby
theamountofsociallynecessarylaborrequiredtoproduce
it.Ifanewdrugtakestwiceasmanyworkingdaystodiscover
andmanufactureastheolddrugitsupersedes,itwillbetwice
asexpensiveakindofinputbasedpricing.Itisashortjump
fromheretocoveringourcosts.
Costcoveringisapalatablespieltomakeifoneistryingto
sellanexpensivedrug.Infact,thecostofproductionstory
hasbeenrepeatedsomanytimesforsolong,thatithas
becomeplausibletolotsofpeoplewhoshouldknowbetter.I
stillreadinhealthpolicypapersthatdrugcompaniesneedto
recouptheircosts.Thisisnonsense.Sunkcostsaresunk.If
companiesaregoingtospendonR&Dtheyneedtobelieve
therearedecentoddsthattheywillmakeagoodreturnon
investment,butthisisadifferentthingtorecoupinganyones
historicR&Dcosts.Thisiswhyfirmshavecontinuedto
investinAlzheimerswheninthedecadefrom2002,99.6%
ofthe413clinicaltrialstesting244experimentaldrugswere

failures.Conversely,shareholderswouldrevoltifacompany
voluntarilydroppeditspricesandcutitsprofitsjustbecause
somearbitraryproportionofR&Dcostshadbeenrecouped.
Drugsdonotbecomecheaptobuyjustbecausetheyare
cheaptomanufacture.Itseemscommonknowledgeamong
Europeanpayersthatcertaindrugs,knownasmonoclonal
antibodies,aredifficulttoproduce.Therefore,payerstendto
bemoresympathetictoantibodieshighprices.However,the
knowledgeisnowfalse.Monoclonalantibodieswerehard
tomanufacture20yearsago,buttherehavebeenhuge
improvementsinyieldsincethen.Productioncoststodayare
oftenonly5%ofthesellingprice.Cheapmonoclonal
antibodiesarestillfewandfarbetween.
Stalespiel
Despiteitspublicrelationsappeal,thecostbasedpricing
storyisbecomingalessfashionable.Thereareawkward
questionsaboutthecoststhatpurportedlyjustifytheprice.
Forexample,threemembersoftheUSCongress,Henry
Waxman,FrankPallone,andDianaDeGettewrotetoGilead
inMarch2014,concernedaboutthepriceofSovaldi,the
~$95,000percurehepatitisCdrug.DrugslikeSovaldiare
causingbudgetaryproblemsforhealthsystemsbecausethey
aremuchmoreconvenientandtolerableforpatientsthanthe
oldertreatments,andmuchmoreeffective.Thenewdrugs
arepullinginahugepoolofpreviouslyuntreatedhepatitisC
patients.EvenforthewellfundedandpriceinsensitiveUS
healthsystem,treating~3millionpeoplea$50,000ago
(assumingdiscounts)isabrutal$150billionheadache.
So,Waxman,Pallone,andDeGette,aftertellingGilead,with
grimobviousness,thatSovaldiwillnotcurepatientsifthey
cannotaffordit,askedthecompanyhowactivitiesbytheUS
drugregulator,theFDA,tostreamlineapprovalandreduce
R&Dcosts,hadbeenfactoredintopricingdecisionsforthe
drug.Andthen,afewmonthslater,SenatorsRonWyden
andChuckGrassleyaskedforitemizedaccountsofthedrugs
initialdiscoveryanddevelopmentcosts.
Ofcourse,neithertheFDAsstreamliningnoritsexpediting
noranyitemizedR&Dexpenditureshadeverbeenfactored
intoanypricingdecisions.NeitherGileadnoranyoneelse
actuallyappliescostbasedpricing.
Nor,aswediscusslater,isitnecessarilygoodpolicytoattack
theeconomicsofthewinners.Thisisbecausethemajorityof
R&Dprojectsfail.Thefailurescostinvestorsandtheindustry
agreatdealofmoney,butbecausetheyfail,theyarenever
scrutinizedbysuspiciousmembersofCongress.Ifyoujust
lookatthewinners,drugR&Dwilllookwildlyprofitable.The
sameistrueofalllotteries.Peoplebuyaticketforadollar
andwinamillion.However,theeconomicsofthewinnersis
notrepresentativethewidergame.Thisiswhy,forexample,
theUKsNationalLotteryisoftencalledthetaxonstupidity.
Reason2:Value(False)
Thisdrugisgreat.Letssharethebenefit.Wearepartners.
Weknowthedrugisexpensive,butjustthinkhowmuchit
isworthtoyouandyourfamilyifyourecoverfromyour
illnessandgobacktowork.Youmightevenearnenoughto
payusbackwhatwechargedyou.

Asthecostbasedpricingstorieshavegonestale,valuebased
pricinghasbecomefashionable.
Itiseasytounderstandwhythedrugindustryiskeentotalk
aboutvaluebasedpricing.First,mostofuslikebeingneither
deadnordisabled,sovaluebasedpricescanbeveryhigh.
Second,valuebasedstoriesmayavoidtheunpickingthat
costbasedstoriesnowprovoke.USpoliticianscanasknasty
questionsaboutthecostoftheR&Drequiredtodiscoverand
developSovaldi(oraboutitsbudgetimpact,oraboutthe
publichealthconsequencesofahighprice),buttheyhavea
hardertimearguingaboutitsvalueversusolderhepatitisC
treatmentsorversusagreatmanyuselessthingsthatUS
healthsystemsbuywithoutcomplaint.
Valuebasedpricingalsohasanappealinglogic.The
EnglishNationalHealthService(NHS),forexample,doesa
bunchofcleverhealtheconomicanalyses,andbelievesthatit
providestheEnglishpopulationwithanextraQuality
AdjustedLifeYear(orQALY)forevery20,000to
30,000(roughly$40,000)thatitspends.Toputitanother
way,foreach$40,000spent,someoneinEnglandgetsto
enjoyoneyearofhighqualitylifethattheywouldhave
otherwisemissed.
Ifanewdruggaveeachpatientanextrayearofhighquality
life(oneQALY),theNHScouldpayupto$40,000per
patient,withoutreducingtheitsaveragecostefficiency.Fora
drugthatyieldedtwoextrayearsofhighqualitylife(two
QALYs),thebreakevenpointwouldbe$80,000perpatient.
Ofcourse,theNHSmightliketopayless,andsplitthe
economicbenefitswiththedrugmanufacturer.Nonetheless,
ifdrugspriceswerebenchmarkedagainsttheQALYsthey
delivered,theNHScouldbeconfidentthatitwasgetting
decentvalueformoney.Atthesametime,pricingdecisions
wouldprovideanincentiveforthedrugindustrytoinvent
drugsthathadabighealthimpact.
Sothetheorygoes.Thetheoryhasspawnedawholenew
industryforhealtheconomists,particularlyinEurope.
However,fromtheperspectiveofhealthsystemsandthe
peoplewhopayforthem,valuebasedpricingstrugglesfor
severalreasons,ofwhichIhighlightthree.
Theorymeetsreality
Thefirstproblemforpayersisthatvaluebasedpricing
evolvedasawayofchargingcustomersmore.Somegoodsor
servicesarepricedonthebasisofinputs(suchaslaborcost)
plusamarkup.Retailstores,forexample,oftenhave
standardmarkupsoncertainkindsofgoods.Some
professionalsstillchargebythehour.Thespotpricesofoilor
wholesaleelectricityarelargelysetbythemarginal
productioncostofthemostcostlyproducerrequiredto
satisfycurrentdemand.
Inotherbusinesses,however,sellershavelearntthatthey
canchargehigherprices,oftenmuchhigher,by
understandingthevalueoftheproducttothebuyer.Luxury
goodsprovideanexample.NooneimaginesthataChanel
suitoraLouisVuittonbagisquitesoexpensivebecauseit
costsalottomake.Thesuitandthebagareexpensive
becauseChanelandLouisVuittonunderstand,manage,and
thenexploit,desireinthemindsofconsumers.

IfIambuyingsomethingthatislikelytobeexpensive,I
specificallydontwantthesellertoknowthevalueofthe
producttome,becausethatvaluedefinesthemaximumprice
thatIwouldbepreparedtopay.Thejobofprofessionalsales
peopleistofindandthenextractthatmaximum.Thedrug
industryhasalotofprofessionalsalespeople.
Thesecondflawstemsfromnationaldifferencesinthevalue
thatisassignedtoanewdrug.Whenpresentedwithidentical
evidenceonthesafetyandefficacyofanewdrug,theEnglish,
Scots,andSwedesendupwithdifferentvalueestimates.
Someofthedifferencereflectsdifferencesindisease
prevalenceandinmedicalpractice.However,muchreflects
arbitrarydifferencesinthewayhealthsystemsaccountfor
costsandbenefits.Shouldthevalueofanewdrugincludethe
taxrevenueonearningsthatarelostasaresultofillness?
Doesntadeadpatientcostlessthanaliveone?Howmuch
moneyislifeworthinIreland,Holland,orSlovakia?Should
alllivesinHollandbeworththesameamount?Inthe
absenceofSarahPalinsimaginarydeathpanels,whoeven
decideshowmuchalifeisworthintheUS?
Whilehealthsystemsbenefitgreatlyfromconsistentinternal
costeffectivenessstandardsagainstwhichtoprioritizewhat
theydo,itisanerrortoconfuseinternalestimatesofvalue
withthepricethatacommercialdrugcompanywillaccept.
Valuebasedincometax
Considertheideaofvaluebasedincometax.IliveintheUK.
SupposeItoldHerMajestysRevenueandCustoms(HMRC,
theUKtaxauthorityequivalenttotheIRSintheUS),thatI
shallhomeschoolmydaughter,thatIamapacifistwho
opposedthewarsinIraqandAfghanistan,thatIwillam
happytotakemychancesifIgetill,andonthatbasis,my
valuebasedincometaxrateshouldbe15.7%andnotthe
20%to45%thatHMRCexpects,dependingonmylevelof
income.Nomatterhowprecisemymeasureofthevalueof
governmentservicestome,theapproachwontsaveme
money.ThisisbecauseHMRCismorepowerfulthanIam.
Thesituationwithdrugsissimilar.Anindividualcountrys
costbenefitanalysismaynotmatterverymuchbecause
nationaldrugpriceshaveglobalimplications.Thedetailsof
nationalpricingpoliciesarehorriblycomplex,butinpractice,
mostcountriestrytokeepacloseeyeonthepriceofdrugsin
othercountries,andthenbehavelike5yearoldchildrenata
party.Iftheyseethatsomeonegotagreatprice,theothers
cryItsnotfair.Iwantone.Therefore,companies
sometimeswalkawayfromthemostobviouslowendvalue
estimatesofsmallandidiosyncraticEuropeanhealthsystems
(andallEuropeanhealthsystemsaresmallandidiosyncratic
whencomparedwiththeUS).Drugcompanyshareholders
applaudthisbehavior,albeitquietlysothattheyavoidthe
politicalopprobriumthatloudapplausewouldattract.
Thusvaluebasedpricingcandriftintovaluebasedrationing.
Somethingalongtheselinesoccurswithexpensivecancer
drugsassessedbytheUKshealtheconomicwatchdog,the
NationalInstituteforHealthandClinicalExcellence,or
NICE.Acompanypresentsitsnewdrug.NICEcalculatesthat
thedrugispoorvalueformoneyatthepriceatwhichitis
offered.Thecompanymaintainsahighprice,fearingknock
oneffectsinothercountries.ThedrugentersaBritishlimbo
theoreticallyonsale,butatapriceatwhichtheNHS
doesntreallybuyit.ThehighUKpriceissuccessfully

signalledtoothercountries.Britishpoliticiansanddrug
companypublicrelationsfolksareinterviewedonTVandsay
howamazed,disappointed,horrified,theyarethatsucha
thingeverhappened.Theprocessthenrepeatsperiodically
whenthenextexpensivecancerdrugscomealong,orwhen
theannualcancerdrugbudgetisblown.
Nobodyknowsanything
Oneofthebestbooksaboutthedrugindustryisaboutthe
movieindustryWilliamGoldmansAdventuresintheScreen
Trade.Goldmanwrotethat:NobodyknowsanythingNot
onepersonintheentiremotionpicturefieldknowsfora
certaintywhatsgoingtowork.Everytimeoutitsaguess
and,ifyourelucky,aneducatedone.
Nobodyknowsforsureatthepointoflaunchwhichdrugs
willtransformmedicine,whichwillturnouttobeduds,and
whichwillpoisonpeople.DrugcompaniesandWallStreet
analystsarehopelessatforecastingdrugsales,evenwhen
mostoftheclinicaltrialdatahavebeencollected.Iwouldbe
surprisedifnationalhealtheconomicagencieshave
clairvoyantpowersthatthecompaniesandtheanalystlack.
Therefore,rushingtodotechnicalhealtheconomicanalyses
tocomeupwithwhatwilloftenbethewrongvaluebased
price,whichmaybeignoredbythedrugcompanyifitis
lowerthanothercountrieswrongnumbers,seemssomewhat
futile.
IrecentlyheardaneminentProfessorofMedicineatOxford
University,say:weseemtohavefinallyworkedouthow
tousestatins.Statins,commerciallysuccessfuldrugsthat
lowercholesterolandreducetheriskofheartattackand
stroke,havebeenusedinmanytens,perhapshundreds,of
millionsofpatientsintherealworldfornearly30years,yet
eventhestatementthatweseemtohavethemworkedout
iscontroversial.Respectablemedicalopinionremains
dividedonpreciselywhobenefitsandbyhowmuch.
Guessingthevalueofmanyotherdrugsisevenharder,
particularlythosethatareusedforavarietyofdifferent
things,eachofwhichwillhaveadifferentvalue.Adrugcalled
Rituximab,launchedasanexcellenttreatmentforone
particularvarietyoflymphoma,isnowactivelymarketedfor
7differentuses(innonHodgkinslymphomaofvarious
differentkindsandinvariousdifferentdrugcocktails,in
chroniclymphocyticleukemia,inrheumatoidarthritis,in
Wegenersgranulomatosisandinmicroscopic
granulomatosis).Rituximabisalsousedofflabelinmultiple
sclerosis,systemiclupuserythematosus,chronic
inflammatorydemyelinatingpolyneuropathy,autoimmune
anemias,idiopathicthrombocytopenicpurpura,pemphigus,
pemphigoid,Gravesdisease,etc.,etc.
Iamnotsurewhich,ifany,ofthesereasonsexplaintheUK
governments2014decisiontoquietlydropitslongstanding
planstomovetheUKtovaluebasedpricing.Other
enthusiastsmightreflectontheUKsretreat.
Reason3:Power(True)
AbrahamLincoln:Ihavealreadyintimatedmyopinion
thatintheworldshistory,certaininventionsand
discoveriesoccurred,ofpeculiarvalue,onaccountoftheir
greatefficiencyinfacilitatingallotherinventionsand

discoveries.Oftheseweretheartsofwritingandof
printing,thediscoveryofAmerica,andtheintroductionof
PatentLaws.
Iwasdismissiveofcostandvalue.Power,ontheotherhand,
mattersthepowerthatfollowsfromtherightstoalegal
monopoly.Mostnewdrugsarelaunchedwithpatent
protectionthatgivestheinventortheoptiontokeepother
peoplescopiesoffthemarketfor12orsoyears.Manydrugs
thenextendtheirmonopolystatusforseveralyearsbeyond
theoriginalpatentterm.
Powerisexercisedinvariousotherindustrieswhere
intellectualpropertymatters.Booksaresimilar.Ifyoucopya
newbookwithoutpermission,youinfringecopyright.Ifyou
copyandsellanewdrugwithoutpermission,youinfringe
patents.Whilebookscanbehardtowriteandnewdrugsare
hardtodiscover,eachextracopyordoseischeapto
manufacture.IfyouwantanEnglishFrenchdictionary,you
wontbetemptedbyaKoreanItaliandictionary.Ifyouarea
womanwithacne,youwontbetemptedbyacureformale
patternbaldness.Thusdirectpricecompetitionoftenmakes
littlesenseforproducers.
Copyrightprotectedbooksandpatentprotecteddrugsthat
sellwellareblockbusters.Somebooksforsmalland
specialistmarkets(academia,law,medicine)canbevery
expensive.Newdrugsforsmallandspecialistmarketscanbe
veryexpensive.Ontheotherhand,bookswhichareoutof
copyrightareoftenavailableincheapeditions.Drugswhose
patentshaveexpired,whichareavailablefromseveral
suppliers,arealsooftenverycheap.
Thereare,however,twoimportantdifferences.Thefirstis
thecomplexityofthedrugbuyingprocess,whichdisconnect
thechooserfromtheuserfromthepayer.Thesecondstems
fromthefactthatreadingthesamebookoverandoveragain
isevenmoreboringthanprescribingorswallowingthesame
pilleveryday.
Powertotheseller
TheUS,theworldsmostimportantdrugmarket,illustrates
thefirstdifference.Mostbooksareboughtbysomeoneusing
theirownmoney.Incontrast,mostdrugsareprescribedbya
doctorforapatient,withmuchofthecostcoveredbyan
insurancecompany.Thusthedecisiontomakeaspecific
drugpurchase(mademainlybythedoctorandpatient)is
disconnectedfrompayment(mademainlybythirdparties
suchashealthinsurancecompanies,healthmaintenance
organizations,andpharmacybenefitmanagers)and
disconnectedfromtheinitialchoiceofhealthcover(generally
madeatadifferenttime,andoftenmadebysomeonewho
isntthepatient).
WhenIlookacrossfromEdinburgh,Americanswithhealth
coverappeartobetechnologicaloptimistswholikealotof
choicebutwhosueifthingsgowrong.Comparedwith
Europeans,theytendtobemoreinterestedinprogressand
noveltyandlessinterestedsocialsolidarity.Itisdifficultto
sellhealthcoverthatstrictlylimitspatientsdrugchoice.Itis
particularlydifficulttorestrictcoverageofnewdrugsthat
treatseriousdiseasesandforwhichtherearefewobvious
substitutes.Thisisbecauseitisthefearofseriousillnessthat
providesthemotivationforinsuringinfirstplace.People
dontinsure(eithervoluntarily,orbecausetheynowhaveto)

becausetheyareworriedtheywillgetacold.Theyinsure
becausetheyareworriedaboutgettingrunoverbyatruckor
gettingcancer.Furthermore,rarediseasesareindividually,if
notcollectively,rare,andtotalmedicalcostsaredominated
bythingsotherthandrugs.Americanshaveexpensive
doctorsselfemployedentrepreneurswhomakemoremoney
themoredifferentthingstheydotothepatient.Therefore,
coveringyetonemoreexpensivedrugforyetonemorerare
cancerdoesnotmakemuchdifferencetothepremiumsthat
ahealthplanchargestheemployerortheindividual.Not
coveringthatonedrug,ontheotherhand,cancause
reputationaldamageandmakehealthcoverhardtosell.
WhatifthespouseorchildoftheCEOofthecorporateclient
everneedsthatonedrug?Thenetresultisthatmost
insuranceplansintheUS,bycommercialnecessity,are
forcedtocovernearlyalldrugs,evenifinafairlygrudging
mannerthatpushessomeofthecostontothepatient.
Thedrugsellersresolveincommercialnegotiationsis
reinforcedbythefactthathugeUSgovernmentprogrammes,
whooftenbuymuchmorethananycommercialpayer,base
theirpricesonthepricesincommercialmarket.Medicaid,
forexample,isnotallowedtonegotiatepricesitself,butcan
demandthebestpricethathasbeenachievedbyany
insurancecompany.
Drugcompaniesknowallthisandsoexploittheirtemporary
monopolieswiththesteelyruthlessnessthattheir
shareholdersdemand.Andboy,aretheyruthless!
ThedrugformerlyknownasCampath
Onerecentexampleisthecaseofadrugformerlyknownas
Campath1H(alsoknownasalemtuzumabandLemtrada).
ThedrugwascreatedintheCambridgeUniversityPathology
Department(henceCampath)intheUKintheearly1980s.
Campathkillswhitebloodcellsinthepatienttowhomitis
administered.Thismaysoundanunlikelytherapeutic
strategy,butitcanbeagoodthingincertaindiseasesifthe
patienthasleukemia(whichisawhitebloodcellcancer),orif
thewhitebloodcellsareattackingthepatientsownbody,as
happensinautoimmunediseases.Onesuchautoimmune
diseaseismultiplesclerosis,wherethepatientsimmune
systemattacksnervefibersinbrainandotherpartsofthe
centralnervoussystem,andwhere,overtime,accumulated
nervedamagecancausedisabilityandevendeath.
CampathscommerciallaunchintheUSwasforleukemiain
2001.Thisprovedasmallmarket.However,in1994,long
beforetheUSleukemialaunch,thefirstreportsemergedthat
Campathwasusefulinmultiplesclerosis.Otherstudies
followedandCampathbecamearespectabletreatmentfora
minorityofpatientswiththedisease.Campathhadan
unusualclinicalprofile.Itappearedferociouslyeffective,but
oftenwithserioussideeffects.DoctorsprescribingCampath
inmultiplesclerosiswereusingitofflabelbasingtheuse
ontheirjudgementofthescientificliterature,ontheneedsof
thepatient,butnotonanyformalregulatorynod.Doctors
areallowed,moreorless,toprescribeanydruginanyway
theyseefit.Muchmoretightlyregulatedisthewaythatdrug
companiesmaypromoteadrug.Companiesmayonly
promoteusesthathavebeenapprovedbyaregulatorsuchas
theFDAintheUSorthebytheEMAinEurope.

Genzyme,lateracquiredbySanofi,decidedtorunthecostly
clinicaltrialstoobtainregulatoryapprovaltopromote
Campathinthelucrativemultiplesclerosismarket(knowing,
ofcourse,thatthetrialswerelikelytosucceedgivenexisting
evidencethatthedrugworked).However,therewasa
commercialproblem.WhenCampathwaslaunchedasa
cancerdrugin2001,cancerdrugsweremuchcheaperthan
theyarenow.Overtheyears,multiplesclerosisdrugshave
alsobecomemuchmoreexpensive.Fromthecompanys
perspective,thedrugwasmuchtoocheap.HadSanofi
appliedthecancerpricetothemultiplesclerosisdose,it
wouldhavebeenchargingaround$6,000peryearwhen
multiplesclerosisdrugshadannualpricescloserto$60,000.
SoSanofiwithdrewCampathfromcommercialsaleinlate
2012andrelauncheditin2013inEuropeandin2014inthe
USwithanewname,Lemtrada,anewmultiplesclerosis
indication,andalistpriceriseofoveronethousandyes,
onethousandpercent.Thetemporarywithdrawaloutraged
neurologistswhohadbeenusingCampathofflabelforyears,
butwhocouldnotgetthedrugfortheirpatientsuntilthere
launch.
However,theoverallpictureiscomplicated,andtheethicsof
Sanofissteelyruthlessnesscouldkeephighschooldebating
societiesbusyforasemesterortwo.Throughoutthe
withdrawal,SanoficontinuedtoprovideCampathto
leukemiapatients,whonowgenerallygetifforfree,butwith
strictcontrolssoitdoesnotleakintothevaluablemultiple
sclerosismarketandcompetewithLemtrada.Multiple
sclerosispatients,wholostatreatmentoptionduringthe
withdrawal,haveprobablygainedaftertherelaunch.
Lemtradahasauniqueandpowerfulprofile.Itispossible,
thoughnotyetproven,thatitisunusuallyeffectiveinhalting
theprogressofmultiplesclerosis.Morepatientsnowgetit,
becausedoctorsandhealthsystemswereoftenreluctantto
useCampathofflabel,evenifthoughtitwascheap.The
additionalcosttohealthsystemsisoffsetbythefactthat
manyofthepatientswhogetLemtradawouldhave
consumedanotherexpensivemultiplesclerosisdrughad
Lemtradaneverbeenapproved.
EventheUKscostconsciousNHScalculatesthatLemtrada
providesgoodvalueformoney.YoumayrecallherethatI
saidthatvaluebasedpricingfirstevolvedasawayof
chargingcustomersmore.
Powergames
Pricingpowerisexercisedruthlesslybutruthlessnesscanbe
subtleandstrategicascalpelratherthanabludgeon.
Powerandpricesareverysensitivetocompetition.Their
simultaneouscollapseismostobviouswhenpatentsand
regulatoryexclusivitiesexpire.Atthatpoint,chemicallyand
biologicallyequivalentgenericcopiesenterthemarketand
healthinsurerscanswitchpatientswithoutphysicians
gettingintheway.Thisiscalledgenericsubstitutionandis
anautomaticandincrediblyeffectiveprocessinsomemajor
healthsystems.Lipitor,acholesteroltreatmentandformerly
theWorldsbestsellingdrug,costaround$1,500perpatient
peryearintheUSbeforeitspatentexpired.Youcannowbuy
versionsofthegenericfor$100peryear.Around86%ofall
USprescriptionsarenowforgenericdrugs.
Therapeuticsubstitutionoccurswhentwoormoredrugs
aremedicallysimilar,thoughnotchemicallyidentical,andit

isreasonableforahealthsystemtoencourage,cajole,or
forcepatientstouseonedrugratherthantheothers.Thisis
trickierthangenericsubstitution.Sincethedrugsarenot
identical,theremaybemedicalreasonswhyoneperson
mightpreferdrugaoverdrugb,butsomeoneelsewould
preferdrugbtodruga.Thisiscommoninpsychiatryor
cancerwherepatientsmayhavestrongpreferences,often
basedonsideeffects.However,whendrugsaresimilarand
highlyeffective(sosomeonerarelyneedsdrugbafterhaving
takendruga),therapeuticsubstitutioncanboosthealth
systemspowerinpricenegotiations.
ReturningtothehepatitisCmarket,thereisawonderful
illustrationthatIhearddiscussedbyGeoffPorges,the
biotechnologyanalystatSanfordBernstein,aWallStreet
investmentfirm,andProfessorBarryNalebuf,aneconomist
andgametheoryexpertfromYale.Thediscussionconcerned
atacticaldanceinvolvingGileadanditscompetitorAbbVie,
whichmaybejoinedin2016byMerckandin2018by
Johnson&Johnson.
GileadshepatitisCdrugSovaldinowhasayoungerGilead
sibling,Harvoni,andsincelate2014,Gileadhasfaceda
competitorAbbViesViekiraPak.PorgesandNalebufargued
thatthechallengethatGilead,AbbVie,Merck,andJohnson
&Johnsonfaceisreminiscentofwhathasbecomeastandard
itemonthebusinessschoolcurriculum,thecaseofHolland
Sweetener,NutraSweet,Coke,andPepsi.
HollandSweetener
NutraSweetoncehadalucrativepatentprotectedmonopoly
onachemicalcalledaspartame,usedbybothCokeandPepsi
tomaketheirlowcaloriedrinkslessdisgusting.Holland
SweetenerwassetuptochallengeNutraSweetsmonopoly
whentheEuropeanandUSpatentsexpiredin1987and1992.
HollandSweetenerinvestedseveraltensofmillionsofdollars
buildingaspartamemanufacturingfacilities.However,its
attempttoenterthemarketdidlittlemorethanforce
NutraSweetintoapricewar.NutraSweetagreedlowpriced
longtermcontractswithbothCokeandPepsi,leaving
HollandSweetenerwithatinyshareofthemarketatthe
miserablylowpricethatitsmarketentryhadtriggered.Coke
andPepsigainedaround$200millionperyearfromlower
aspartamepricesandNutraSweetlostasymmetricsum.
HollandSweeterwasagreatdisappointmentforitsinvestors,
butagreatbonusforCokeandPepsi,eventhoughneither
everboughtanyofitsaspartame.
AmildparallelhasalreadyoccurredintheUShepatitisC
market.ViekiraPakisslightlylessconvenientandlesswidely
usefulthantheGileaddrugs,althoughstillextremely
effective.AbbViedidanexclusivedealwithoneUSpayer,
ExpressScripts,atapricemuchlowerthanGilead.In
response,Gileadagreedexclusivecontractswitharangeof
payersatalargediscounttoitsformerprice.BeforeViekira
Pak,theaverageGileaddiscountwasaround20%.After
ViekiraPak,theaverageGileaddiscountmayapproach45%.
InamannerreminiscentofHollandSweetener,ViekiraPak
gainedonly5%ofthemarket,yetpusheddownpricesacross
theboard.ItisprovingmorevaluabletoUSconsumersthan
toAbbVie,thecompanythatbroughtittomarket.
Competitionislikelytorampupagainin2016and2018,
withnewdrugsfromMerckandJohnson&Johnson.The
challengeforthesenewcomerswillbeselltheirdrugswithout

firinglargetorpedoesintothemarkettheyaretryingtoenter.
ThechallengeforGileadandAbbVieistosomehowcontract
withthepayerssoonsoastorenderthemselvestorpedo
proof,whileatthesametimedeterringMerckandJohnson&
Johnsonfromtryinganythingtooexplosive.Meanwhile,
somepayerswillactasagentsprovocateurs,hopingthat
Gilead,AbbVie,Merck,andJohnson&Johnsonbehavelike
theGermanHighSeasFleetinScapaFlowin1919,and
scuttlethemselves.
Elasticbandsanddeadweightlosses
CommercialshenanigansoccurintheUShealthsystem,an
environmentinwhichusedcarsalesmenandgametheorists
wouldflourish.Mostotherdrugbuyingsystems,particularly
thoseinEurope,appeartohavebeendesignedbycivil
servantsandpublicsectorhealtheconomistswhoimagine
thereisacorrectcostbasedorvaluebasedpriceforadrug
(althoughthismaybechanging.Sovaldihasgivenseveral
Europeancountriesacrashcourseincompetitive
procurement).Europeangovernmentstendtobeprice
setterswhocaninprincipleexertstrongcontroloverthe
drugconsumptionofthepeoplewhousetheirhealth
systems.Buttheirfreedomtooperateisconstrainedbythe
valuebasedrationingproblemfromtheprevioussection.As
oneglobalhealthcareinvestortoldmelastyear,Drug
companiesfearapoliticalbacklashintheUSunlessthey
narrowtheUSEuropepricedifferential.Thisdoesnot
necessarilymeanUSpricesgodown.Thisfearactslike
economicelasticwhichpreventsdevelopedworlddrugprices
fromstrayingtoofarfromtheUS.
BeforeweEuropeanscomplainaboutAmericanelastic
draggingupourdrugprices,weshouldrememberthat
profitsfromindividualEuropeancountriesaretoopunyto
motivateseriouscommercialR&Dinvestment.AsSimon
Baker,aninvestmentanalystatExane,BNPParibas,toldme
lastyearthatdrugR&DislikeNATOfrom1949to1989
somethingfromwhichEuropeansderivehugebenefit,but
largelypaidforbyAmericans.AndbeforeAmericans
complainthattheirhighpricesaresubsidizingEuropeans,
theyshouldrememberthattheirdrugsaremainlyexpensive
becausetheyhaveabuyingprocessthatgivespowertothe
industry.IfEuropeanspaidalotmore,Americanswould
notpaymuchless(althoughAmericansmightgetafewmore
newdrugs).
TheeconomicelasticprotectsUSprofits,andprofitsinother
priceinsensitivecountries.However,thetightertheelastic,
themorecountriesandmorepatients,whowouldhavepaid
somethingforthedrug,endupconsumingandpaying
nothing.Thelossofbenefittoconsumersiscalleda
deadweightlossbyeconomists.Whenitcomestomedicine,
mostofusregardthedeadweightlossasmorallyoffensive,
particularlynowitappliestorichpeoplelikeus,ratherthan
HIVpatientsinAfrica.
Companieshaveawayoflooseningtheelastic,reducingthe
deadweightloss,andmakingmoremoneyatthesametime.
Economistscallthelooseningprocesspricediscrimination.
Elasticloosenswhenpricingisopaqueratherthan
transparentwhenonehealthsystemcannoteasilyeavesdrop
onanother,andcomplainthatitsnotfair.Thusthereisa
lotofdeliberateobfuscationoftherealprices,netofrebates,
discounts,clawbacks,budgetcaps,etc.,thathealthsystems

actuallypay.Elasticalsoloosenswhentherearebarriersto
trade.TheEuropeanUnionisafreetradezone.Therefore,if
onesellspillsintoGreece,wherepricesarelow,itismore
profitableoveralltomakesuretheyareinGreeklanguage
onlypackaging,inGreeklanguageonlyblisterpacks,with
somethingobviousandGreekprintedonthepills,andif
possibleinadosethatissubtlydifferentfromanydosethat
canbelegallysoldintheUKorGermany.Thismakesit
tedioustorepackagethepills,beforeshippingthemtoparts
oftheEuropeanUnionwheretheycompetewithsimilarpills
thatthemanufacturerissellingahigherprice:Tediousbut
notimpossible,asGermanfriendstakingreexportedGreek
drugsrecentlytoldme.
Theelasticbecomesextremelyloosewhencompaniesare
confidenttheycancontrolleakage.OriginalCampathisnow
availableforfreeinleukemia,butCampathrebrandedas
Lemtradacostsaround$140,000foracourseinmultiple
sclerosis.Sovaldihasan$85,000USlistprice(offsetby
opaquediscountsintherangeof30%to45%).MostWestern
Europeansarestuckwithpricesthataremorethanhalfthe
USfigure.However,IndiaandEgyptgetthesamedrugfor
lessthan$1,000perpatientextremelyexpensiveforIndians
andEgyptianshighlyproblematicfornationalhealth
provisionbutlessthan2%ofthediscountedUSprice.
Thisraisesdreamsofpharmaceuticaltourism:Enjoya12
weekGrandTour,whereyoucangazeattheawesome
pyramidsandtheinscrutableSphinxofGiza,explorethe
treasuresofTutankhamen,gaspatthewondersofLuxor,
whilebaskinginthesustainedvirologicresponseyoucan
onlydreamofbuyingintheUS.Somemaydream,but
Gileadgottherealreadyandputitscorporatetowelsonthe
sunloungers.EgyptiansmustproveresidencytogetSovaldi.
Touristsneednotapply.
Thepoweroftheold
AtthestartofthePowersection,wecompareddrugswith
books,butsaidthereweresomeimportantdifferences.Here
wereturntothesecondnovelty.
Onlypeoplewhoareveryyoungorveryreligiouslikelooking
attheexactsamebookoverandoveragain.Incontrast,
doctorsdonotgetboredofprescribingthesamedrug,day
afterday.Manydrugsbecomemorevaluableovertime,as
theirrisksaremanagedandtheirbenefitsexplored.Drugs
alsogetmuchcheaperatthepointatwhichtheirpatents
expireandgenericversionsenterthemarket.Thedrug
industryiscreatinganeverimprovingbackcatalogueof
virtuallyfreeandhighlyeffectivemedicines,againstwhich
newinventionscompete.
IhavecalledthisTheBetterthantheBeatlesProblem.It
wouldbehardtosellnewsongsifeverynewsongwas
comparedforqualityagainsttheBeatlesdiscography,if
everyonealreadyownedtheBeatlesrecords,and
importantlyifnooneevergotboredoflisteningto
StrawberryFieldsorHeyJude.Thisisthesituationinthe
drugindustryanintellectualpropertybusiness,where
patentsexpireyettheclassicsbecomeneitherboringnor
unfashionable.
TheBetterthantheBeatlesProblemisahugeeconomicdrag
ontheindustry.ItisthemainreasonwhyR&Dhasbeen
pushedtowardsrarerandgenerallyseriousdiseaseswhere

regulatorsaremorerisktolerantandwherepayershavethe
leastabilitytoresistthecompaniespricingpower.
TheBetterthantheBeatlesProblem:Stopgriping,
youingrates.Whileyouweremoaningaboutourgreed,we
havebuiltyouafantasticcollectionofalmostfreegeneric
medicine.Allthatoldstuffthatactuallyworksismakingit
nearimpossibletofindanythingthatmakesusmoney.You
thinkyouhavegotproblemswithdrugprices!Weare
cuttingourthroatshere!
Drugcompanieshaveapoint.Patentscomeandgobut
genericsareforever(fornoninfectiousdiseases,atleast).
Thegenericpharmacopoeiahasbecomeamedicalwonder.I
dontknowforsure,butIwouldguessthatonecanbuy
today,atrockbottomgenericprices,asetofsmallmolecule
drugsthathasgreatermedicalutilitythantheentireset
availabletoanyone,anywhere,atanypricein1995.
Nearlyallthegenericmedicinechestwascreatedbyfirms
whoinvestedinR&Dtowinfutureprofitsthattheytried
prettyhardtomaximizeShorttermfinancialgainbuildinga
longtermcommongood.Thisstrikesmethestrongest
defenceofthecurrentsystem.Butunfortunatelyforthedrug
industry,itisatoughdefencetoselltothejury,nomatter
whatAbrahamLincolnthoughtaboutpatentsandprogress.
Reason4:Prizes(True)
GeorgeOrwell,1984:TheLottery,withitsweeklypay
outofenormousprizes,wastheonepubliceventtowhich
theprolespaidseriousattention.
DrugR&Dhaseconomicsthatresemblealotteryalbeita
peculiaronewheretheprizeistherighttoexercisealegal
monopoly.
Onlysomeonelackingambitionwouldplaythelotteryhoping
torecouptheircosts.Privatesectorinvestors,theproles
intheOrwellquote,donotlackambition.Furthermore,the
R&Dlotteryisexpensivetoplay,mostgamesareabust,and
therarewinstakealongtimetopayout.Investorsanddrug
companieschoosetheirgames(cancer,Alzheimers,obesity,
etc.)byguessingatthevalueofthemonopoly,thecostofthe
R&D,andtheoddsofsuccess.
Expensivetickets
ThatcommercialdrugR&Disoftenanexpensivegameis,to
useBritishvernacular,bothbleedinobviousand
controversialatthesametime.Itisbleedinobviousbecause
drugcompaniesaveragecostsperwincanestimatedby
dividingoneunambiguousandpubliclyavailablenumber
(theamountspentbythedrugindustryonR&Deveryyear,
whichisover$100billion)byanotherunambiguousand
publiclyavailablenumber(thenumberofnewdrugs
approvedeachyearbytheFDAandEMA,whichinrecent
yearshasbeenintherangeof20to40).Thisgivesaverage
costsintherangeof$2.5to$5billionpernewdrugthat
emerges.HealtheconomistsatTuftsUniversityroutinelyget
tosimilarnumbersinamuchclevererway,androutinely
attractflakfromindustrycriticsfortheirbleedinobvious
result.

SomeTuftscriticsarguethatdrugscanbediscoveredand
broughttomarketforasumthatismuchclosertothecostof
aMcDonaldsHappyMealthanitisto$2.5billion.Ithink
thebleedinobviouscommercialaverageiscriticizedfortwo
reasons.Oneofthereasonsisverybad,buttheotherisworth
thinkingabout.
Thebadreasonisthatpeoplehavegiventoomuchcredence
totheindustrysspielonthecostofproduction.They
imaginethatpriceswillfalliftheycansomehowprovethat
theindustryislyingaboutthecostofproducingnewdrugs.
Theyaremistakenbecausepricesdependonmarketpower,
andnotonR&Dcosts.
Theotherobjectionisinteresting,butdoesnotinvalidatethe
bleedinobviouscommercialaverage.PerdrugR&D
spendingishugelyvariable.Somecancerdrugsemergeafter
trialsinonlyacoupleofhundredpatients.Trialsfordrugs
thatchangetheriskofheartattacksandstroke,ontheother
hand,sometimesneed20,000or30,000patients.Some
therapyareashaveconsumedhugeresourcesbuthavesofar
yieldedverylittle(e.g.,the99.6%failurerateofthe413
Alzheimersdiseasetrialsbetween2002and2012).
CommercialR&Disalsowellcommercial.Companies
absolutelyrequireexpensiveclinicaltrialdatatoconvincethe
regulatortoallowthemtopromoteadrugforanyparticular
use,toconvincehealthsystemstopayforthedrug,andto
persuadephysicianstoprescribedrugaratherthansimilar
drugb(andviceversa).EvenRituximab,atherapeutic
triumph,requireddifferentclinicaltrialstosupporteachone
ofitssevenapprovedindications.Ifoneweretofocusonthe
costsofR&Dfororphandrugsforrarediseases,orfor
neglecteddiseasesinthepoorerpartsoftheworld,whichis
whatsomeoftheindustryswellinformedcriticsdo,R&D
costsperdrugwouldprobablybefarlowerthanthe$2.5
billioncommercialaveragemaybetentimeslowerorless.
However,ifwereturntothebleedinobviouscommercial
figure,wecandissectitasfollows.First,investorsbelieve
thatmoneyhasacost.Iftheyhadnotputmoneyintodrug
R&D,theycouldhaveputittoworkinalcohol,fastfood,or
tobacco.DrugR&Disaslowprocess,andalotofmoneyis
spentearlyonthingsthatdontwork.Therefore,aroundhalf
ofthe$2.5billionisthetimecostofmoneyinvestors
interestonthecashthatwastiedupforyears.Somepeople
thefindtheinclusionofthetimecostofmoneyobjectionable.
Ifanyreaderssharethisobjection,theymaywanttolendme
$1.25billiondollarsatzeropercentinterest.Iwilltrytopay
itbackin20yearsroughlythetimeittakestogetpaidback
onR&Dspending.Ladiesandgentlemen,formanorderly
lineplease.
Ofthe$1.25billionofoutofpocketcosts,thedirect
spendingoneachapproveddrug,althoughwildlyvariable,
averagesaround30%ofthetotal.Directspendingonthings
thatfailedaveragesaround70%.
Ittakesluck.Itsnotfair.Roughlynineoutoftendrug
candidatesthatenterclinicaltrialsinmanarenever
launched.Evenforthefewdrugsthatareultimately
approved,thewinningsareskewed.Themostsuccessful10%
ofapproveddrugs,only1%ofthosethatenteredclinical
trials,maybe3newdrugseachyear,generatehalfofthe
profitsoftheentiredrugindustry.
Becausethatswherethemoneyis

Asistypicalforlotteries,gamesgetmoreorlesspopularas
playersguessesoftheodds,costs,andprizeschange.The
cancerR&Dlotteryispopularrightnow,withcompanies
raisingmoneyfromventurecapitalists,fromflotationson
stockmarkets,andbysellingthemselvestobigdrug
companies.Betterdiagnosesandnewtreatmentapproaches
haveimprovedtheoddsofsuccessandhavemadesmaller
andcheaperclinicaltrialspractical.Pricingpowerishigh,
andinvestorsseemtobemakingabigbetthat,despitenoisy
complaints,UShealthsystemsinabilitytosaynoto
expensivecancerdrugswilllastanotherdecadeatleast.
Somegames,suchastheantibioticR&Dlottery,falloutof
fashion.Buyersfornewlydiscoveredantibioticsaregenerally
hospitalsand,byhistoricalaccident,hospitalsstruggleto
passthecostofinpatientantibioticsthroughtoinsurance
companies.Hospitals,whichmaybegettingafixed$10,000
feeforthesurgicalpatientwhoacquiredaninfection,would
hatetospend$4,000onanantibiotic,whenasperthe
BetterthantheBeatlesProblemthereisalargeback
catalogueofvirtuallyfreegenerics,oneormoreofwhichare
likelytowork.Itisthereforemucheasiertosellabarely
effectivecancerdrugfor$70,000pertreatmentthanitisto
sellalifesavingantibioticfor$4,000.
Andotherlotteriesneverreallygetofftheground.Howmany
investorswouldgambletowinmonopolypricingpowerover
poorpeoplewithtropicaldiseaseseveniftheR&Dtickets
weredirtcheap?Whensuchgamesareplayed(e.g.,
GlaxoSmithKlinesstrikingpersistenceandmodestclinical
successwithamalariavaccine,or600millionantimalarial
treatmentsfromNovartis)theytendtobephilanthropicnot
commercial.
FutileReformsversusImplausibleReforms
Itisnormaltofinishthiskindofarticlewithafewfirm
recommendations.Whyexplainaproblemifyoudont
pretendyouknowhowtofixit?Andanyway,
recommendationsmakeiteasiertogetspeaking
engagementsandlucrativeconsultingwork.However,Iam
goingtogoagainstfashion.Iwillexplainwhytheproblemof
highdrugpricesishardtofix,beforemakingafewvague
suggestionsthatexpertsshouldregardasimplausible.
Amistakethatmanycriticsofthedrugindustrymakeisto
imaginethatbecausenewdrugsareveryexpensive,the
industryissystematicallycheating,theremustbealotof
slackinthesystem,andifonlytheslackwereremoved,we
wouldhaveaflowofgoodcheapnewdrugs.Ithinkthatthe
truthismuchworse:Theindustryistryinghardtodiscover
anddevelopthingstosellitischargingasmuchasthe
marketwillbearevenFirstWorldhealthsystemsare
baulkingaccesstothenewestdrugsisproblematicbut
outsideofaselectfewdiseaseareasthefinancialreturnson
R&Dinvestmentarepoorandwithouttheprivatesector
investors,therewouldbevanishinglyfewnewdrugs.
Itistruethatinvestorsarehappiernowthantheywere4or5
yearsagowhenpipelinesseemedverybare,buttherecent
increaseinnewdrugapprovalsislinkedtotherapyareas
wherepricingpowerishighestandwhere,asdirect
consequence,pricesattractthemostpoliticalscrutiny.
Therefore,thisfeelslikeapotentiallyfragilerecovery.

Remember,itisnotunusualtohaveindustrieswhere
customersandinvestorsbothbelievetheyaregettingabad
deal,socustomersandcapitalsimultaneouslyretreat:The
USsteelindustrybetween1960and1980theBritishship
buildingindustrybetween1950and1980thespermwhale
oilindustrybetween1840and1880etc.Thesituation,when
itarises,ischaracteristicofindustriesindecline.
Thereisaclassofpolicyproblemwherecommonsensehas
beenappliedforseveraldecadesbutnothingmuchseemsto
changeandwearestillunhappywiththeresult.Whenfaced
withsuchaproblem,optionsinclude:(a)Rationalfutility
(i.e.,keeprepeatingcommonsensesolutionswhich
experienceshowseithercantbeimplementedorelsedont
work)or(b),hopefulimplausibility(i.e.,trynewthingsthat
areprobableratherthansurefirefailures).Thisisthe
policyequivalentofSherlockHolmesline:HowoftenhaveI
saidtoyouthatwhenyouhaveeliminatedtheimpossible,
whateverremains,howeverimprobable,mustbethetruth?
Butitisworse.TherewasalwaysatruthforHolmes,but
theremaybenoidealpolicy.
Highdrugpriceslooktomelikeoneoftheseproblems.
Reforminghealthsystemsisverydifficult.Thecreationofthe
NationalHealthServiceintheUKin1948requiredtheGreat
DepressionandtheSecondWorldWartobuildcollectivist
consensus.LookingacrossfromEdinburgh,themost
surprisingthingaboutObamacareishowmuchpoliticaland
legalfussitcausedwhilemakinglittlechangetothe
structuresthatmakeUShealthcareexpensive.TheUS
governmentkeptitsnoseoutofdrugpricing.Affluent
Americansremaintechnologicaloptimistswholikechoice.
Thebuyingpowerofhealthplansremainslow.
If,asstillseemslikely,theUSescapesmajordrugprice
reforms,theninvisibleeconomicelasticwillholduppricesin
otherdevelopedcountries.Andanyway,iftheUStook
effectiveactiontoreducedrugprices,itwouldtriggersome
withdrawalofcapitalfromdrugR&D.Aggressiveprice
reformcouldbeaPyrrhicvictory:lowerpricesbutonfewer
newdrugsinthelongrun.
Therefore,alikelyoutcomeisthatthingsgrindslowlyalong
theircurrenttrajectories.Theeconomicstructureswithin
whichdrugsareboughtwillbelargelyunreformed.The
temporarymonopoliesthatgiveinventorspricingpowerwill
remaininplace.Theexistingpowerrelationshipswillpersist.
Newdrugswillgenerallyremainexpensive.UShealthcare
expenditureswillcreephigherasapercentageofGDP.Afew
morecountriesmayfollowthelikesoftheEngland,Scotland,
Ireland,andtheNetherlandsandsetfirmcosteffectiveness
thresholds.PerhapsEuropeancountrieswillclubtogether
morefrequentlytoincreasetheirpowerinpricenegotiations.
Theindustryandbuyersmaygetbetteratprice
discrimination.Therapeuticsubstitutionwillprovide
occasionalpricereliefwhenseveralsimilardrugsemergeat
roughlythesametime.Theindustrymaygetbetterat
makingdrugslikeSovaldieasytobuywithoutblowingthis
yearshealthbudget(e.g.,Dontwait,curetoday,withthe
costspreadover10easyandconvenientannualpayments).
Thisseemstobewhatmostdrugandbiotechinvestors
expect.Theymaybewrong,buttheyhavelessreasontobe
biasedthanmostotherpeopleinvolvedinthedrugbusiness.
Hopefulimplausibility

Somuchforrationalfutility.Whatabouthopeful
implausibility?
Priceswillfallifbuyersincreasetheirpowerversussellers.
Europeancountriesshouldbuyasablock.Theblockshould
paytokeepmoremetoodrugsinthegame,fundtrialsto
provetherapeuticequivalence,andthenruncompetitive
tenderstofindthecheapestsupplierforpanEuropean
demand.SomeDemocratsintheUSwantthepubliclyfunded
MedicareandMedicaidprogrammestousetheirhuge
untappedbuyingpowertonegotiateprices.MostUS
Republicanshatethisidea,butsomemightconceiveof
libertarianalternatives.Insurancecompaniescouldpriceand
sellpoliciesonthebasisofthecosteffectivenessofany
treatmenttheycover.Optimistswithlimitedcashmight
choosetoinsurethemselvesandtheirfamiliesforall
treatmentsthatcostupto$30,000perQALY.Theycan
expecttobepickedupiftheyarerunoverbyatruck,buttoo
badifoneoftheirkidsisbornwithanexpensivedisease.
Wealthyhypochondriacs,ontheotherhand,couldbuycover
upto$2,000,000perQALYalltheuselessandexpensive
drugstheywantandtheirdoggetsfreeBotox.This
arrangementwouldestablishamarketbasedlinkbetween
treatmentpriceandvolume,anddrivedownprices.
Pricingpowercanalsoshiftwithachangeinintellectual
propertylaws,orintheirenforcement.Atpresent,the
intellectualpropertytailisfirmlywaggingthetherapeutic
dog.Intellectualpropertylawsarenotlawsofnature,butare
theretopromotethecommongood.Itshould,therefore,be
possibletoputthedogbackinchargeofitstail.
Patentshaveonlyevergivencarefullyboundedrightstothe
holder.Theboundarieschangeovertime.Someboundaries
couldberetractedtoincreaseaffordability.Forexample,very
longperiodsofmarketexclusivityarecostlytohealth
systems,yetdolittletoincentivizetheinitialR&D
investment.ThisisbecausetheinitialR&Dinvestors,with
theirtimecostofmoney,largelyignoreearningsinthe
distantfuture,longafterthedrughasbeenbroughtto
market.
Otherboundariesmaybeextended.Evolutionislazy.
Biologicalmachinerythatdoesonething(e.g.,signalpain)is
recycledtodoothers(e.g.,makebloodclot)sodrugsthatdo
onethingtendtodootherthingstoo.Aspirinisapainkiller,
anantiinflammatory,andprotectspeoplefromheart
attacks.However,oncepatentsexpire,itishardto
incentivizeworktoexploitnewuses,evenwhentheworkis
cheap.Atpresent,thedrugindustryisforcedtofocuson
robustlypatentablenovelmoleculesratherthantherapeutic
utilityperse.Novelmoleculesareriskyandunpredictable,
whichraisesthecostofR&D,reducescompetition,andraises
theindustryspricingpower.Thereshouldbestronger
incentivestocommercializenewusesofolddrugs.
Delinkage
Iaskedseveralexpertstoreaddraftsofthisarticle.Thefew
whogotthisfarsaidthatIshouldfinishwithsomething
aboutR&Dcostsandhowtoreducethem.Afterall,ifpower
shiftsfromsellerstobuyers,pricesfallandprizesshrink,so
youneedcheaperR&Dtokeeptheprivatesectorinterested
inthegame.Ishould,theyadvised,consideradaptive
licensing,openinnovation,precisionmedicine,
phenotypicscreeningandvariousotherthings.

Iamsympathetictosuchideas,soIthoughthardaboutthe
advicebeforeignoringit.Idontseeitispracticaltowrite
usefullyabouttheproblemofR&Dcostswithoutwritinga
differentarticleoramuchlongerarticle.Therefore,Iam
goingtoconcludewithsomethingsimpler,whichdoesnot
dependoncheaperR&Dabigprizethatcomeswithout
pricingpower.
AsIsaidintheprevioussection,theR&Dlotteryfor
antibioticswasalousygameforthelast20years.Thescience
ishard,thetrialswereexpensive,thebuyersarepeculiarly
pricesensitive,andthebestnewdrugsmaybeheldin
reserve.WhatcapitalistwouldriskmoneyonR&Dforcheap
drugsthathardlyanyonewilluse?Unfortunately,drug
resistantbacteriadontcareabouttheeconomicsofR&D.
Theywillhappilyevolvewhilethecapitalistsinvestin
somethingelse.Thusthereismarketfailure:Theriseofdrug
resistantbacteriafiftyyearsafterwegotusedtotheideathat
richpeoplelikeusdontgethorriblebacterialinfections
anymore.
Thereisabigideaattheheartofproposalstodelivernew
antibiotics.Theideaistoweaken,oreveneliminate,the
connectionbetweenpricingpowerandthesizeoftheprize
thatcompaniesreceiveforsuccessfulR&D.Theideaiscalled
delinkage.Initsmostextremeform,aninternational
consortiumwouldofferlargeprospectiveprizestodrug
companiesforeachnewclassofantibioticsprizesupto$3.5
billion.Onreceiptoftheprize,thecompanyhandsoverall
intellectualpropertyrightstotheconsortiumwhichthen
arrangescheapmanufactureandcontrolsdistribution.
Delinkagehasenteredthemainstreamforantibiotics
becausetheconventionalprizeforsuccessfulR&D,rightsto
exerciseamonopoly,failsfortworeasons.First,thevalueof
themonopolyistoosmalltoexciteenoughinvestors.Second,
highprices,eveniftheycouldbeachieved,mightcreatethe
wrongincentives.Therewouldbethetemptationto
maximizeprofitsbysellinglotsofthenewpills,encouraging
theevolutionofdrugresistanceamongbacteria,and
achievingpreciselythewrongpolicyoutcome.
IfdelinkagestimulatesantibioticR&Dandsupports
equitableandresponsibleuseofnewantibiotics,at
reasonablecosttogovernmentswhoputuptheprizemoney,
thendelinkagevariantscouldapplytodrugclasseswhere
FirstWorldhealthsystemsthinkthemarketisfailingin
differentways.Withantibioticstheproblemisinsufficient
marketpower.Insomeothertherapyareas,theproblemis
toomuch.
Iamnotsureifdelinkagewillworkforantibiotics.Itlooks
fiercelycomplexinpractice.Itrequiresinternational
cooperationandagenciesthatdontyetexist.Itmayprove
lesscosteffectivethanthepricebasedincentives.Itmay
appealtocollectivistEuropeansbutfounderontheshoalsof
UShealthcareexceptionalism.Weshouldknowinaround15
years.
Acknowledgements
IthankDanielKleinandFrekeVuijst,whoImetatthe2015
GoldlabSymposium,forencouragingmetotrytowrite
somethingpopularandaccessibleondrugpricing,
althoughImayhavefailedonbothcounts.IthankLarry
GoldandMarcFeldmannforinvitingmetotheGoldlab

Symposium.
GeoffreyOwen,AndrewJack,MattHerper,DanHurley,
MarcWortman,RichardBarker,JoyceTait,Marian
Jarlenski,DavidHealy,MartinMichel,GeoffreyPorges,Tim
Anderson,RonnyGal,SimonBaker,JimBosley,Matthew
Todd,RichardDeGeorge,SallyMarlow,RichardTorbett,
andMireilleFarrandonprovidedhelpofvariouskinds,
includingviolentdisagreement.
AversionofthisarticlewillsoonbepublishedbyInnogen,
UniversityofEdinburghandTheOpenUniversity,as
InnogenWorkingPaperNo.114.
JackScannellcoinedthetermEroomsLaw(MooresLaw
backwards)todescribetheexponentialdeclineinR&D
efficiencyinthedrugindustrybetween1950and2010.He
coveredEuropeanhealthcarestocksatSanfordBernstein
from2005to2012.HestudiedMedicalSciencesat
CambridgeUniversity.Hehasbeenanacademic
neuroscientistandhasworkedincommercialdrug
discovery.HenowstudiesR&Dproductivity,andisbasedat
Innogen(UniversityofEdinburgh)andCASMI(University
ofOxford).
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