Sunday, February 22, 2015

The AARP Bulletin - Comments From a Pharmeceutical Company Insider

The November 2004 issue of the AARP Bulletin has a lead article titled “The Insiders”. The cover says “Three insiders speak out on how the drug industry really works”.

The first featured Insider is Peter Rost, M.D., Vice President of Marketing for the Endocrinology Division of Pfizer.

Dr. Rost’s comments suggest that a degree in one field does not imply much about knowledge in another field (except for me, of course).

According to AARP, Dr. Rost’s messages include the following. My comments are in italics.

  • Drug makers are untruthful when they insist that importing drugs from abroad is unsafe or that lowering U.S. prices would hurt research.

I also think the issue is not safety. However, every MBA program I know of, and probably in the world, teaches that lowering anticipated prices turns some “go” projects into “no go” projects. Moreover every sensible project evaluation method I have seen has this mathematical characteristic.  So, lower drug prices should reduce research.

Be your own judge. Imagine you are an entrepreneur. Will reducing the revenue you expect to get, other things equal, ever lead you to adopt a project you rejected with the original revenue?  Of course not. Will increasing enough the revenue you expect to get, other things equal, lead you to adopt a project you rejected with the original revenue? Of course.

Take the claim to its logical conclusion. Legislate that drugs must be sold at production cost. Do you think that this won’t reduce research, hence the availability of new drugs?

  • More than 700,000 Americans die each year from heart disease and studies show that 50 percent of people on cholesterol-lowering drugs don’t use them as prescribed, and the more they have to pay, the more they stop taking them. “So it is obvious to me that probably tens of thousands of Americans are dying today because they can’t afford drugs.”

The higher the price the less quantity demanded? How novel. This is supply and demand. The same supply and demand that leads to the conclusion that lower prices will reduce research. Dr. Rost wants to have his cake and eat it, too.

Yes, it is too bad that tens of thousands of Americans are dying today because they can’t afford drugs or, to be more precise, because they prefer to spend their money on other things. But how many more thousands would be dying today if the relatively new and more effective drugs had not been invented yet and would only be invented twenty years from now?

Less money spent on research reduces the rate of research results. Think of it as “research years” become longer than “people years”. Research results fall further and further behind, year by year. If Dr. Rost is concerned about current (mostly older) people, shouldn’t he be just as concerned about children (the current people that will benefit the most from the next few years research) and future people? Perhaps he forgot about the millions of future people that will die from the reduced rate of development of new, more effective drugs caused by reduced research. Or, maybe it never occurred to him.

As for not using drugs as prescribed, that is the patient’s problem. I don’t approve of spending money on coddling irresponsible adults.

  • Dr. Rost is quoted as saying “it’s just not true” that reduced American prices and government price controls would decimate profits and destroy vital research. He is then quoted as saying “Research is the last expense they’d cut, not the first as they claim.” If price controls came in, he adds, at first “there’d be a one-time fall in profits, but then they’d start climbing again, and life would go on.”

It is profitability, i.e., return on investment, that matters, not profits. If price controls are effective, i.e., binding, then why would profitability recover after an initial fall? More likely, profitability would not recover. And it is profitability that determines how much you spend on research.

Consider a simple example. You produce a product at a cost of $75 per unit. Your investment in the plant and equipment necessary to do it is $100. You sell the product for $100 per unit. Your profitability is 25/100 = 0.25, or 25%. You add 10% to your plant and equipment each year, so your growth rate of plant and equipment and cost is 10% annually. If you keep your price at $100, your revenues grow at 10% annually. Now, someone forces you to sell your product for $80 and forces you to continue to expand your plant and equipment at 10% annually. Your profit is down 80% to start, but then grows at 10% thereafter. Your profitability is down to 5/100 = 5% to start and stays there. Don’t you think that with an 80% reduction in profitability, you would find something else to do with some of your money? If so, you won’t make the investment that will produce a 10% growth rate in your original product.

You might wonder how any educated person could miss this. But you have to keep in mind that Dr. Rost is from Sweden.

  • Although the industry says well over half the world’s new medicines are researched and developed by U.S. companies, not by those in countries with price controls, Dr. Rost says that half the world’s innovative drugs are invented in countries that have “what is called price control.” He goes on to say that “But that term implies you’re forced to sell a drug at a certain price. It’s not true. You negotiate with governments. I once had a really good drug and personally negotiated with the pricing authorities in Sweden. I got a price approved that was 100 percent higher than in the U.S. market.

In other words, Dr. Rost negotiated a price that bilked his fellow citizens by arranging to have a price set at above the free market price.  This is not the kind of price control that is the issue.

Pricing by fiat hurts consumers because only a market can determine relative value accurately. Moreover, we all can guess that in the countries that have “what is called price control”, the average price is likely to be lower than the market would set. This is what counts, not the fact that governments sometimes are willing participants in bilking their citizens.


Ravindra Deo said...

The argument about allowing imports is specious. Allowing imports will REMOVE pricing distortions and allow drugs to be manufactured and priced efficiently. By not allowing imports we are not encouraging research, we are subsidizing the Germans, the French, the Swiss and the British. Not something that I, as an American, want or should do.

TOG said...

A simplified picture of import restrictions is that they make price discrimination possible. Roughly, foreign drug prices are close to marginal cost and domestic drug prices are close to marginal revenue, which is above marginal cost.

Marginal cost does not pay for research.

The result is that we pay for research and the availability of new drugs and foreigners are freeloaders.

One way of putting this in perspective is that old drugs exist in a competitive market and new drugs do not. If you insist on marginal cost pricing, simply buy old drugs. If old drugs do not solve your health problem, then buy new drugs. But you don't get the new drugs without payiing the research cost in addition to marginal cost.