Why are some pharmaceuticals so expensive?

Answers to your questions about the news.
Aug. 16 2010 6:03 PM

The $8,000 Pill

Why are some pharmaceuticals so expensive?

Pill prices preposterous. Click image to expand.
Pill prices preposterous

The FDA may revoke its approval of Avastin, the world's top-selling cancer drug, for treatment of breast cancer. Regulators are only supposed to compare the drug's benefits to its risks, but many industry observers note that the real problem with Avastin is its astronomical price tag: A month's supply costs approximately $8,000. Why are some drugs so much more expensive than others?

Because they fill an unmet need in the market. In the United States, the priciest medicines aren't necessarily the ones that cost the most to develop, nor those that save the most lives. The most expensive drugs are those that have no competitors. When a truly novel blockbuster drug hits the market, there is very little to guide manufacturers and insurers in their negotiations. The largest constraint is public perception. Insurers fear that, if they refuse to fork over the dough, their sick customers will be outraged. Manufacturers don't want the public or Congress to view them as price gougers. Negotiators eventually settle on a price between those two poles. Few drug makers are lucky enough to face this problem, though. Most debutant drugs find the market already crowded with similar products, and prices are set by the competition.

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Consider two examples. When Provenge, a controversial prostate cancer drug, hit the market this year, the maker could demand a ransom because there was no real analogue. (Patients are given three infusions of Provenge, each costing $31,000.) In contrast, the cholesterol-lowering drug Livalo, which earned FDA approval in 2009, had to contend with well-established statins like Lipitor and Crestor. Even though the drugs work differently, they all serve the same purpose. The manufacturer had little leverage in negotiating with insurers and had to undercut its competitors on price. The cost of Livalo, at about $3.30 per dose, is 15 percent lower than Crestor.

The process of drug valuation is more quantitative in the United Kingdom, where regulators have a system to compare the clinical benefit of a drug to its price. The National Institute for Clinical Excellence uses a system called the Quality Adjusted Life Years measurement, which sets the value of a year of healthy living at between $31,000 and $47,000. So even if a drug prolongs a patient's life, the British National Health Service typically won't cover the medicine if it costs more than that amount. (In breast cancer patients, Avastin appears to extend life by at most five months. The NHS doesn't cover its use for most diseases.)

You hear a lot about how expensive it is to bring a drug to market. All of that is true, especially for cancer drugs. It costs around $1.75 billion to develop the average cancer medicine. Only drugs for respiratory disorders, at $2 billion, can top that total. (AIDS drugs and anti-parasitics are the real bargains, at between $500 million and $700 million.) But there is no correlation whatsoever between the cost of developing an individual drug and its eventual price. Drug companies have to make a profit over the long term. Most of the chemicals that a company experiments with never make it to market. Of those that do, only 20 percent are ultimately profitable. They cover these losses—and then some—by squeezing as much money out of their few successes as possible.

Manufacturing costs play a role in pricing decisions, although a small one. Avastin belongs to a category of drugs called biologics, which are large molecules that usually have to be manufactured by DNA manipulation. Biologics cost more to make than traditional drugs, which usually are generated through cheaper chemical reactions. Still, manufacturing costs normally don't exceed a few percentage points of sales revenue.

Got a question about today's news? Ask the Explainer.

Explainer thanks Patricia Danzon of the Wharton School of the University of Pennsylvania, Uwe Reinhardt of Princeton University, and John Vernon of the University of North Carolina at Chapel Hill.

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