Calling all competitors.

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The Strange Case of Off-Patent Drug Price Gougers

Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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There’s a conflict at the heart of pharmaceutical pricing in the U.S.: On the one hand, it’s in the public’s interest for pharma companies to get a good return on the huge investments they often make in developing new drugs. On the other, it’s in the public’s interest to be able to afford those drugs.

We try to resolve this by granting companies temporary monopolies (aka patents) on the drugs they develop -- letting them effectively set the price unilaterally -- but then allowing competition from generic substitutes once the patents expire.  Lots of people have strong opinions about whether we’ve struck the right balance, or should regulate drug prices as most other wealthy countries do -- although regulating prices appears to depress spending on research to develop new drugs.

So … that’s a tough one. I’m not going to resolve it for you today, or probably ever. But here’s an interesting and too-little-emphasized fact: Most of the recent high-profile controversies over drug pricing don’t have much of anything to do with this seemingly intractable conflict. For example:

None of the products mentioned above were developed by the companies selling them now. Mylan doesn’t even make the EpiPen (Pfizer does); it just acquired the marketing rights nine years ago. It’s able to charge so much because the design of the injector is proprietary. Competitor Sanofi did get Food and Drug Administration approval for its Auvi-Q injector in 2012, but abandoned the product early this year because of dosage problems.

With Daraprim, meanwhile, the market for the drug is quite small, so no one ever bothered to develop a generic competitor. And one of the (many) issues at Valeant was that it effectively controlled a specialty pharmacy, Philidor, that altered doctors’ orders to substitute more expensive Valeant drugs for their generic competitors.

What’s going on, basically, is that a new breed of pharmaceutical company has emerged (Valeant is, or at least was, the archetype) that doesn’t develop drugs but identifies business opportunities in existing drugs --many of them with expired patents -- that the previous owners were too lazy or timid or decent to fully exploit. So they acquire them, and jack up the prices. One should take the price increases I’ve cited above with a grain of salt; as Peter Coy explained in Bloomberg Businessweek last week, rebates and other incentives mean that most insurers pay nowhere near list price.  But still, the general idea has been to extract more money out of old drugs than was being extracted before.

There is clear business logic to this, of course. And increasing the value of off-patent drugs presumably gives drug companies at least a little bit more financial incentive to develop new drugs. But sudden big price increases in off-patent drugs also feel like a violation of the long-standing contract between the pharmaceutical industry and society -- and they have invited a political backlash that may end up costing the industry far more than Mylan, Turing and Valeant’s price hikes have gained.

So what’s the solution? A couple of weeks ago, Vox’s Sarah Kliff argued that the EpiPen price increases showed why we need drug-price regulation in the U.S. That brought a long response from pseudonymous physician-blogger Scott Alexander arguing that, in EpiPen’s case, the main problem seemed to be that the FDA had rejected potential competitor after potential competitor (and hadn’t exactly made things easy for Sanofi). It was too much regulation that allowed Mylan to charge so much, not too little. Kliff then responded to Alexander, then Alexander to Kliff’s response -- it’s all quite entertaining and informative.

In the case of the EpiPen, I’m pretty sure Alexander (and my Bloomberg View colleague Megan McArdle) are right that competition, not price regulation, is the solution to the problem. It’s a product for which there is a large and growing market, and there are already multiple competitors being sold in Europe, where prices for both the generics and brand-name EpiPens are much lower than in the U.S. Tear down this wall, FDA!

The situation is totally different, though, for Daraprim, which is essential for treating certain parasitic infections but is (1) only prescribed to about 2,000 Americans a year and (2) doesn’t need to be taken for very long. That isn't a market opportunity to warm a generics manufacturer’s heart. In fact, it may be a natural monopoly.

In an article on the off-patent pricing issue published earlier this year in the Journal of Law and the Biosciences, Harvard Medical School Ph.D. student (and startup co-founder) Naren Tallapraganda described one Daraprim workaround: Imprimis Pharmaceuticals, a compounding pharmacy that “fills doctor-prescribed, patient-specific formulations of mixtures of drugs,” has made a deal with pharmacy-benefits manager Express Scripts to sell a compound of Daraprim’s active ingredient and a complementary drug for $1 a tablet. Still, there are limits to what compounding pharmacies can do, Tallapraganda writes. For some off-patent monopolies, government price regulation might actually be the best available remedy.

  1. Patent duration in the U.S. is 20 years, but drug testing and FDA approval takes years, so the effective patent monopoly is much shorter than that.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net