Lecture Health economics - Chapter 11: The pharmaceutical industry

Lecture Health economics - Chapter 11: The pharmaceutical industry. This chapter presents the following content: Competitiveness of the pharmaceutical industry, conduct, performance.

The Pharmaceutical Industry

Professor Vivian HoHealth Economics

Fall 2009

Benefits of Drugs

Reduce mortality

Reduce morbidity/improve quality of lifeReduce cost of treating diseases

Can competition be accurate

measured at the industry level?

Most drugs are not substitutes to the

Therapeutic Market Four-Firm Ratio

Express Scripts Drug Trend Report, 2006

*Includes “Generics” as a top-4 firm

Firms tend to make most profits from

a few key drugs

Company

Percent of Revenues

Johnson & Johnson 44.7

Percent of Net Revenues

Bristol-Myers Squibb 47.5

Top 3 Drugs as a % of Worldwide

6 Month Prescription Sales, 2007

The Buyer Side

Buyers of Prescription Drugs, 2007

How 3rd parties influence drug demand

Even if consumers exert little influence over drug choice, 3rd parties are

making the market more competitive

Formularies - list of selected drugs

physicians may prescribe

Used by hospitals to limit inventories and costs

Used by most HMOs and many PPOs

Used by many state Medicaid programs

Drug utilization review

Used by insurers to enforce formularies, identify inappropriate prescribing practices

Government influence

1990 Omnibus Budget Reconciliation Act - Federal funding provided for drug only if state Medicaid program receives

manufacturer rebate agreement

Government influence (cont.)

1992 Veterans Health Care Act - price

discounts for Federal Supply Schedule,

VA, Dept of Defense

These programs may restrict costs for

government, but drug firms may be forced

to raise nonfederal prices

“…managed care emphasizes less-expensive, preventive types of treatment”

“The rate of growth for drugs to treat high blood

pressure and high cholesterol in certain managed-care strongholds on the West Cost has gone off the charts” WSJ 10/17/96

“ Consumers in the $94 billion prescription drug market are mostly

indifferent to price

What will happen when they all become budget conscious?

Forbes 4/5/99

Pharmacy Benefit Managers

General Strengths

Intermediaries that purchase drugs from manufacturers and pharmacies at a

reduced price for health insurers

PBMs provide drugs at lower costs

 Achieve econ of scale in pharmacy

benefits by serving multiple plan sponsors

 Large market share on buyer’s side

stronger negotiating power w/ drug

companies

Pharmacy Benefit Managers

General Strengths

PBMs can use their patient information

to their strategic advantage

 e.g Medco’s 60m patients

 How drugs prescribed, used, impact on disease

Can prevent inappropriate drug

interactions, under/over medication

Vertical Integration

Brand name drug companies were purchasing PBMs

Estimated

Vertical Integration

Good or bad idea?

 Buy the information, not the PBM

“Industry consultants and Medco competitors argue that Merck could have bought that

information from Medco or others in the field without buying the company.” NYT 8/5/93

 Critics argue that PBMs will only serve to lower prescription pharmaceutical prices

WSJ 2/2/98

Vertical Integration

Comments from Roy Vagelos, former

Merck CEO

 “In classic terms of competition, we could see

that the power of the buyers was growing…PBMs were…bringing together the person who chooses the drug and the person who pays for the drug.”

 “Having salespeople visit doctors’ offices does not allow us to reach PBMs, HMOs, or plan

sponsors the major players in the emerging

market.”

Vertical Integration

Merck bought Medco as a response to

managed care

Strategic attempt to market power How?

Followup on patients w/ chronic illness

who may stop taking prescribed meds

Position Merck drugs favorably on

formulary

e.g lower patient copay, or lower cost to plan sponsor

Vertical Integration

• In 2001, Medco accounted for $26b of Merck’s $46b sales

• Medco filled 537m prescriptions in 2001

• But profit margins for Medco <3%

Vertical Integration

Regulators worried that patients and

employers would be hurt by this type of

Role of the FDA

The Food and Drug Administration

approves a new drug before it can be sold

in the marketplace

 Also determines whether drugs require a

physician prescription vs OTC sales

The FDA requires extensive, costly testing before approving a drug

 What is the economic argument for the FDA’s role?

Role of the FDA

Type 1 error: The FDA rejects the

application for a new drug that is truly safe and effective

Type 2 error: The FDA approves a drug

that is unsafe or ineffective

If you worked for the FDA, which error

would you rather make?

Role of the FDA

On Sept 20 2004, Merck announced it was recalling Vioxx, its $2.5b-a-year arthritis

medicine

Was shown to double the risk of heart

attacks and strokes in long-term users

Merck lost 27% of its total market

capitalization in the stock market ($27b) in one day

Role of the FDA

Can we compare the benefits of allowing novel, risky drugs on the market to the

costs? (Olson, 2004)

“Novel” drugs offer therapeutic gains over existing remedies

 1 st of a kind in a therapeutic area (e.g Viagra)

 New additions to an existing class, which are safer or more effective (e.g Celebrex)

Role of the FDA

Adverse drug reactions (ADRs)

 Severe reactions to drugs that are fatal, threatening, permanently disabling or require hospitalization

life- Most ADRs filed by physicians and other

health professionals, reported to drug’s

manufacturer or the FDA

 Data is collected in the FDA’s spontaneous reports system

Role of the FDA

The stock of novel drugs introduced

1990-1995 was estimated to result in 1.7m life years saved

 (Predicted deaths avoided per drug) x

(estimated life years gained per drug) x (#

Role of the FDA

Losses due to ADRs may be

underestimated

 Only ADR deaths in 1 st 2 years after FDA

approval were considered

 ADRs may be underreported

 Many ADRs do not cause death, but result in hospitalization or serious disability

Is the FDA being too lax or too lenient in approving new drugs?

Barriers to entry

Government patents

Brand loyalty advantage

Control over a key input

 Rationale: Monopoly restriction of output

better than having no output at all

Monopoly power of patents is not always strong

Patents granted for chemical

composition, not therapeutic novelty

Lipitor, Crestor, and Zocor all compete in the cholesterol-lowering drug market

Significant part of patent life may be

spent trying to get FDA approval

“effective” patent life = 8 years

Monopoly power of patents is not always strong

1984 Waxman-Hatch Act - benefits for both brand-name and generic

companies

Effective life of new drug patent can be

extended up to 5 years if FDA delayed

market introduction

Fast approval process for generics:

eliminated proof of safety & effectiveness