Why Drugs Cost So Much

by on August 17, 2012

It's the rare American (or one with phenomenally good health insurance) who hasn't griped at least once about the cost of prescription medication.

Currently, U.S. health care costs are rising faster than general inflation--due to an increase in prices, not usage. And prescription drug prices are rising even faster than general health care costs.

A recently published report found that prescription drug prices increased at an annual rate of 8.3% from 2006 through the beginning of 2010, significantly faster than the 3.8% annual increase in overall health care costs.

Why Prescription Drugs Cost So MuchThe costs can be astonishing. ABC5 News investigated pricing among the most popular drugs in America. Prices varied at different pharmacies, but below is a short list of CVS' prices for a 30-day supply of these drugs, without insurance:

  1. Lipitor, for lowering cholesterol: $225.99
  2. Nexium, for heartburn: $249.99
  3. Plavix, a blood thinner: $258.99
  4. Advair, for asthma: $316.99
  5. The above prices are a bargain compared to Abilify, one of the newest antipsychotics, which costs $1,091.99 for a month's supply.

It's enough to make people sick or, at least, angry.

Why does medication cost so much--and who decides what the company should charge?

Although there's no algorithm to determine the price of a medication, and the internal discussions among pharmaceutical company executives make these determinations well-kept secrets (who did write the price tag for Abilify? Wouldn't you love to talk to that man or woman?), there are a number of factors that determine what the consumer will have to pay for a drug.

In a PLOS blog entitled "Diverse Perspectives on Science and Medicine," post author Jessica Wapner suggests the following considerations on the part of the drug companies.

First are the estimates of how popular this drug is likely to be:

1.  How many people does the company think will take a given drug? and

2.  How long will a given patient be on the drug (on average)?

These are hard questions to answer, but the pharmaceutical companies work long and hard to make strong estimates --and work with the promotion division to help meet them. [It seems that drug to consumer advertising does, indeed, increase drug usage, as patients ask their doctors for medications they've seen advertised on TV.]

Then come market issues:

3.  How many of those people can the company expect to be privately insured, and

4.  How many will have Medicare or Medicaid, and

5.  How many will have no insurance at all?

Once the drug companies estimate the uninsured percentages, they then consider the number of patients to whom they will offer patient assistance.   The Pharmaceutical Research and Manufacturers of America (PRMA) said its member companies provided free or reduced drugs to 6.2 million people via patient assistant programs  in 2003 alone. This, too, will factor into the cost of the drug.

Other factors particular to the way the finances work in the drug world come into play as well:

6.  How many years will this drug have market exclusivity--and could that exclusivity be extended?

Related:  Drugs Losing Patent Protection in 2012.

7.  Is this a drug that is meant to treat those who have no other options and that could be the difference between life and death? Or does it treat a milder condition? And how much more can companies charge for a life-saving compound--and still get away with it?

Finally drug companies factor in some staggering costs--the costs of inventing and making the drug, the cost of promoting it, and the cost of defending it from litigation.

Let's stop to spend some time here, since it's in this arena that the numbers are more available, and can become truly astonishing.

Josh Bloom, director of chemical and pharmaceutical sciences at the American Council on Science and Health, a health-care education and advocacy group based in New York, notes that when people demonize drug-makers for their billions in sales on a blockbuster med, they forget some important information:

  • It takes about 14 years to bring a drug to market.
  • It costs about $1.3 billion.
  • For every drug that reaches the shelves, over 50 other research programs fail.
  • Only 2 of every 10 approved drugs turn a profit.

During this year's Super Bowl, a representative from drug-maker Eli Lilly posted on the company's blog what $1.3 billion looks like, in football terms. Some of her ideas of what you could do with that amount of money?

You could buy:

  • "371 Super Bowl ads. The average cost of a Super Bowl ad is $3.5 million dollars."
  • "2 professional football stadiums. The average cost of a new professional football stadium over the last ten years is $536 million." Or perhaps:
  • "11,000 houses in Indianapolis. The median cost of a house in Indianapolis is $118,100.; 2,500 houses in New York. The median cost of a house in New York is $504,500; 3,500 houses in Boston. The median cost of a house in Boston is $369,600.

Okay--so drug companies do need to recoup large amounts of money. But...

What takes so long and makes the process so expensive in the first place?

Matthew Harper, who writes for Forbes, has some answers.

First pharmaceutical companies must run clinical trials, where the drug is utilized on humans to determine its efficacy and discover any untoward side effects. Clinical trials are mandatory for a drug to get approval from the Food and Drug Administration, and, claims Mr. Harper, can cost as much as $100 million a pop. [The FDA will often send the company back for additional trials, before the drug is approved, as well.]

Then there's manufacturing. Harper suggests that the combined cost of manufacturing and clinical testing can be as much as $1 billion.

But, he says, "the main expense is failure."

In 2010, Pfizer failed to get a drug to market that would fight heart disease by raising good cholesterol.

Pfizer had already spent $1 billion on its efforts. That money will need to be made up—in higher prices for the drugs that do make it to market.

According to his estimates, Eli Lilly spent around $50 billion from 1997-2011 in research and development (or R&D, in drug company lingo). AstraZeneca spent a comparable amount: close to $59 billion.

However, since during that time AstraZeneca successfully got only 5 drugs to market, while Lilly got 11, AstraZeneca essentially spent over $11.5 billion per drug, while Lilly spent just around $4.5 billion. The failure to get the drugs successfully to market, after all the research and development dollars invested, costs a company billions, and, for the companies to stay afloat and profitable, these costs are passed along to the consumer.

Frustrating for everyone involved, lawsuits also ratchet up the price of medications

An October 2005 report from the Manhattan Institute found that lawsuits raise prices in all areas of healthcare, and that "While the excesses of the litigation industry alone cannot explain America's mounting medical costs," the study notes, "litigation is a large, and growing, contributor to our health-care bill."

As of January 1st, 2006, drug-maker Wyeth had set aside $21 billion in reserve to address the expected litigation for its anti-obesity drug Fen-Phen. In 2011 alone drug-maker AstraZeneca (actually a British company) had set aside $647 million to settle lawsuits surrounding its antipsychotic drug Seroquel, after already costing itself over $1 billion in legal fees, fines, and settlements, for not disclosing some adverse affects the company well-knew the drug could cause.

In the same year, Abbott reserved $1.5 billion to settle off-label lawsuits surrounding its anti-seizure and mood-stabilizing drug Depakote.

This diverting of funds from R&D and promotion yields an increase in drug prices, as the cutting companies' development or research budgets would knock the companies out of the game. So they simply raise drug prices, to cover lawsuit costs, and still leave them with a health research and development budget.

Finally there are the costs for advertising

In 2007, for example, Merck spent more advertising its arthritis drug Vioxx (now off the market) than "$125 million spent promoting Pepsi or the $146 million spent on Budweiser beer ads. It even came close to the $169 million spent promoting GM's Saturn, the nation's most advertised car."

The first way these ads increase drug prices, of course, is that the advertising budget for drug companies is large, and those expenditures must be recouped.  Spending on direct-to-consumer advertising (DCTA) increased over 330% from 1999-2009--and drug prices increased steadily over those years, as well.

Two researchers, who published their findings in the January 3 2008, issue of PLoS Medicine, found that pharmaceutical companies spent more--in fact, almost double--on promotion as opposed to R&D. Those expenditures clearly boost the costs of medications.

Then there is a secondary reason that the drug promotion raises prices, according to some theories. By increasing demand for the advertised drug through the commercials, the companies also raise price, a basic supply and demand situation.

Dhaval Dave, Associate Professor of Economics at Bentley University, researched the impact of drug advertising, and shared in his piece, "Direct-to-consumer advertising in pharmaceutical markets: Effects on demand and prices" that "We find robust evidence that broadcast DTCA raises the demand (sales) for the advertised drug as well as its price . . . .[A] 100% increase in broadcast DTCA will raise demand by about 10% and price by about 5%. . ."

Notably, a paper published just before Dave's disagrees with his finding that advertising increases sales. Daily Finance reported on a study in the Archives of Internal Medicine, which analyzed pharmaceutical company spending for Plavix, an anti-clotting drug, and found that DCTA did not increase use of the drug, but still increased price, due to the company's need to recoup its expenditures.

The outsize effects of drug promotion don't end with DCTA. Promotion to doctors through sales representatives visiting physicians directly in their offices has even more impact on demand than DCTA. That, asserts Dave, is why physician advertising accounts for 85% of a drug promotion.

What to make of all this!

It's easy to feel frustrated as a consumer, frustrated at the amount of money you're spending on your medications, frustrated when you hear that pharmaceutical companies spend more on promotion than R&D, frustrated that drug prices keep increasing while your salary stays steady, frustrated when you learn that in other countries they cap drug prices so the costs don't surpass the inflation rate.

But at the same time it is important to remember that there are two sides to every story, and pharmaceutical companies have very real reasons for charging the sums they do. Fundamentally, they believe that these costs allow them to go on developing, creating, patenting and marketing medications that can change the lives of millions of people.

Why does it cost more in the US ?

So--why does your medicine cost more in the United States than it does in Canada, or England?  Well, we've gotten stuck footing the bill for most research and development, it seems. Other countries just aren't coming out with the quantity and quality of life-altering medications that the U.S. is; innovation in Europe and Canada doesn't compare with what goes on in America. So all these costs of development and failure—very real and steep costs--are carried by the American public.

Michael Greve, a legal scholar at the American Enterprise Institute, claims that price controls in other countries force America to pay for the world in research and development. “The rest of the world free-rides on America’s innovative capacity in this area,” he says.

The Pharmaceutical Research and Manufacturers of America (PRMA) adds that profits, rather than being vilified, are necessary to fund the research that in time develops drugs to cure diseases, and change the face of health care as they do so.  So, they claim, we need to have a new way of looking at billions of dollars in sales for drug companies. We need not begrudge it—we might even, suggest some, feel grateful for it, as the profit motive keeps development of new drugs running smoothly.

Lori Reilly, PRMA vice-resident, believes “We’re a lot better off having innovative drugs and having a debate about prices, than we are not having innovative drugs.”

How much is ‘too expensive’?

Others argue that the best way to look at drug prices is in comparison to the alternatives: pain, suffering, surgery, chemotherapy, death.

A study run by the National Institutes of Health found that using anti-clotting drugs on stroke patients saves $4400 per patient by cutting the requisite days in the hospital.

And a number of the new--and staggeringly expensive--drugs, can for the first time treat conditions that were untreatable before their development. For example, 339 AIDS medications came to market between 1987 and 1999. In 2009 the FDA approved Folotyn (pralatrexate), the first treatment for Lymphoma. It's cost? An astonishing $30,000 a month.

But how can you put a price tag on a life-saving cocktails and medications? How much is ‘too expensive’ for your life, or that of your wife, or child, or parent?

So when you ask why your medicine costs so much, think about R&D costs, the price of innovation, the cost of failure that is part and parcel of innovation, the impact lawsuits have on what you pay at the counter--and think to yourself whether the price you're so shocked by isn't really much cheaper than a horrific alternative.

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