Money-Back Guarantee

Apr 01, 2008

HIGH DRUG PRICES HAVE BECOME A DOUBLE-EDGED SWORD. Pharmaceutical companies argue that they need high prices to allow them to continue R&D investment for helpful new drugs, which are increasingly difficult and costly to find. In response, payers implement formularies and other incentives to limit drug use and curtail costs. Unfortunately, this back-and-forth between pharma companies and payers hasn't optimized patient care. Rather, it's just refocused the discussion on cost. It used to be that we talked about prescribing the best drugs and treatments for the patient. Now, the refrain is different. Payers want to know: What is the least costly drug that adequately treats each patient?

Resolving this dilemma—and finally getting beyond the point where shrinking market share erodes any gains made by higher prices—requires companies and payers to change the way they buy and sell drugs. Companies and payers should seek common ground. In doing so, execs should move from focusing their negotiations on "price per unit of drug" to "price for value delivered."

The industry can start to rethink their approach by focusing on ways to drive volume without undermining value. Since the incremental cost to make most drugs is usually small, additional volume can add substantially to profit. The challenge is to develop strategies that enable companies to capture high prices for populations of patients for whom the drug delivers high value and therapeutic benefit, while simultaneously pricing lower to drive volume from populations that get less benefit or have less ability to pay.

Several other industries with similar cost structures—including the software, information products, and semiconductor industries—have solved this problem. They recognize that they are not in the business of selling products—rather, they are in the business of developing and selling access to intellectual property. As such, they have evolved highly effective models of pricing, such as pricing per application, per user, or per expected or actual effect.

Already, some pharma companies are experimenting with these pricing models. To date, that mostly has been in reaction to organized resistance—most notably, from the United Kingdom's National Institute for Health and Clinical Excellence (NICE). But by applying such models proactively, companies can increase market share, encourage faster uptake, and penetrate developing markets.

Let's look at three common models for pricing intellectual property that could help pharma win more volume and earn additional revenue to fund the growing cost of innovation.

Performance-Based Pricing

In any industry, whenever customers are uncertain if promised benefits will be realized in practice, they are reluctant to pay the asking price.

This is particularly true for new drugs, where payers balk at reimbursing for therapies until they see proof of sustainable benefits in actual practice. Frequently, this leads to a tug-of-war between payers, who are unwilling to pay a premium for an unproven value, and pharma companies, which don't want to get locked into a commodity price for a drug that may be worth much more. Meanwhile, the period of patent protection wastes away and patients lose out on new treatment options.

To overcome this problem, it is usually much cheaper for sellers to somehow guarantee outcomes than either to suffer the delay in adoption or to forgo the price premium that the innovation warrants. Honeywell used this model to drive adoption of its software-managed heating and cooling systems by tying payment for the product to the building owner's energy savings. In this way, it created a payment scheme based on the product's results in practice.

Pfizer implemented a version of this model in 2001. The company convinced the State of Florida to put all of Pfizer's drugs on the state's Medicaid formulary. In return, Pfizer agreed to payment based on the results of an independent audit of system-wide cost savings from patients using its drugs. If its drugs failed to generate long-term cost savings across the healthcare system, the company would rebate part of the drug cost. In doing so, Pfizer went beyond being a drug company to become a true healthcare company. And in the end, the performance-based approach worked, enabling Pfizer to avoid up-front discounts or back-end rebates, while saving the State of Florida $41.9 million in other healthcare costs.

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