Prescription Drugs

Drug Price Gouging?

Prices are set based on what the market will bear



The price of Daraprim, a 62-year old drug used to treat the parasite infection toxoplasmosis, skyrocketed earlier this month, rising from $13.50 to $750 per pill—an increase of 5,000 percent. Martin Shkreli, the head of the drug's new marketer Turing Pharmaceuticals, has been widely excoriated as a heartless profiteer preying on sick people. Similarly steep recent price increases in other medications have also been decried and investigated recently by congressional committees. For example, URL Pharma turned the ancient anti-gout drug colchicine into Colcrys, boosting the price from pennies per pill to $5 each; the price of Mallinckrodt's Ofirmev pain injections are up 250 percent; and Horizon Pharma's Vimovo pain tablets now cost 600 percent more.

Are these price hikes indicative of an overall trend? Not according to the Express Scripts Prescription Price Index. The pharmacy benefits manager, which keeps track of the prices of both branded drugs and generic drugs, reports that since 2008 "the prices for the most commonly used generic medications decreased to $37.13 (in 2008 dollars), and prices for the most commonly used brand medications increased to $227.39 (in 2008 dollars)."


Overall, the company notes that since 2008, "the average price of brand drugs has almost doubled, while the average price of generic drugs has been cut roughly in half."

As in other markets, more competitors generally mean lower prices. The Federal Trade Commission reports that prices drop about 20 percent when first generic manufacturer enters the market for a branded drug whose patent has expired. As more generic competitors enter, the price falls to as low as 20 percent of the original branded drug price. The Food and Drug Administration (FDA) points out that nearly 8 in 10 prescriptions filled in the United States are for generic drugs. Using data from the IMS Health Institute, the Generic Pharmaceutical Association calculates that the cost savings in 2013 from using generics was $239 billion and that generic products saved the U.S. health system nearly $1.5 trillion between 2004 and 2013.

So what is going with Daraprim?

Daraprim was discovered in 1953, and its patent expired in in the 1970s. The pharmaceutical giant GlaxoSmithKline (GSK) sold it until 2010, when the company divested itself of the U.S. rights to this small market drug to CorePharma, a subsidiary of Tower Holdings. (Basically, this means GSK transferred its FDA license to market the drug in the United States. The company continues to make and sell the pill in other countries.) In October 2014, Impax Laboratories bought Tower, acquiring the marketing rights to Daraprim in the process. In August of this year, Impax sold the rights to Turing. The drug is prescribed to only a few thousand patients per year, so no other manufacturer has had the incentive to develop a competitive pill. If they had wanted to manufacture their own version, they first would have to conduct comparative clinical trials to convince the FDA that their compounds are identical to Daraprim.

Shkreli devised a plan to exploit the situation. First, he apparently talked Impax into starving the wholesale market of the drug, so that when Turing completed its purchase of the rights there were no extra pills floating around. Next, he set up an exclusive distribution network as a way of preventing potential competitors from obtaining enough Daraprim to conduct those trials for the FDA. With potential competitors blocked, his monopoly did what monopolies do: set its prices to maximize profits.

Following a fierce backlash—Democratic presidential candidate Hillary Clinton declared that "Price gouging like this in the specialty drug market is outrageous"—Shkreli has backed down, saying that Turing will lower the price of Daraprim. But he still plans to hang on to his monopoly. 

What about the other drugs seeing sharp price increases? In colchicine's case, it's one of about a thousand medications that were grandfathered in before the FDA got the power to approve drugs' efficacy and safety in 1962. The agency wants to have the efficacy, safety, and dosing of these earlier medicines tested in clinical trials, so companies that conduct such trials can (if the agency approves their formulation) get three years of exclusivity to market the drugs. Thus did colchicine, used for centuries to treat gout, become Colcrys, a product with a government-enforced monopoly. The good news is that a generic version of colchicine became available this year. 

Orfimev and Vimovo are still patent-protected monopolies. In theory, patents are awarded as incentives to get pharmaceutical companies to invest billions to find and market new medications. (The Tufts University Center for the Study of Drug Development estimates that it costs $2.5 billion to get a new drug from petri dish to patient bedsides now.) The manufacturers of Orfimev and Vimovo sold the drugs' marketing rights to other companies, which decided that the medicines were undervalued.

Other factors also play a role in steeply rising prices for some generic pharmaceuticals, including industry consolidation and increasing regulatory burdens. There is a strong relationship between a drug's market size and the number of companies that decide to make it. The fewer prescriptions that are likely to be filled, the fewer competitors will emerge. A 2013 study by the Federal Trade Commission found that "drugs that eventually attract at least five competitors face a steep decline in prices." So if, say, there are only two manufacturers of a rarely prescribed drug, it's easy for them to form a cartel. There is also little incentive for another company to challenge their monopoly by seeking to enter such a small market. 

In addition, the FDA has increased its scrutiny of generic pharmaceutical manufacturing processes. One result, as Scott Gottlieb of the American Enterprise Institute has noted, is that "higher manufacturing costs, and the tighter scrutiny applied to new manufacturing facilities, have increased the entry costs for new generic drugs and generic drug makers." Furthermore, the higher costs make drug production unprofitable for some generic drugmakers that then choose to stop producing marginal products.

There is also a growing backlog of new applications seeking FDA approval for generic drugs. Average review time for an application is now over three years. So even if another company decided to enter the Daraprim market, Turing could probably count on at least a three-year competition-free period in which to sell the drug at a high price.

Reputation matters, and customers can still complain, call out, and shame companies they believe are exploiting them. That's what happened in the case of Daraprim: The media firestorm pushed Turing to lower its price. But the best long-term solution to the situation is to enhance competition. The FDA should immediately adopt an explicit policy in which applications by companies seeking to compete with generic monopolies such as Daraprim are fast-tracked over the backlogged queue.

While Daraprim and a few other monopolized medications make headlines and prompt congressional hearings, they are outliers. The good news is that competition continues to lower prices for most generic drugs and benefit patients.