FDA May Hold the Key to Holding Down Drug Costs

Pharmaceutical companies are back in the hot seat. Earlier criticism focused on expensive, newly developed drugs for cancer and hepatitis C. Now censure is directed at companies that buy old drugs with few therapeutic alternatives and impose enormous price increases.

Critics cite this behavior as evidence that the drug market does not work and needs additional regulation. The critics are both right and wrong: The current market, hobbled by inefficient regulation, does not work, but the solution is better, not more, regulation. And, unlike the earlier criticisms of drug companies, here public outrage is justified and helpful.

The latest furor began with the disclosure that Turing Pharmaceuticals acquired a 62 year old drug, Daraprim (pyrimethamine), used to treat the parasitic infection toxoplasmosis, and immediately increased the price 5000 percent. Toxoplasmosis can cause severe disabilities and even death in pregnant women, their newborns and people with compromised immune systems  --such as HIV patients and patients receiving chemotherapy or immunosuppressive drugs. Turing was emulating Valeant Pharmaceuticals, whose business model consists of purchasing companies and older drugs and jacking up prices.

In a free market, Turing can charge whatever it wants to maximize profits. If the price is too high, physicians will use alternative treatments. If profits are high, other manufacturers will come into the market to make the drug whose patent protection has expired or will develop new, patent protected, drugs to compete with Daraprim. But this description is too simplistic.

First, the market cannot adjust so easily. Daraprim is the best treatment for toxoplasmosis. There aren’t effective alternatives for physicians to prescribe. More importantly, government regulation has created severe barriers for other potential makers of the drug or alternative treatments. Generic drug applications to the FDA (known as “Abbreviated New Drug Applications” or ANDA) to make the same drug cost applicants $10-20 million and can take 50 months. The FDA Office of Generic Drugs reports that over the past five years, it has received more ANDAs than expected, median review times have lengthened and the ANDA backlog has risen to 4,000 applications. A company trying to develop a new, competitor drug would face even more daunting FDA approval hurdles costing billions of dollars and taking many years.

Second, according to behavioral economist Daniel Kahneman and others, firms’ behaviors are influenced by more than just profit maximization. Profit-seeking firms also consider fairness. Manufacturers and suppliers, even those with some degree of monopoly power, do not always raise prices as high as the market will bear. For example, entertainment and sports firms offer tickets at standard prices for popular events that generate excess demand and companies refrain from price increases during periods of shortages. In part, this behavior (sacrificing short-term profits) is an attempt to maximize long-term profits by producing goodwill and a trusted reputation among customers. But it also appears that firms are concerned about their reputation for fairness apart from considerations of profits.

Kahneman found fairness judgments are influenced by “reference transactions” — the history of previous prices, transactions between a firm and its customers and profits — which serve as guideposts for acceptable new prices and transactions. Community standards allow firms to continue the terms of the reference transaction and obtain reference profits. Customers will accept price increase as “fair” if they reflect increased costs even during periods of slack demand. But price and profit increases well beyond reference values that are not justified by increased costs are considered “unfair.” Exploitation of monopoly power and of vulnerable, dependent buyers is also condemned.

Mainline pharmaceutical companies generally adhere to these norms. Companies criticized for expensive new drugs can legitimately claim that the new drugs took years and billions of dollars to develop and that profits will fund future research. Prices increases on older drugs occur but are less common and more moderate than generally believed. A 2009 GAO report noted increased numbers of brand-name drugs with price increases greater than 100 percent over the preceding eight years but found that these drugs only account for half a percent of all brand name products. In the past year Pfizer raised prices on 133 of its 600 drugs and Merck raised prices on 38 of its 200 drugs, but the increases only averaged 8-9 percent. Glaxo Smith Kline (GSK) manufactured Daraprim for years but kept the price low. Similarly, GSK kept the price low on Albendazole, another antiparasitic drug with few alternatives, years after its patent expired. But when GSK sold Albendazole marketing rights to Amedra Pharmaceuticals (later acquired by Impax Laboratories, the same company that sold Daraprim to Turing) Amedra increased the price twenty-fold over three years.

Turing Pharmaceuticals did not incur the costs of developing a new drug. It bought an established, inexpensive drug. Contrary to its CEO’s universally dismissed claim, Daraprim profits will not finance toxoplasmosis research. The price increase was so far beyond the reference pricing and profits for Daraprim that it elicited an immediate and harsh public backlash. Not surprisingly, Turing’s CEO announced a price decrease. Likewise, Rodelis Therapeutics, which acquired cycloserine, a treatment for drug-resistant tuberculosis, and raised the price overnight, bowed to public pressure and returned the drug to the nonprofit organization from which Rodelis acquired it. Valeant Pharmaceuticals though, remains unrepentant, arguing it is entitled to price increases.

Market norms and public outrage have largely restricted unfair pharmaceutical company behavior. Going forward, the FDA Office of Generic Drugs should fast-track ANDAs where high drug prices result from shortages or, as in the case of Turing and Valeant Pharmaceuticals, manufacturers exploit dominant market positions for drugs with few alternatives.