The Great American Drug Deal

by Peter Kolchinsky

  Taking a problem to an extreme often reveals its working parts. A company charging $10 billion/patient/year for a very effective drug to treat 1,000 patients with a very rare condition would make $1 trillion/year. If this company were built like a typical biotech company serving such a small number of patients, it might have 100 employees and $100 million/year in expenses (e.g., salaries of employees, but also rent, cost of manufacturing the drug, accounting and legal expenses), which are insignificant compared to the revenues. So after paying 21% in corporate tax, the company would have a 79% profit margin, which would stand out.

  Alternatively, to keep its profits down, the company could pay its 100 employees each billions of dollars each year, which would also not go unnoticed. Or it could pay average wages but employ tens of millions of people, which would also stand out as particularly wasteful, having so many people working for the benefit of so few.

  And if you cut the price of that company’s drug by 90% or even 99%, the company would either still be wildly profitable with a profit margin over 78%, or the workers would still be wildly overpaid, or there would still be far more workers than would seem reasonable. Such absurdity is how you would recognize that a drug is dramatically overpriced.

  But when you look at the drug development industry in the US, the numbers are not consistent with drugs being wildly overpriced, despite how the drug industry is portrayed by the media. The drug industry generated $344 billion in sales in the US and about $1.15 trillion worldwide in 2018. It has profit margins that range from 10-20%, which is less than banks and software, and around the same as the oil and gas industry.213 Roughly 3% of the US workforce (4.7 million people) is directly and indirectly employed in the drug industry (roughly 15 million globally) and earn an estimated average salary between $60,000-80,000. This is slightly above the US median income of $58,500/year—although not unreasonably higher considering all the scientists and others with advanced training that work in drug development.214 Executive compensation gets a lot of attention, but there are so few executives that even if they all got paid $1 million year (and most are paid much less),215 they would account for a small fraction of the industry’s expenses.

  Consider that it would take only a 20% drop in drug prices worldwide or a 30% cut in the US price alone to wipe out most profits and executive compensation, both cash and stock (since stock values are tied to profits). Without funding from investors (who would not want to invest their capital in an unprofitable industry) and unable to recruit workers from other industries that pay better, the drug industry would shrink and make fewer new medicines. Yet to a patient without insurance, a 20% or 30% discount on a $20,000/year drug doesn’t make it affordable—that’s what we need insurance reform for. So if the industry is to continue to employ the people it does and attract investors to fund innovation, it will have to maintain its current revenues and profits.

  As this book goes to print, Congress is debating a proposal to impose a combination of price controls and international reference pricing. Lawmakers want to reduce America’s spending on branded drugs by $100 billion/year for ten years, $1 trillion in total, which represents a 37% reduction in branded drug revenues.216 The Congressional Budget Office (CBO) notes that the industry launches approximately 30 new drugs per year, a projected 300 novel drugs over a decade. Yet somehow the CBO calculates that a 37% cut in American branded drug spending would only reduce the number of new drugs created by 8-15 over 10 years.217 How could they think the impact is so modest?

  One answer is that the CBO believes that reference pricing would raise prices in Europe, so maybe the CBO assumes Europe will pay more for drugs. This puts too much faith in the healthcare systems of countries that have already proven themselves willing to deny patients access to treatments. Another answer is that the CBO assumes that drugs already pretty far along in development will still prove worthwhile for companies to bring to market. That’s probably correct. Price controls would have the greatest chilling effect on the earliest stages of innovation. Pension funds, university endowments, and other investors would likely pull their money from venture capital funds that invest in biotechnology, because those funds would no longer offer good enough returns. Those funds would then no longer be able to seed the industry with as many novel projects. After five years, it would become more apparent that, for certain types of challenging diseases or therapies that are expensive to develop, there are fewer clinical-stage drug candidates. After that, the real reduction in new drug approvals would become clear.

  By asking the CBO to look out one decade, as is conventional when considering the impact of new legislation but inappropriate for the long timelines involved in drug development, Congress is being short-sighted and the public is being misled. If the CBO were to calculate the reduction to new drug approvals in the second decade after the introduction of such price controls, it would become apparent just how much American patients would stand to lose.

  Price Check

  Why don’t companies just raise drug prices 10-fold if America is price-insensitive? Because the executives and board members who run these companies actually feel the social pressure to justify their prices. They can justify profits that are above average, but not record-setting. Similarly, they can justify employing a finite number of employees and paying them salaries that are generally above-average, but not record-setting. Given these limitations, total revenues of the drug industry can only be so high at this time. Competition is a second factor: There are many drug classes that have multiple similar drugs that insurers can play off one another, as happened with hepatitis C drugs to cause their prices to come down dramatically. And finally, whenever a company finds a great, one-of-a-kind drug that is highly in-demand and can command a high price, the on-patent life of that drug is finite, so any inflated profit this company makes is temporary.

  Profitable drug companies lose revenue and profit every time one of their branded drugs goes generic, which allows us to see how they respond to these situations. Some of them lay off people and shrink down to a size that allows them to remain profitable from their now-reduced revenues. Others have developed new drugs that they can launch to replace the lost revenue. If a company hasn’t developed any new drugs, they will often use the cash they have accumulated from selling their old drugs to buy companies that are developing new drugs, which rewards those companies’ innovators and investors. Drug companies can also make up for lost revenue by raising the prices of their other drugs, which only works for so long because those drugs, in most cases, also eventually go generic.218 So as long as drugs go generic, the only way for drug companies to survive for the long run is to continue to launch new drugs at prices that allow the industry to stay profitable.

  Any one company might look like it’s doing exceptionally well at any given time, but they don’t stay on top forever and investors own a portfolio of drug companies. So the companies doing well compensate for the ones that are struggling. Any discussion of price controls therefore cannot assume that the industry will be fine if only the standout drugs get clipped. It’s those drugs that make the whole portfolio work, just like a restaurant that charges a lot for a few items can’t be accused of price gouging if the profits of the business as a whole are reasonable—those items might be what are sustaining the business. So we have to look at the whole enterprise. An analysis of the drug industry overall shows that there is little room for price cuts either globally or in the US, certainly not enough to make drugs affordable for patients without insurance or the many who can’t afford their out-of-pocket costs. The solution patients need is insurance reform.

  At the societal level, drugs going generic is the drug price control we have long had and the only one we need to ensure that society continues to get value from what it pays for drugs.

  * * *

  213Rebecca E. Wolitz, “New GAO Report on Drug Industry Profits,” SLS (blog), Jan. 10, 2018, https://law.stanford.edu/2018/01/10/new-gao
-report-on-drug-industry-profits/.

  214“Biopharmaceutical Spotlight,” Select USA, International Trade Administration, accessed Oct. 15, 2019, https://www.selectusa.gov/pharmaceutical-and-biotech-industries-united-states;

  European Federation of Pharmaceutical Industries and Associations, The Pharmaceutical Industry in Figures (Brussels, Belgium: EFPIA, 2018), https://www.efpia.eu/media/361960/efpia-pharmafigures2018_v07-hq.pdf;

  Mateji Mikulic, “Global Pharmaceutical Industry—Statistics & Facts,” Statista, Aug. 13, 2019, https://www.statista.com/topics/1764/global-pharmaceutical-industry/.

  215I’m only counting cash compensation. The headlines one sees about executives making millions of dollars are due to situations where an executive’s stock or stock options have gone up in value. However, since in the case of this thought experiment we are considering what happens if we cut drug prices and wipe out industry profits, then the value of all stock goes to zero and all stock compensation is worthless, leaving only cash compensation to consider.

  216US Congress, House, Lower Drug Costs Now Act of 2019.

  217Phillip L. Swagel to Honorable Frank Pallone Jr., official email, Oct. 11, 2019, “Effects of Drug Price Negotiation.”

  218As I discussed in Chapter 8, ungenericizable drugs can turn a dynamic company that should be hungry to discover new drugs into one that can sit back on its laurels, just enjoying the profits of one product. Introducing contractual genericization would bring these products back into alignment with the Biotech Social Contract and ensure that all companies stay hungry for the next medical breakthrough.

  Part 3

  Beyond Conventional Thinking

  12

  Direct-to-Consumer Advertising: Hated, Misunderstood, Essential

  In mid-2019, television viewers in the United States stopped seeing a familiar sight during commercial breaks: A middle-aged man, sitting at a picnic table by the beach massaging his foot.219 He grimaces as his feet—“feet that made waves in high school”—are wracked with the “shooting, burning pins and needles” of diabetic nerve pain. Cut to the bare feet of a surfer, a dad kicking a ball, and the boot-clad feet of a carpenter building a home. “So I talked to my doctor, and he prescribed Lyrica,” says the man, a refrain that has been repurposed across decades of pharmaceutical advertisements. These commercials have fueled countless satires and sparked a fierce, ongoing debate about the role of marketing and advertising in the use and price of drugs. As is often the case in the healthcare industry, a closer look reveals some surprising truths and misconceptions.

  Paternalism and the First Wave of DTC Drug Advertising

  In the past, patients were expected to place complete trust in their doctors. Doctors, with their training and superior knowledge about available treatments, were to be obeyed without question and were even permitted to make decisions on patients’ behalf without obtaining informed consent. If the doctor deemed it best, it was not unusual for him to keep a patient in the dark about their own condition—for instance, a doctor might inform a patient’s family of an incurable cancer diagnosis, but not actually tell the patient. This approach to medicine, often referred to as “paternalism,” made it possible for doctors to process more patients in less time. To our modern sensibilities, it might feel more analogous to the way a veterinarian treats sheep.

  In the days of paternalistic medicine, pharmaceutical companies promoted FDA-approved drugs directly and exclusively to physicians.220 Direct-to-consumer advertising (DTC) did not emerge until the 1980s,221 prompting an outcry from physicians and watchdog groups alike.

  Those practicing paternalistic medicine felt their authority challenged by patients asking too many questions and demanding treatments that a doctor considered inappropriate. They argued that DTC ads left patients misinformed and clamoring for medicines they did not need. To be fair, in these early days, some companies took advantage of the lack of advertising regulations to play fast and loose with the facts or seize on the fears of the worried well.

  This backlash resulted in the FDA issuing a swift moratorium on DTC pharmaceutical ads in 1983. Two years later, strict rules and regulations were put in place to make sure information was as clear and complete as possible. Since the airtime required to put all that information into a radio or TV ad was expensive, DTC drug ads were mainly relegated to print advertising. The modern era of DTC advertising didn’t arrive until 1997, when the FDA allowed television and radio ads to mention a drug’s most important risks and then direct patients to other sources for additional information (as opposed to requiring ads to numbingly rattle off all the details included in print ads). Per those regulations, all pharmaceutical DTC ads that make medical claims:

  cannot be false or misleading;

  must present a balance of risks and benefits;

  must state facts that are material to the advertised uses; and

  must include every risk from the product’s approved labeling (if in print) or several sources where a patient might find information about all the risks.222

  That’s a lot of information—approaching what a physician would learn if they read the scientific literature—and it is often dry and inaccessible, because it is restricted to scientifically proven medical claims. Vague wording and imagery can result in skewed, overly rosy messaging, which results in a gray area policed, appropriately, by watchdog groups and the FDA.

  With the emergence of the Internet, patients became more informed—even if not always better informed—about their health. They came to their doctors with printouts of what they saw online, which didn’t always agree with what their doctors had told them, and sometimes the Internet was right.

  In medicine, as in everything, the opposite of knowledge is not ignorance but the illusion of knowledge—thinking you know when you actually don’t. This confidence can lead to physicians not staying up to date with recent medical discoveries and inadvertently steering patients away from the best treatment options. And that’s why paternalistic medicine is on its way out, and why doctors who still practice it are considered dinosaurs.223

  Physicians have increasingly come to accept their limitations with humility and embrace shared decision-making, which empowers patients to stay informed and involved in defining their own treatment plans. Today, what little paternalism is condoned (e.g., restraining a post-surgical patient who rips out their IV in a panic) is considered a last resort after attempting to inform and collaborate with patients and their caregivers.224

  In this changing environment, DTC drug advertising was sometimes embraced as a way for patients to become more informed and to engender discussions about new treatments. Even physicians (45%, according to a study published in 2006) began to see the merits of DTC advertising.225

  After all, physicians today are more overworked than ever, facing ever greater demands on their time and attention. The knowledge they must master and the tools they must know how to use are continually changing and expanding. They know more than physicians did fifty years ago, but not on a relative basis—there is simply more to know now—and what they don’t know is increasingly evident. Their every decision is scrutinized and second-guessed by patients and their family members, other physicians, insurance companies, and lawyers, and their mistakes are all the more public in the Internet-era.

  It isn’t reasonable to expect physicians to read and internalize every piece of literature about every new drug that hits the market.226 While many physicians will hear out pharmaceutical sales reps to stay informed of the latest advances, some institutions and physicians discourage or even ban sales reps from meeting with doctors.227 So having a patient mention symptoms or treatments they’ve learned about through a television commercial or magazine ad can spark a discussion that might not otherwise have happened and lead to a better treatment decision.

  The Arguments Against DTC Advertising

&
nbsp; Of course, a lot of doctors and other people remain staunchly opposed to DTC drug advertising, many of whom cite reasons ultimately rooted in paternalism, wishing patients would stop getting their information from anyone but their doctors.228

  A well-cited article written in 1999 by two physicians captures the anti-DTC view:229

  [The DTC advertising of a drug] unreasonably increases consumer expectations, forces doctors to spend time disabusing patients of misinformation, diminishes the doctor-patient relationship because a doctor refuses to prescribe an advertised drug, or results in poor practice if the doctor capitulates and prescribes an inappropriate agent.

  They go on to suggest that DTC advertising somehow compels doctors to prescribe what they know are wrong treatments for patients:

  If [doctors] believe that patients want and expect drugs then doctors will prescribe them even when they know they are not indicated, even when patients don’t specifically ask for them, and even when an individual patient never expected the drug but the doctor thinks he or she did.

  Some physicians cite demands on their time as a reason for doing away with DTC advertising. They argue that they simply don’t have time in their schedules to deal with patients who come into their offices with treatment ideas they got from television commercials. Similarly, a 2006 study revealed that some doctors disapproved of medical information on the Internet for related reasons.230 While I don’t agree with their proposed solution, it’s impossible not to acknowledge that doctors are short on time.

  In healthcare, there is a strong push by hospitals and practices for “productivity,” which means doctors are expected to max out the number of patients they see in a day. At the same time, the administrative burden on doctors has been climbing. For every ten minutes they spend with a patient, they spend twenty staring at a screen, entering more and more details as demanded by payers. Doctors call it “pajama time” since much of it is done while lying in bed at night, and most report spending up to two hours every night doing this work.231 This is especially problematic for family physicians, who are often the first line of care and are expected to have some level of expertise in every area of medicine. They are pushed to be ultra-productive in their time with patients, and their time away from patients is filled with administrative work—not, for example, with reading the latest journal articles to learn of new treatment options. Strained for time, I can appreciate why some doctors wish that patients would ease up with all their Internet- and DTC-driven questions and demands.