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research spiral
16
Long Range Planning. Vol. 24, No. 2, pp. 16 :o 27, 1991 Printed in Great Britain
00~1~301/91
S3.00 + .or)
Pergamon
Press plc
Pharmaceuticals The Price/Research Spiral :
Heirzx Redwood
Prices and research are intertwined in most industries where research and development are carried on over a long term, with a high failure rate. The need for a steady cash flow !n this situation is vital to keep research projects moving. Rationaland political pricing strategies have to be built into the planning process. Rational pricing is important to position a new product in relation to the competition. In the pharmaceutical industry pricing becomes a political act also as it impinges on areas of public concern and public sector spending.
Prices and Research are not often mentioned in the same breath. Prices are n-idely regarded as a short term operational responsibility. Lvhercas Research is an essential preoccupation of long term strategy in science-based industries like pharmaceuticals. Are Prices and Research, then, as indigestible for management as chalk and cheese? They may have been unconnected once upon a time, in the golden age of the pharmaceutical industry when research was cheap and discoveries plentiful. Today, far from being chalk and cheese, Price and Research are more like biscuits and cheese: they go together-they ‘belong’. That does not mean that the research scientist in his laboratory should become a pricing espcrt. Pricing is a function of commercial management and of the world outside. In the field of health care, the two are often engaged in bitter conflict which, in efi?ct, binds them together. The bond bet\veen prices and research arises from the clash between two equally pressing needs: a research-based company’s need of high prices and profits in order to fund more research and development; and the more and more difficult struggle by health care providers to contain the escalation of costs. How real is this conflict1 Very real. It is one of the central issues of pharmapolitics. Heinz Redwood is an Independent consultant. He was for many years in charge of Corporate Planning for Fisons plc.
Putting pressure on drug prices helps to balance health care budgets, or so the authorities say. Does it really? Controlling prices and not allowing them to rise will inhibit research and development funding, or so the industry says. Will it really? Above all, when looking beyond this year’s health care budget and this year’s company budget, and planning for the longer term-are these assertions still true? These are the main questions to be addressed by this paper. For a start, it will be useful to pinpoint the place of drugs in health care, both therapeutically and financially.
(1) The Place of Drugs in Health Care Nobody can deny the contribution to therapy made by new drugs during this century. The so-called ‘wonder drugs’ were indeed medical miracles. Combined with measures to improve sanitation and education, the new drugs that were discovered between 1930 and 1950 began the process whereby most infectious diseases have been brought under control in the Developed World. Today, only about 1 per cent of all deaths in Europe, North America and Japan are caused by infectious diseases. Table 1. Life expectancy (mean, OECD countries)
at birth,
Year of birth
1900 to 1980s
Years expectancy
1900 1930 1950 1980s Source: Organization (OECD) 1987.
48 57 65 71 for Economic
Co-operation
and Development
Pharmaceuticals: The result has been a steady rise in life expectancy at birth, from 48 years for someone born in 1900, to 71 years for those born in the early 1980s. In effect, during the last 40 years, life expectancy at birth has risen at the rate of about 3 months every year in developed countries, and there is no sign as yet that this trend is coming to a halt (OECD, 1987).’ The consequences
are far-reaching:
The Prices Research
Table 3. Increase in geriatric 65 and 73 Condition
conditions
increase
Senile dementia Stroke Arthritis Bad eyesight Deafness
17
Spiral between
(times)
4
1.5
Source: Royal College of Physicians studies, 1981.’
In the first place, there is now a pow-erful demographic shift towards the Over-60s in the Developed World : Table 2. Over-60s developed world
population
trends in the
Projected increase
Year
Millions
1980
185
2000 2020
230 300
Source: World Health Organization,
M
(%)
45 70
(+24) (+30)
compared with one-and-a-half times arthritis, bad eyesight and deafness.
in stroke,
By the mid-1980s the cost to society of senile dementia in the U.S.A. \vas estimated to be in the range of S3MObn per alllliltfr. A high proportion of the total arises from the social cost of loss ofearnings and productivity among family members of working age who have to care for senile relatives at home. These are REAL losses, as anyone relative thus afflicted will confirm.
with an elderly
1 987.2
The World Health Organization has estimated an increase of 45 million people over the age of 60 between 1980 and the year 2000 in the Developed Countries. This will accelerate to a further 70 million (or 30 per cent) during the following two decades to 2020. The second result of longer life expectancy is an enormous rise in the demand for health care of all kinds, because-so far-there is no fall in morbidity in old age. In other words, we do not necessarily die of chronic diseases as once we used to die from acute infections. Today most of us live on after 60: with hypertension, with arthritic limbs, with duodenal ulcers, breathing problems, acute depressions, and at worst-it has to be faced-as cabbages. Only a small minority live in perfect health until one morning at the age of 99, they happen not to wake up. ‘Dying of Old Age’ is a myth. Living with chronic disease is reality. Few chronic diseases are curable today but-except for senility-most can be controlled, sometimes by adopting a healthier life style; more often with medical treatment and the use of drugs. The economic impact of the demographic shift, although much talked about, has in fact barely begun. It has daunting implications. Let us take as an example senile dementia, of which Alzheimer’s Disease is only one form. Five studies by the Royal College of Physicians in 1981 demonstrated that the prevalence of senile dementia rises exponentially with age. Between 65 and 75, there is a fourfold increase in dementia,
The interesting fact is that drugs are playing a negligible part in alleviating the costly march of senile dementia, because etfective drugs to delay its onset or to arrest its course have yet to be discovered and developed. One does not have to be an economist to draw the conclusion that effective drug treatment-if it could be developed-would cost society a lot less than nursing homes or community care for the unfortunate victims of senile dementia. In more general terms, new drugs that prevent, postpone, retard. or alleviate chronic diseases-even if incapable of curing them-are in many cases highly cost-effective in terms of the overall ramifications of health care expenditure. They will increase the drug budget, perhaps substantially. Does that matter, if they produce economies elsewhere in the health care system? At this point, research comes back into the picture: new drugs are needed for senile dementia, but none have yet been developed. A review of the situation in 1989 (Scrip, 1989)’ set the tone: obstacles and pessimism galore. It painted a gloomy picture of drug therapy for senile dementia: its inadequacies, the feeble scientific foundations of some of the research, its methodological confusion. Why the surprise? such a situation is typical of the state of medicine before a break-through. There will be a break-through eventually, but nobody can say how soon, hoxv far-reaching, and after how many false starts and costly failures in research and development. Back in the 192Os, we would have found a similar state of uncertainty about the role of drugs in the treatment of
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Long Range
Planning
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Vol. 34
infectious diseases lvhich, today, \\-e granted. Even Fleming, having discovered lin in 1938, \\-as actually unable to prove its medicine and. by 1936. had given up tr)-ing
take for penicilutility in to do so.
As for random chemical synthesis, rll,lt was arrogantly condemned by academics in the 1920s as ‘unscientific’ and useless-until the flood of sulphonamide drugs, discovered and developed unscientifically in the laboratories of the German, Swiss, British and American pharmaceutical industries during the 193Os, proved otherwise. The lesson for today is that medical problems are there to be solved, and that drug discovery and pharmaceutical development will be a necessary component of man)- of the solutions. So much for the sublime: the altar of Research. Turning no\v to the ridiculous-Prices-the real question is: are drug prices ridiculously high or ridiculously low? The answer depends on whether one considers them from the point of view of the authorities or from that of the pharmaceutical industry. Each believes that the other is making a ridiculous fuss. But prices really are no laughing matter; for today’s prices lay the foundations for tomorrow’s drug research. Before probing the precise relationship between prices and research, it is useful to look at drugs in the perspective of all forms of expenditure on health care.
Institutional Ambulatory Pharmaceutical Other
1970
Early 1980s
WI
(%I
50 20 12 18 100
and Italy, and louver in the U.S.A.
If reason-and in health care, more by logic by now have wet flannel :
and
not emotion-were the motive force and if cost containment were dictated and less by politics, two points would hit the authorities like the smack of a
Point l--In a cost containment drive, as much can be saved when hospital costs are reduced by 2 per cent as when the drug bill is cut by 10 per cent. Point 2-Long-term, severe pressure on drug prices is damaging to the pharmaceutical industry’s financial resilience and hence to its capacity for sustaining a high-risk stance in research and development.
Point 1 is a fact. Point proposes to argue it.
2 is arguable.
(2) The Science-Finance
This paper
Cycle
First of all, it is important to look at Research & Development (R & D) not in a scientific ivory tower but as part of a financial cycle in which cash is invested at risk and has to be recouped before the cycle of investment is resumed. It is, in effect, a Science--Finance Cycle, shown on Chart 1 in its application to the pharmaceutical industry. The Science-Finance Cycle can be suitably adapted to the circumstances of other research-based industries. If pharmaceutical research leads to the discovery of a patentable product, the period of maximum financial risk is not that of research itself, but development and, later, success or failure in international marketing.
Table 4. Cost components of health care expenditure by the public sector (OECD countries, % of total) Component
Germany Canada.
54 21 10 15
100
Source: OECD. 1987.’
Studies by the Organization for Economic Cooperation and Development (OECD) have shown that, in Europe, North America, and Japan, hospitals and other institutions were responsible for over half of all health care spending by the early 1980s. General practitioners and ambulator)care took a further 20 per cent. These proportions were rising. By contrast, pharmaceutical costs accounted for only 10 per cent of health care spending, and this proportion had fallen by two percentage points since 1970. By 1987, pharmaceutical spending in the U.K. was still at 10.1 per cent of the cost of the National Health Service. It was higher in France,
For a new drug, development occupies about twothirds of the time from discovery to launch; and absorbs two-thirds or more of total R & D expenditure. Analysis has shown that only l-in-5 development projects reach the market at all 1988) ;6 the others are dropped (Pharmaprojects, somewhere along the way. Of the ones that reach the market, only about l-in23 can be described as highly successful financially (Redwood, 1989).’ Others may well be profitable, too, but not sufficiently profitable to pay for the failures and provide a return on overall risk investment in R & D. What
does all this mean in practice?
There are about 250 research-based companies in the world. Collectively, yearonR&D.
pharmaceutical
they spend about 15 billiorz dollars each
As a result of that expenditure,
they manage
each
Pharmaceuticals:
The Price/Research
Spiral
19
RESEARCH Discovery, Screening
F&-investment
\ Patent Protection \,
Post-marketing Surveillance
.:
:.
International Marketing
Chart
1. Cycle of maximum
risk
year to introduce only two or three new drugs that are capable of achieving major financial success.
success depends cially supportive
Evidently, pharmaceutical research and development is high-risk and, faced with risk of this magnitude, two major questions need to be asked:
In the Science-Finance Cycle, the entire drug development process and the subsequent phase of international marketing are attended and pursued all the way by intervention. Good management of development involves exercising judgement in the choice of priorities, the allocation of resources, and ensuring that the organization of development activities across the world is effective. Management error in any of these can cause even the best drug discovery to fail.
(1) What
is it that determines
(2) How can success?
one
turn
research
scientific
success?
into
financial
To the first question-how can one achieve research success?-the honest answer is that nobody really knows. Creative science is as mysterious as creative art. Most research-based pharmaceutical companies on both sides of the Atlantic believe quite simply that: Good
Research
plus a fair dollop lie ne sais quoi’.
= Good
Individual
of luck, serendipity,
Scientists voodoo,
and
Everyone agrees, however, that, to turn scientific discovery into financial success-which is the management process of development followed by international marketing-demands more than a genius on the premises. Indeed, some believe that genius is best banished from development where
on firm management external environment.
and a fman-
On the other hand, much of the area of maximum risk, as the Cycle shows (Chart 1) is also that of maximum intervention by the authorities, reaching a financial climax when it comes to pricing and social security reimbursement. Both can determine the financial potential of a new drug: that much is obvious. What is less self-evident is the interaction of pricing and reimbursement decisions with other phases of the Science-Finance Cycle. Broadly speaking, it is a 20-year cycle. That is the official span of patent life from discovery to expiry in most countries. But e&xrive patent life-from first marketing to patent expiry-is only l&12 years for patented products ranking among
20
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Vol. 2-J
April 1991
the Top-100 drugs in the world’s leading markets; and only about 7 years on average for n/l drugs. ‘Effective’ patent life (Chart 2) is what matters. It has eroded rapidly during the past decade: in the U.K., from nearly 16 years for leading products that were launched in the 1960s to under 12 years for those introduced after 1980. Similar or worse erosion occurred in the U.S.A., France and Germany. That is why patent term restoration is now a prominent topic on the European pharmapolitical agenda (Redwood, 1990).8
18-
‘\ U.S.A France U.K. Germany Japan
\ l
\
.\
\ \ \
v l
. q
o
T\
Products Launched Before July 1970
Chart
2. Effective
All
patent
All
Products Launched After June 1980
life
Most companies depend on only one or two leading patented drugs for the revenue that will keep the Science--Finance Cycle turning. Half of the official patent span is absorbed by drug development and regulatory approval for these leading drugs. Patent expiry brings generic competition (i.e. the entry of cheaper ‘copies’ of the pioneer brand) and a rapid fall in price and profitability. C~rce~~t&ly, that is as it should be. Patent protection and product monopoly oltglzt to be followed by genuine competition. There is no reason to quarrel with the principle of generic competition-provided it follows an adequately long period of patent protection, with high prices and high profitability. If these conditions-adequate protection and high profitability-are not met, then the ScienceFinance cycle comes to a halt. The need to reduce risk becomes paramount: either less is re-invested, or the risk profile of the R & D portfolio is squeezed: fewer original, more ‘me-too’ research projects with a better chance ofreaching the market, make a persuasive option when the chips are down.
There are four main ways in which Finance Cycle can be disrupted:
the Science-
Table 3. The Science--Finance factors
disruption
(1) (2) (3) (4)
Cycle:
Bad management Hostile intervention Patent expiry Risk aversion
Prices and research run in parallel across this minefield of disruption. Often, weak management can be spotted by observing its pricing strategy. Hostile intervention by the authorities, on the other hand, cuts do\vn management’s room for manoeuvre and can put severe pressure on profits via pricing and reimbursement. Pricing decisions at the approach of patent cspiry are among the most demanding tests of management strategy, and the results are bound to influence the rcsourccs available for Research & Devclopment. Finally, risk aversion will show its colours either in pricing policy or in R R: D spending. One point ought to be brought out clearly: it is NOT a symptom of weak management to reduce the company’s risk profile. Indeed, doing so can be proof of strong and realistic management. But pharmaceutical R Es D is by its very nature uncertain of outcome and high-risk financially. To adopt a low-risk posture in R & D may give all the right signals of prudent conduct in management butexcept by chance-it is not going to produce those gigantic leaps in therapy that society needs if it is to cope with the coming surge of chronic morbidity in old age. In essence, then, PRICES and RESEARCH are bound together in a web of risk, management, and intervention. Bad management will no doubt somehow find a n-ay of getting into a mess even when risk is minimal and there is no external intervention. Assuming Good Management, the question remains whether there is a long-term relationship in pharmaceuticals between intervcntion in pricing and reimbursement on the one hand, and the acceptance of risk in Research ei Development on the other? The ans\v*er is: ‘Probably, yes’. It is not an instant relationship (‘you cut my price, so I cut my R & D’), but one that kvorks its way through the system over the years as a kind of slow motion spiral (Chart 3), for whose twists management and the authorities can each be responsible at different times. The spiral itself is shown on the left of Chart 3. It moves from pricing systems (free or controlled) to actual prices and profits in the market; the advent of competition from generics after patent expiry; the
Pharmaceuticals:
Risk
I-+
c-x*
R & D Success
*
Re-invest R & D
The Price/Research
Strong
Weak
High, Rising
Lower, Rising
Rare
Very Rare
Very High
As High as Permitted
Very High
As High as Possible
Spiral
21
As High as Permitted
Reaction 1
Pressure
More Control
NCE = New Chemical Entity
Chart
3. Free-pricing
spiral
risk posture in R ei D, dictated by financial resources; actual spending decisions on R & D; and the frequency of major success in development projects. That leads on to pricing decisions for new products. The spiral then turns to the reinvestment of profit in more R & D; pricing decisions for the next generation of new products; and the political reaction to spiralling drug costs. Ho\v does external intervention in pricing with the attitude towards risk in R & D? First, consider what generally tions of pricing freedom.
interact
happens under condi-
Without price control, the pharmaceutical industry is highly profitable. As a counterweight, there is a strong generic movement backed by health care providers and legislators. The industry adopts a high risk posture in R & D, partly because it can afford to do so, and partly because it cannot afford NOT to do so: competition drives risk. Expenditure on R & D now rises steeply as, in fact, it has done in the U.S.A. throughout the 1980s.
On rare occasions, a major success is scored-one of the two or three ‘blockbuster’ drugs that reach the world market each year. Such compounds are priced well above existing competitive drugs. A series of quantum jumps in new product pricing eventually provokes a political reaction. Health care providers and legislators think up new ways of containing the drug bill. This eventually knocks the industry back as the pendulum swings, until a new spiral begins to unwind. The swing of the pendulum can be observed very clearly in countries where the price of drugs is not controlled: in Germany and Holland where moves to introduce ‘reference prices’ (which limit reimbursement by social security to a set ‘reference’ level) are being hotly debated; in Denmark, where many products have been transferred from prescription-only to over-the-counter status and consequently removed from reimbursement by social security; and in the U.K. with the introduction of drug budgets for doctors’ practices. The
free-pricing
spiral (Chart 3) is, of course,
an
33 __
Long Range
Planning
Vol. 2-l
April 1991
over-simplification of a more complex series of interactions. It nevertheless demonstrates in broad terms the operation of long-term interaction cycles in countries like the U.S.A., West Germany and, up to a point, the U.K. whose Pharmaceutical Price Regulation Scheme stands between pricing freedom and control. The alternative spiral-under direct product-byproduct price control-unwinds in a different manner. To start with, drug prices are low and generics are weak, because low controlled prices offer neither scope nor incentive to generic competition. The industry-‘s risk posture under this type of system is also vveak, because the reward for success, too, is controlled-so why go out on a limb? Nevertheless, measured against limited profitability and constrained resources, financia1 commitment to R & D in price-controlled countries is high and rising, because companies see R & D as their only hope of remaining competitive in the long run. If major research SLKCCSS is infrequent under the benign and prosperous conditions of pricing freedom, it is extremely rare in controlled systems, as will be demonstrated numerately, below. Although introductory prices for new research-based products are usually higher than those of the older drugs against which they are competing, in controlled systems the pricing decision still rests with the authorities. Prices can only be ‘as high as permitted’. As a consequence. the amounts reinvested in R & D are circumscribed, too, and success in the next cycle of research projects is again subject to price control: higher than before, but lower than under conditions of pricing freedom. Politically, how-ever, a spiral is a spiral even if its elasticity is compressed by controls. The health care budget is always getting out of hand. When even controlled prices are spiralling upwards every time a new drug is launched, an alarm bell rings. It tells the authorities that they should exercise even tighter control. If that causes a new attack of risk aversion in the national pharmaceutical industry . . . too bad, but control feeds on control, yet it always remains hungry. Again, the sequence is over-simplified, but basically it illustrates a form of spiral descent that is characteristic of, for example, the price controlled pharmaceutical industries of France, Italy, Belgium and Spain. To illustrate this, a comparison of drug prices in the European Community (Chart 4) divides member states neatly according to their pricing systems. All the countries that run systems of product-byproduct control of pharmaceutical prices are below the European average, whereas the free pricing or profit control countries (plus Ireland whose prices
linked
are
to those in the U.K.)
appear
above
the
line. The national pharmaceutical industries of countries with low prices have gradually become less comboth as originators of petitive internationally, genuinely innovative drugs and in their penetration of international markets. In the long run, the research output of national pharmaceutical industries lines up more or less inversely to the severity of their drug pricing and reimbursement systems, as an important study by Etienne Barral has clearly demonstrated: Table 6. Pharmaceutical research new chemical entities by country 1975-1986
Country U.S.A. Japan Germany France Switzerland U.K. Italy Others
Source: Barral,
results: % of of origin,
All NCEs WI
NCEs marketed world-wide (%I
25 19 13 12 6 5 10 - 10 100
42 5 7 5 7 18 0 - 16 100
1 987.9
The left-hand column shows the country of origin of 610 drug substances (New Chemical Entities or NCEs) that were introduced during the 11 years from 1975 to 1986. It gives a fairly balanced picture, reflecting broadly the size of each of the industries (American, Japanese, German, French, etc.). In the right-hand column, only those drugs which achieved global marketing status are shown: there were only 60 of these during the 11 years. The other 550 fell short of world-wide marketing, often because they were in a sense designed to fit national medical traditions under controlled pricing and reimbursement systems: French drugs for France; Italian drugs for Italy; Japanese drugs for Japan, and so on. The 60 world-wide
drugs fall into two groups:
The first is therapeutically innovative, and may or may not have been financially rewarding. One can be highly innovative in a tiny market segment. Some ofthese 60 drugs were, however, highly successful. The second group is therapeutically competitive but leans towards the ‘me-too’ end of the spectrum. It usually offers some claimable advantages. It is typically the seventh cephalosporin, or beta-blocker, or non-steroidal antiarthritic rather than the first. Its global penetration arises less from originality than from the originator’s competitive muscle
Pharmaceuticals:
The PriceiResearch
Spiral
23
-Germany - Denmark
- Netherlands
- Ireland
K.
-
ECA\ ferage
- Belgium
- Italy
- Greece
60
1988
1986
Source: BEUC 1987, 1989’O Except Denmark, Greece 1986: estimates
Chart which way.
4. Comparison
of drug prices in the EC
can make a moderate
product
advantage
go a long
The common element between innovative and competitive new drugs that are marketed worldwide is the multinational spread of the originator. It is dif?icult to achieve high profits with low selling prices in the price controlled countries. This in turn inhibits overseas marketing investment by domestic firms, because the financial risk in starting one’s o\vn organization in, say, the United Stares or Japan is deemed to be too high. So it is not surprising to find that French and Italian drugs-which make up over 20 per cent of ‘All NCEs’ in the column on the left (Table 6), account for only 5 per cent of ‘World-wide NCEs’ in the column on the right. The number of French and
Italian drug companies that have a viable base of their own in the U.S.A. and Japan can in fact be counted on the fingers of one hand; and with a few fingers to spare. Most have set themselves low-ke) targets in terms of innovation: sufficient to satisf) the national authorities for pricing purposes and reimbursement in the home market; not enough to risk globetrotting. By contrast, American drugs, covering 25 per cent of ‘All NCEs’ on the left, take the lion’s share of -+2 per cent of ‘World-wide NCEs’ on the right. Here, high prices in a large domestic market have provided the financial resources for multinational expansion which, in its turn, has provided funds for reinvestment in R & D-a formula which has given the American drug industry an almost unassailable lead.
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The British pharmaceutical industry has benefited from a balanced system of relatively high drug prices, but Lvith a ceiling on profitability on sales to the National Health Service. Prices and profits have been high enough to encourage R & D in the U.K. which has proved both creative and remunerative. All British research-based companies have set up multinational marketing facilities in the European Community, North America, and Japan. With only 5 per cent ot ‘All NCEs’, British drugs made up no less than 18 per cent of ‘World-wide NCEs’ during this period (Table 6). It has to be said that pricing freedom is no guarantee of success in R & D. The somewhat meagre level of creative achievement by the German pharmaceutical industry betxveen 1973 and 1986 shows it. Price control, on the other hand, makes it much more difficult to pay for creative risk, and also undermines the scope for taking chances Lvith multinational expansion. Long-term, the result is a loss not only of the power to compete internationally but of the will to do so. Competition in the ‘Single Europe’ of 1992 and beyond should be seen in this light: two-thirds of all ‘World-wide NCEs’ introduced between 1975 and 1986 kverc of American, British and Swiss origin. There is little evidence to suggest that their lead will be seriously challenged in the 1990s except by Japan. The pharmaceutical industries of the European Community (csccpt the British) look particularly vulnerable: structurally weak; creatively low-key; and squeezed hard by pricing and reimbursement pressures. The German industry is among the world leaders but has not been very creative in recent years, and it is now under severe pressure in the domestic market. The American, British and Swiss pharmaceutical industries are stronger structurally and creatively. They, too, will have to cope with pricing pressures, but they are more resilient. Their chances of compctitivc survival are therefore correspondingly better. No comparison of international competitiveness would be complete without examining the trade between pharmaceutical exports and balance
imports of the countries leading pharmaceutical
Table 7. World trade balance 1987 (Medicinal Pharmaceutical Products: exports less imports Surplus +/Deficit -)
Source:
OECD,
1 98g5.
and
Sm European Community Switzerland U.S.A. Japan
+4189 +2156 +850 -1521
Sourcet OECD, 1 98g5.
At first sight, all seems ~vrll with the European Community in this respect. In 1987. the Community had a pharmaceutical trade surplus of over S4bn; Switzerland alone produced a surplus of more than S2bn; the U.S.A. made less than Slbn; and Japan had a trade deficit of Slibn. A world trade surplus ma!- be useful, but the true indicator of international competitiveness is the pharmaceutical trade balance with OECD Corrnfries, because trade within the Developed World has become a mirror of innovative success and multinational market penetration. Apart from parallel imports, most intra-OECD trade in pharmaceuticals is now in single source, research-intermediate or finished products, often bet\\-een parent companies and their overseas subsidiaries. SuccessfLll R & D has become, as near as matters. a prerequlslte for multinational penetration. To demonstrate the difference between world trade and OECD trade in pharmaceuticals, the next chart splits each trade balance betxveen OECD and the Rest of the World: Here, Switzerland shows up more strongly than ever, with the greater part of its positive balance arising from trade with other OECD countries. By contrast, Community
the ‘colonial’ legacy of European trade is shown by the fact that 85 per
Table 8. Pharmaceutical trade balance with OECD countries and rest of world (Medicinal and Pharmaceutical Products: exports less imports Surplus +/De&it (S million))
European Community Switzerland U.S.A. Japan
\l\-hich make up the Lvorld’s industries.
Total
of which with OECD
+4189 +2156 +850 -1521
+ 624 t-1464 +478 -1602
OECD % of total 15 68
Pharmaceuticals: cent of its phamaceutical from the Less Developed
trade balance Countries.
is derived
The American surplus is balanced between the two, whilst the Japanese deficit is entirely due to the fact that Japanese drug companies have not yet established many operating subsidiaries in Europe and the U.S.A., whereas American and European drug firms have increasingly set themselves up in Japan. The vveakness of the European Community is even worse than it appears at first sight. Europe is totally unbalanced in its intra-OECD trade (which includes trade between member states of the Community). Germany and the U.K. among the leading countries, together vvith Denmark and Ireland among the smaller member states, are in pharmaceutical surplus in their OECD trade. France is neutral. The rest are in deficit; Italy badly so. Once again, the ranking order reflects the long term repercussions of pricing systems. Of the countries with pricing freedom, only the Netherlands are in deficit. On the other hand, no country with product-by product drug price control has a pharmaceutical trade surplus. A clear thread runs across the entire picture: expressed in medical language, drug price control is contra-indicated for high-risk and innovative R & D. Adverse reactions include a propensity to concentrate on the domestic market and to abstain from multinational investment. The result is competitive anaemia, one symptom of which is a negative pharmaceutical trade balance. The disease is chronic rather than acute, and it cannot be cured overnight. Long-term control breeds long-term debility.
(3) Pricing Research
New
Products
from
So far, this paper has pleadedfor the pharmaceutical industry. Now, in discussing corporate pricing policies for new products from research, it has to
adopt a different industry.
stance:
25
one of pleading
u~it/z the
With rising costs and mounting pressures of competition and intervention, is not the right policy quite simply: ‘Charge whatever you can’? What the market will bear? What the authorities will wear? That, after all, is what a Company needs; and if it fails to get it, soon there vvill be no Company. Surely that is being realistic? Yes and No. It is realistic from the company’s point of view; but the company has to live in the reality of another world outside: that of pharmapolitics. Pharmapolitics is rather like dormant for years but, when condition is feverish and the dangerously high temperature. and it spreads like wildfire. accepted lesson. 7 Prevention is
malaria: it may be it breaks out, the patient soon runs a Ignore the causes And the generally better than cure.
Here is a particularly sick example of how to ignore that principle: Any resemblance to living persons is purely coincidental. A Marketing Director, with a carefully prepared brief running to at least 50 pages, proposes an introductory price of 100 for a new, research-based drug in a country with pricing freedom. It happens, however, that at that very moment, the Managing Director is hard-pressed to meet the budget for the year. Worse, his Board of Directors is shaking like a plate ofjelly at the thought of what the stock market is expecting from the Company next year. The Board makes an instant decision. It agrees that the price of the new drug should be fixed, not at 100, but at 150. That will apply to free-pricing markets. In the others, the Marketing Director is told, ‘do the best you can’. Apologies
to management.
Table 9. Pharmaceutical trade balance of EC member states with OECD countries, 1987 (Medicinal and Pharmaceutical Products: exports less imports, Surplus +/Deficit - (S million)) Country
Sm
Country
Germany United Kingdom European Community Denmark Ireland France
+ 1093 + 630 +624 + 250 +88 +2
Belgium/Lux. Portugal Netherlands Greece Spain Italy
Source: OECD, 1 98g5.
Spiral
The Price/Research
Sm -25 -150 -156 -162 -216 -730
The author is not trying
Long Range
26
Planning
Vol. 33
April 1991
to be facetious-surely some readers will recognize the situation-and he is not implying that the principles of rational price setting are being ignored everywhere. What is suggested is that the same short-term pressures that drive governments into short-sighted measures to contain costs, push pharmaceutical into short-sighted pricing decisions companies when, just for once, a new product from research allows management some elbow room for manoeuvre under pricing freedom. So the price is set in response to the Company’s needs. Whether that is the RIGHT price, depends on the answer to another question: for whose benefit should a new drug be priced? For the Company’s! the patient’s (if the patient pays, that is)? or for the health care provider’s benefit? Commonsense suggests that, as in any business deal, it will only work if there is something in it for all the parties. There are esclusively needs :
dangers in in response it ignores
pricing a new to a company’s
or underrates
product internal
fi
firstly,
competition;
a
secondly, it disregards ness of the drug;
*
thirdly, it can provoke the political reaction at the end of the Pricing/Research spiral (Chart 3).
the level of cost-effective-
Averting the first danger is a matter of elementary good management. To ignore competition never pays. Cost-effectiveness as a concept may still be regarded as virgin territory, but not for much longer. The measurement of health outcome in relation to drug input will be difficult, imperfect, but ultimately necessary to demonstrate medical ‘Value for Money’ of drugs sold at very high prices. Finally, the political dimension. Here arises the greatest danger from pricing policies that are designed mainly to satisfy the industry’s own financial needs. Pricing a new drug today is a political act. Even under pricing freedom, the highest prices have to be justified. There must be a rationale for such prices that can be defended when challenged. The cost of research and the company’s financial needs alorle will no longer suffice as a rational form of defence. The valve of new, research-based drugs will have to be expressed in terms of clinical performance, costeffectiveness, and competitive ‘value for money’ if
the industry is to live with the reality of pharmapolitics in the 1990s. From an ivory tower, the price can always be sent up into the clouds; but in the real world of health care, it will sooner or later have to come down to earth.
(4) Prices and Research: The Wider Implications for Management The intertwining of Prices and Research occurs in most industries in which project research and development occupy many years, with a high failure rate, and consequently a need for enough cash flow from successful projects to keep the Science-Finance Cycle moving. Pricing new products created by this type of research is a major planning discipline throughout the development period and the commercial life of the product. Rational pricing is important not only for positioning the new product relative to existing competition : in research-based industries that impinge directly on public opinion (health care, energy, the environment), or on public sector spending, pricing is a political act. Industry and politics have never mixed easily. The industrialist regards the politician as an opportunist and the civil servant as an advocate of controls over industry. In return, politicians and civil servants look on industrialists as the embodiment of profit greed, and on their organizations as vehicles that are made to have no other purpose than financial success, irrespective of society’s priorities. What industry often forgets is that government is usually in a position to have the last word. What government often forgets is that, without industry, few of the brightest discoveries would ever see the light of day as marketable products. These acts of forgetfulness can involve a high cost if, as a result of public polic,):, industries are enfeebled and eventually fail; or it, as a result of political industry mishandles Prices and maladroitness, Research. In short, where there is research, there is a need to build rational and ‘political’ pricing strategy into the planning process.
References (1)
OECD, Financing and Delivering Health Care-A Analysis of OECD Countries, Paris (1987).
(2)
WHO,
World
Health
Statistics
Annual
1987,
Comparative
Geneva
(1987).
Pharmaceuticals: (3)
Royal College of Physicians studies, reported by J. Grimley Evans, in EpidemiologyandAging, an International Perspective, Chapter 3, ‘The epidemiology of the dementias of the elderly’, Springer, New York (1988).
(4)
Scrip, Dementia Classification and Outlook. 16th August 1989, p. 23.
Therapy-a
(5)
OECD. Foreign Trade by Commodities
1987. Paris (1989).
(6)
Pharmaprojects, Surrey).
1988 issues (PJB Publications
Spiral
27
(7)
H. Redwood, The Price of Health-the Link Between Research in the Pharmaceutical industry and Health Care Systems in the Developed World, Adam Smith Institute, London (1989).
(8)
H. Redwood, Pharmaceutical Patent Term Restoration 1990s. Oldwicks Press Limited. Felixstowe (1990).
(9)
P. E. Barral, Douse ans de R&ultats de la Recherche Pharmaceutique dans le Monde (19751986). Prospective et Sante Publique, Paris (1987).
(10)
BEUC (Bureau Europeen des Unionsde Consommateurs),Third Survey of EC pharmaceutical prices, Scrip 7th July 1989, p. 5.
Pessimistic
Ltd. Richmond,
The Price/Research
for the
Long Range Planning. Vol. 24, No. 2, pp. 16 :o 27, 1991 Printed in Great Britain
00~1~301/91
S3.00 + .or)
Pergamon
Press plc
Pharmaceuticals The Price/Research Spiral :
Heirzx Redwood
Prices and research are intertwined in most industries where research and development are carried on over a long term, with a high failure rate. The need for a steady cash flow !n this situation is vital to keep research projects moving. Rationaland political pricing strategies have to be built into the planning process. Rational pricing is important to position a new product in relation to the competition. In the pharmaceutical industry pricing becomes a political act also as it impinges on areas of public concern and public sector spending.
Prices and Research are not often mentioned in the same breath. Prices are n-idely regarded as a short term operational responsibility. Lvhercas Research is an essential preoccupation of long term strategy in science-based industries like pharmaceuticals. Are Prices and Research, then, as indigestible for management as chalk and cheese? They may have been unconnected once upon a time, in the golden age of the pharmaceutical industry when research was cheap and discoveries plentiful. Today, far from being chalk and cheese, Price and Research are more like biscuits and cheese: they go together-they ‘belong’. That does not mean that the research scientist in his laboratory should become a pricing espcrt. Pricing is a function of commercial management and of the world outside. In the field of health care, the two are often engaged in bitter conflict which, in efi?ct, binds them together. The bond bet\veen prices and research arises from the clash between two equally pressing needs: a research-based company’s need of high prices and profits in order to fund more research and development; and the more and more difficult struggle by health care providers to contain the escalation of costs. How real is this conflict1 Very real. It is one of the central issues of pharmapolitics. Heinz Redwood is an Independent consultant. He was for many years in charge of Corporate Planning for Fisons plc.
Putting pressure on drug prices helps to balance health care budgets, or so the authorities say. Does it really? Controlling prices and not allowing them to rise will inhibit research and development funding, or so the industry says. Will it really? Above all, when looking beyond this year’s health care budget and this year’s company budget, and planning for the longer term-are these assertions still true? These are the main questions to be addressed by this paper. For a start, it will be useful to pinpoint the place of drugs in health care, both therapeutically and financially.
(1) The Place of Drugs in Health Care Nobody can deny the contribution to therapy made by new drugs during this century. The so-called ‘wonder drugs’ were indeed medical miracles. Combined with measures to improve sanitation and education, the new drugs that were discovered between 1930 and 1950 began the process whereby most infectious diseases have been brought under control in the Developed World. Today, only about 1 per cent of all deaths in Europe, North America and Japan are caused by infectious diseases. Table 1. Life expectancy (mean, OECD countries)
at birth,
Year of birth
1900 to 1980s
Years expectancy
1900 1930 1950 1980s Source: Organization (OECD) 1987.
48 57 65 71 for Economic
Co-operation
and Development
Pharmaceuticals: The result has been a steady rise in life expectancy at birth, from 48 years for someone born in 1900, to 71 years for those born in the early 1980s. In effect, during the last 40 years, life expectancy at birth has risen at the rate of about 3 months every year in developed countries, and there is no sign as yet that this trend is coming to a halt (OECD, 1987).’ The consequences
are far-reaching:
The Prices Research
Table 3. Increase in geriatric 65 and 73 Condition
conditions
increase
Senile dementia Stroke Arthritis Bad eyesight Deafness
17
Spiral between
(times)
4
1.5
Source: Royal College of Physicians studies, 1981.’
In the first place, there is now a pow-erful demographic shift towards the Over-60s in the Developed World : Table 2. Over-60s developed world
population
trends in the
Projected increase
Year
Millions
1980
185
2000 2020
230 300
Source: World Health Organization,
M
(%)
45 70
(+24) (+30)
compared with one-and-a-half times arthritis, bad eyesight and deafness.
in stroke,
By the mid-1980s the cost to society of senile dementia in the U.S.A. \vas estimated to be in the range of S3MObn per alllliltfr. A high proportion of the total arises from the social cost of loss ofearnings and productivity among family members of working age who have to care for senile relatives at home. These are REAL losses, as anyone relative thus afflicted will confirm.
with an elderly
1 987.2
The World Health Organization has estimated an increase of 45 million people over the age of 60 between 1980 and the year 2000 in the Developed Countries. This will accelerate to a further 70 million (or 30 per cent) during the following two decades to 2020. The second result of longer life expectancy is an enormous rise in the demand for health care of all kinds, because-so far-there is no fall in morbidity in old age. In other words, we do not necessarily die of chronic diseases as once we used to die from acute infections. Today most of us live on after 60: with hypertension, with arthritic limbs, with duodenal ulcers, breathing problems, acute depressions, and at worst-it has to be faced-as cabbages. Only a small minority live in perfect health until one morning at the age of 99, they happen not to wake up. ‘Dying of Old Age’ is a myth. Living with chronic disease is reality. Few chronic diseases are curable today but-except for senility-most can be controlled, sometimes by adopting a healthier life style; more often with medical treatment and the use of drugs. The economic impact of the demographic shift, although much talked about, has in fact barely begun. It has daunting implications. Let us take as an example senile dementia, of which Alzheimer’s Disease is only one form. Five studies by the Royal College of Physicians in 1981 demonstrated that the prevalence of senile dementia rises exponentially with age. Between 65 and 75, there is a fourfold increase in dementia,
The interesting fact is that drugs are playing a negligible part in alleviating the costly march of senile dementia, because etfective drugs to delay its onset or to arrest its course have yet to be discovered and developed. One does not have to be an economist to draw the conclusion that effective drug treatment-if it could be developed-would cost society a lot less than nursing homes or community care for the unfortunate victims of senile dementia. In more general terms, new drugs that prevent, postpone, retard. or alleviate chronic diseases-even if incapable of curing them-are in many cases highly cost-effective in terms of the overall ramifications of health care expenditure. They will increase the drug budget, perhaps substantially. Does that matter, if they produce economies elsewhere in the health care system? At this point, research comes back into the picture: new drugs are needed for senile dementia, but none have yet been developed. A review of the situation in 1989 (Scrip, 1989)’ set the tone: obstacles and pessimism galore. It painted a gloomy picture of drug therapy for senile dementia: its inadequacies, the feeble scientific foundations of some of the research, its methodological confusion. Why the surprise? such a situation is typical of the state of medicine before a break-through. There will be a break-through eventually, but nobody can say how soon, hoxv far-reaching, and after how many false starts and costly failures in research and development. Back in the 192Os, we would have found a similar state of uncertainty about the role of drugs in the treatment of
18
Long Range
Planning
April 1991
Vol. 34
infectious diseases lvhich, today, \\-e granted. Even Fleming, having discovered lin in 1938, \\-as actually unable to prove its medicine and. by 1936. had given up tr)-ing
take for penicilutility in to do so.
As for random chemical synthesis, rll,lt was arrogantly condemned by academics in the 1920s as ‘unscientific’ and useless-until the flood of sulphonamide drugs, discovered and developed unscientifically in the laboratories of the German, Swiss, British and American pharmaceutical industries during the 193Os, proved otherwise. The lesson for today is that medical problems are there to be solved, and that drug discovery and pharmaceutical development will be a necessary component of man)- of the solutions. So much for the sublime: the altar of Research. Turning no\v to the ridiculous-Prices-the real question is: are drug prices ridiculously high or ridiculously low? The answer depends on whether one considers them from the point of view of the authorities or from that of the pharmaceutical industry. Each believes that the other is making a ridiculous fuss. But prices really are no laughing matter; for today’s prices lay the foundations for tomorrow’s drug research. Before probing the precise relationship between prices and research, it is useful to look at drugs in the perspective of all forms of expenditure on health care.
Institutional Ambulatory Pharmaceutical Other
1970
Early 1980s
WI
(%I
50 20 12 18 100
and Italy, and louver in the U.S.A.
If reason-and in health care, more by logic by now have wet flannel :
and
not emotion-were the motive force and if cost containment were dictated and less by politics, two points would hit the authorities like the smack of a
Point l--In a cost containment drive, as much can be saved when hospital costs are reduced by 2 per cent as when the drug bill is cut by 10 per cent. Point 2-Long-term, severe pressure on drug prices is damaging to the pharmaceutical industry’s financial resilience and hence to its capacity for sustaining a high-risk stance in research and development.
Point 1 is a fact. Point proposes to argue it.
2 is arguable.
(2) The Science-Finance
This paper
Cycle
First of all, it is important to look at Research & Development (R & D) not in a scientific ivory tower but as part of a financial cycle in which cash is invested at risk and has to be recouped before the cycle of investment is resumed. It is, in effect, a Science--Finance Cycle, shown on Chart 1 in its application to the pharmaceutical industry. The Science-Finance Cycle can be suitably adapted to the circumstances of other research-based industries. If pharmaceutical research leads to the discovery of a patentable product, the period of maximum financial risk is not that of research itself, but development and, later, success or failure in international marketing.
Table 4. Cost components of health care expenditure by the public sector (OECD countries, % of total) Component
Germany Canada.
54 21 10 15
100
Source: OECD. 1987.’
Studies by the Organization for Economic Cooperation and Development (OECD) have shown that, in Europe, North America, and Japan, hospitals and other institutions were responsible for over half of all health care spending by the early 1980s. General practitioners and ambulator)care took a further 20 per cent. These proportions were rising. By contrast, pharmaceutical costs accounted for only 10 per cent of health care spending, and this proportion had fallen by two percentage points since 1970. By 1987, pharmaceutical spending in the U.K. was still at 10.1 per cent of the cost of the National Health Service. It was higher in France,
For a new drug, development occupies about twothirds of the time from discovery to launch; and absorbs two-thirds or more of total R & D expenditure. Analysis has shown that only l-in-5 development projects reach the market at all 1988) ;6 the others are dropped (Pharmaprojects, somewhere along the way. Of the ones that reach the market, only about l-in23 can be described as highly successful financially (Redwood, 1989).’ Others may well be profitable, too, but not sufficiently profitable to pay for the failures and provide a return on overall risk investment in R & D. What
does all this mean in practice?
There are about 250 research-based companies in the world. Collectively, yearonR&D.
pharmaceutical
they spend about 15 billiorz dollars each
As a result of that expenditure,
they manage
each
Pharmaceuticals:
The Price/Research
Spiral
19
RESEARCH Discovery, Screening
F&-investment
\ Patent Protection \,
Post-marketing Surveillance
.:
:.
International Marketing
Chart
1. Cycle of maximum
risk
year to introduce only two or three new drugs that are capable of achieving major financial success.
success depends cially supportive
Evidently, pharmaceutical research and development is high-risk and, faced with risk of this magnitude, two major questions need to be asked:
In the Science-Finance Cycle, the entire drug development process and the subsequent phase of international marketing are attended and pursued all the way by intervention. Good management of development involves exercising judgement in the choice of priorities, the allocation of resources, and ensuring that the organization of development activities across the world is effective. Management error in any of these can cause even the best drug discovery to fail.
(1) What
is it that determines
(2) How can success?
one
turn
research
scientific
success?
into
financial
To the first question-how can one achieve research success?-the honest answer is that nobody really knows. Creative science is as mysterious as creative art. Most research-based pharmaceutical companies on both sides of the Atlantic believe quite simply that: Good
Research
plus a fair dollop lie ne sais quoi’.
= Good
Individual
of luck, serendipity,
Scientists voodoo,
and
Everyone agrees, however, that, to turn scientific discovery into financial success-which is the management process of development followed by international marketing-demands more than a genius on the premises. Indeed, some believe that genius is best banished from development where
on firm management external environment.
and a fman-
On the other hand, much of the area of maximum risk, as the Cycle shows (Chart 1) is also that of maximum intervention by the authorities, reaching a financial climax when it comes to pricing and social security reimbursement. Both can determine the financial potential of a new drug: that much is obvious. What is less self-evident is the interaction of pricing and reimbursement decisions with other phases of the Science-Finance Cycle. Broadly speaking, it is a 20-year cycle. That is the official span of patent life from discovery to expiry in most countries. But e&xrive patent life-from first marketing to patent expiry-is only l&12 years for patented products ranking among
20
Long Range
Planning
Vol. 2-J
April 1991
the Top-100 drugs in the world’s leading markets; and only about 7 years on average for n/l drugs. ‘Effective’ patent life (Chart 2) is what matters. It has eroded rapidly during the past decade: in the U.K., from nearly 16 years for leading products that were launched in the 1960s to under 12 years for those introduced after 1980. Similar or worse erosion occurred in the U.S.A., France and Germany. That is why patent term restoration is now a prominent topic on the European pharmapolitical agenda (Redwood, 1990).8
18-
‘\ U.S.A France U.K. Germany Japan
\ l
\
.\
\ \ \
v l
. q
o
T\
Products Launched Before July 1970
Chart
2. Effective
All
patent
All
Products Launched After June 1980
life
Most companies depend on only one or two leading patented drugs for the revenue that will keep the Science--Finance Cycle turning. Half of the official patent span is absorbed by drug development and regulatory approval for these leading drugs. Patent expiry brings generic competition (i.e. the entry of cheaper ‘copies’ of the pioneer brand) and a rapid fall in price and profitability. C~rce~~t&ly, that is as it should be. Patent protection and product monopoly oltglzt to be followed by genuine competition. There is no reason to quarrel with the principle of generic competition-provided it follows an adequately long period of patent protection, with high prices and high profitability. If these conditions-adequate protection and high profitability-are not met, then the ScienceFinance cycle comes to a halt. The need to reduce risk becomes paramount: either less is re-invested, or the risk profile of the R & D portfolio is squeezed: fewer original, more ‘me-too’ research projects with a better chance ofreaching the market, make a persuasive option when the chips are down.
There are four main ways in which Finance Cycle can be disrupted:
the Science-
Table 3. The Science--Finance factors
disruption
(1) (2) (3) (4)
Cycle:
Bad management Hostile intervention Patent expiry Risk aversion
Prices and research run in parallel across this minefield of disruption. Often, weak management can be spotted by observing its pricing strategy. Hostile intervention by the authorities, on the other hand, cuts do\vn management’s room for manoeuvre and can put severe pressure on profits via pricing and reimbursement. Pricing decisions at the approach of patent cspiry are among the most demanding tests of management strategy, and the results are bound to influence the rcsourccs available for Research & Devclopment. Finally, risk aversion will show its colours either in pricing policy or in R R: D spending. One point ought to be brought out clearly: it is NOT a symptom of weak management to reduce the company’s risk profile. Indeed, doing so can be proof of strong and realistic management. But pharmaceutical R Es D is by its very nature uncertain of outcome and high-risk financially. To adopt a low-risk posture in R & D may give all the right signals of prudent conduct in management butexcept by chance-it is not going to produce those gigantic leaps in therapy that society needs if it is to cope with the coming surge of chronic morbidity in old age. In essence, then, PRICES and RESEARCH are bound together in a web of risk, management, and intervention. Bad management will no doubt somehow find a n-ay of getting into a mess even when risk is minimal and there is no external intervention. Assuming Good Management, the question remains whether there is a long-term relationship in pharmaceuticals between intervcntion in pricing and reimbursement on the one hand, and the acceptance of risk in Research ei Development on the other? The ans\v*er is: ‘Probably, yes’. It is not an instant relationship (‘you cut my price, so I cut my R & D’), but one that kvorks its way through the system over the years as a kind of slow motion spiral (Chart 3), for whose twists management and the authorities can each be responsible at different times. The spiral itself is shown on the left of Chart 3. It moves from pricing systems (free or controlled) to actual prices and profits in the market; the advent of competition from generics after patent expiry; the
Pharmaceuticals:
Risk
I-+
c-x*
R & D Success
*
Re-invest R & D
The Price/Research
Strong
Weak
High, Rising
Lower, Rising
Rare
Very Rare
Very High
As High as Permitted
Very High
As High as Possible
Spiral
21
As High as Permitted
Reaction 1
Pressure
More Control
NCE = New Chemical Entity
Chart
3. Free-pricing
spiral
risk posture in R ei D, dictated by financial resources; actual spending decisions on R & D; and the frequency of major success in development projects. That leads on to pricing decisions for new products. The spiral then turns to the reinvestment of profit in more R & D; pricing decisions for the next generation of new products; and the political reaction to spiralling drug costs. Ho\v does external intervention in pricing with the attitude towards risk in R & D? First, consider what generally tions of pricing freedom.
interact
happens under condi-
Without price control, the pharmaceutical industry is highly profitable. As a counterweight, there is a strong generic movement backed by health care providers and legislators. The industry adopts a high risk posture in R & D, partly because it can afford to do so, and partly because it cannot afford NOT to do so: competition drives risk. Expenditure on R & D now rises steeply as, in fact, it has done in the U.S.A. throughout the 1980s.
On rare occasions, a major success is scored-one of the two or three ‘blockbuster’ drugs that reach the world market each year. Such compounds are priced well above existing competitive drugs. A series of quantum jumps in new product pricing eventually provokes a political reaction. Health care providers and legislators think up new ways of containing the drug bill. This eventually knocks the industry back as the pendulum swings, until a new spiral begins to unwind. The swing of the pendulum can be observed very clearly in countries where the price of drugs is not controlled: in Germany and Holland where moves to introduce ‘reference prices’ (which limit reimbursement by social security to a set ‘reference’ level) are being hotly debated; in Denmark, where many products have been transferred from prescription-only to over-the-counter status and consequently removed from reimbursement by social security; and in the U.K. with the introduction of drug budgets for doctors’ practices. The
free-pricing
spiral (Chart 3) is, of course,
an
33 __
Long Range
Planning
Vol. 2-l
April 1991
over-simplification of a more complex series of interactions. It nevertheless demonstrates in broad terms the operation of long-term interaction cycles in countries like the U.S.A., West Germany and, up to a point, the U.K. whose Pharmaceutical Price Regulation Scheme stands between pricing freedom and control. The alternative spiral-under direct product-byproduct price control-unwinds in a different manner. To start with, drug prices are low and generics are weak, because low controlled prices offer neither scope nor incentive to generic competition. The industry-‘s risk posture under this type of system is also vveak, because the reward for success, too, is controlled-so why go out on a limb? Nevertheless, measured against limited profitability and constrained resources, financia1 commitment to R & D in price-controlled countries is high and rising, because companies see R & D as their only hope of remaining competitive in the long run. If major research SLKCCSS is infrequent under the benign and prosperous conditions of pricing freedom, it is extremely rare in controlled systems, as will be demonstrated numerately, below. Although introductory prices for new research-based products are usually higher than those of the older drugs against which they are competing, in controlled systems the pricing decision still rests with the authorities. Prices can only be ‘as high as permitted’. As a consequence. the amounts reinvested in R & D are circumscribed, too, and success in the next cycle of research projects is again subject to price control: higher than before, but lower than under conditions of pricing freedom. Politically, how-ever, a spiral is a spiral even if its elasticity is compressed by controls. The health care budget is always getting out of hand. When even controlled prices are spiralling upwards every time a new drug is launched, an alarm bell rings. It tells the authorities that they should exercise even tighter control. If that causes a new attack of risk aversion in the national pharmaceutical industry . . . too bad, but control feeds on control, yet it always remains hungry. Again, the sequence is over-simplified, but basically it illustrates a form of spiral descent that is characteristic of, for example, the price controlled pharmaceutical industries of France, Italy, Belgium and Spain. To illustrate this, a comparison of drug prices in the European Community (Chart 4) divides member states neatly according to their pricing systems. All the countries that run systems of product-byproduct control of pharmaceutical prices are below the European average, whereas the free pricing or profit control countries (plus Ireland whose prices
linked
are
to those in the U.K.)
appear
above
the
line. The national pharmaceutical industries of countries with low prices have gradually become less comboth as originators of petitive internationally, genuinely innovative drugs and in their penetration of international markets. In the long run, the research output of national pharmaceutical industries lines up more or less inversely to the severity of their drug pricing and reimbursement systems, as an important study by Etienne Barral has clearly demonstrated: Table 6. Pharmaceutical research new chemical entities by country 1975-1986
Country U.S.A. Japan Germany France Switzerland U.K. Italy Others
Source: Barral,
results: % of of origin,
All NCEs WI
NCEs marketed world-wide (%I
25 19 13 12 6 5 10 - 10 100
42 5 7 5 7 18 0 - 16 100
1 987.9
The left-hand column shows the country of origin of 610 drug substances (New Chemical Entities or NCEs) that were introduced during the 11 years from 1975 to 1986. It gives a fairly balanced picture, reflecting broadly the size of each of the industries (American, Japanese, German, French, etc.). In the right-hand column, only those drugs which achieved global marketing status are shown: there were only 60 of these during the 11 years. The other 550 fell short of world-wide marketing, often because they were in a sense designed to fit national medical traditions under controlled pricing and reimbursement systems: French drugs for France; Italian drugs for Italy; Japanese drugs for Japan, and so on. The 60 world-wide
drugs fall into two groups:
The first is therapeutically innovative, and may or may not have been financially rewarding. One can be highly innovative in a tiny market segment. Some ofthese 60 drugs were, however, highly successful. The second group is therapeutically competitive but leans towards the ‘me-too’ end of the spectrum. It usually offers some claimable advantages. It is typically the seventh cephalosporin, or beta-blocker, or non-steroidal antiarthritic rather than the first. Its global penetration arises less from originality than from the originator’s competitive muscle
Pharmaceuticals:
The PriceiResearch
Spiral
23
-Germany - Denmark
- Netherlands
- Ireland
K.
-
ECA\ ferage
- Belgium
- Italy
- Greece
60
1988
1986
Source: BEUC 1987, 1989’O Except Denmark, Greece 1986: estimates
Chart which way.
4. Comparison
of drug prices in the EC
can make a moderate
product
advantage
go a long
The common element between innovative and competitive new drugs that are marketed worldwide is the multinational spread of the originator. It is dif?icult to achieve high profits with low selling prices in the price controlled countries. This in turn inhibits overseas marketing investment by domestic firms, because the financial risk in starting one’s o\vn organization in, say, the United Stares or Japan is deemed to be too high. So it is not surprising to find that French and Italian drugs-which make up over 20 per cent of ‘All NCEs’ in the column on the left (Table 6), account for only 5 per cent of ‘World-wide NCEs’ in the column on the right. The number of French and
Italian drug companies that have a viable base of their own in the U.S.A. and Japan can in fact be counted on the fingers of one hand; and with a few fingers to spare. Most have set themselves low-ke) targets in terms of innovation: sufficient to satisf) the national authorities for pricing purposes and reimbursement in the home market; not enough to risk globetrotting. By contrast, American drugs, covering 25 per cent of ‘All NCEs’ on the left, take the lion’s share of -+2 per cent of ‘World-wide NCEs’ on the right. Here, high prices in a large domestic market have provided the financial resources for multinational expansion which, in its turn, has provided funds for reinvestment in R & D-a formula which has given the American drug industry an almost unassailable lead.
2-l
Long Range
Planning
Vol. 2-i
April 1991
The British pharmaceutical industry has benefited from a balanced system of relatively high drug prices, but Lvith a ceiling on profitability on sales to the National Health Service. Prices and profits have been high enough to encourage R & D in the U.K. which has proved both creative and remunerative. All British research-based companies have set up multinational marketing facilities in the European Community, North America, and Japan. With only 5 per cent ot ‘All NCEs’, British drugs made up no less than 18 per cent of ‘World-wide NCEs’ during this period (Table 6). It has to be said that pricing freedom is no guarantee of success in R & D. The somewhat meagre level of creative achievement by the German pharmaceutical industry betxveen 1973 and 1986 shows it. Price control, on the other hand, makes it much more difficult to pay for creative risk, and also undermines the scope for taking chances Lvith multinational expansion. Long-term, the result is a loss not only of the power to compete internationally but of the will to do so. Competition in the ‘Single Europe’ of 1992 and beyond should be seen in this light: two-thirds of all ‘World-wide NCEs’ introduced between 1975 and 1986 kverc of American, British and Swiss origin. There is little evidence to suggest that their lead will be seriously challenged in the 1990s except by Japan. The pharmaceutical industries of the European Community (csccpt the British) look particularly vulnerable: structurally weak; creatively low-key; and squeezed hard by pricing and reimbursement pressures. The German industry is among the world leaders but has not been very creative in recent years, and it is now under severe pressure in the domestic market. The American, British and Swiss pharmaceutical industries are stronger structurally and creatively. They, too, will have to cope with pricing pressures, but they are more resilient. Their chances of compctitivc survival are therefore correspondingly better. No comparison of international competitiveness would be complete without examining the trade between pharmaceutical exports and balance
imports of the countries leading pharmaceutical
Table 7. World trade balance 1987 (Medicinal Pharmaceutical Products: exports less imports Surplus +/Deficit -)
Source:
OECD,
1 98g5.
and
Sm European Community Switzerland U.S.A. Japan
+4189 +2156 +850 -1521
Sourcet OECD, 1 98g5.
At first sight, all seems ~vrll with the European Community in this respect. In 1987. the Community had a pharmaceutical trade surplus of over S4bn; Switzerland alone produced a surplus of more than S2bn; the U.S.A. made less than Slbn; and Japan had a trade deficit of Slibn. A world trade surplus ma!- be useful, but the true indicator of international competitiveness is the pharmaceutical trade balance with OECD Corrnfries, because trade within the Developed World has become a mirror of innovative success and multinational market penetration. Apart from parallel imports, most intra-OECD trade in pharmaceuticals is now in single source, research-intermediate or finished products, often bet\\-een parent companies and their overseas subsidiaries. SuccessfLll R & D has become, as near as matters. a prerequlslte for multinational penetration. To demonstrate the difference between world trade and OECD trade in pharmaceuticals, the next chart splits each trade balance betxveen OECD and the Rest of the World: Here, Switzerland shows up more strongly than ever, with the greater part of its positive balance arising from trade with other OECD countries. By contrast, Community
the ‘colonial’ legacy of European trade is shown by the fact that 85 per
Table 8. Pharmaceutical trade balance with OECD countries and rest of world (Medicinal and Pharmaceutical Products: exports less imports Surplus +/De&it (S million))
European Community Switzerland U.S.A. Japan
\l\-hich make up the Lvorld’s industries.
Total
of which with OECD
+4189 +2156 +850 -1521
+ 624 t-1464 +478 -1602
OECD % of total 15 68
Pharmaceuticals: cent of its phamaceutical from the Less Developed
trade balance Countries.
is derived
The American surplus is balanced between the two, whilst the Japanese deficit is entirely due to the fact that Japanese drug companies have not yet established many operating subsidiaries in Europe and the U.S.A., whereas American and European drug firms have increasingly set themselves up in Japan. The vveakness of the European Community is even worse than it appears at first sight. Europe is totally unbalanced in its intra-OECD trade (which includes trade between member states of the Community). Germany and the U.K. among the leading countries, together vvith Denmark and Ireland among the smaller member states, are in pharmaceutical surplus in their OECD trade. France is neutral. The rest are in deficit; Italy badly so. Once again, the ranking order reflects the long term repercussions of pricing systems. Of the countries with pricing freedom, only the Netherlands are in deficit. On the other hand, no country with product-by product drug price control has a pharmaceutical trade surplus. A clear thread runs across the entire picture: expressed in medical language, drug price control is contra-indicated for high-risk and innovative R & D. Adverse reactions include a propensity to concentrate on the domestic market and to abstain from multinational investment. The result is competitive anaemia, one symptom of which is a negative pharmaceutical trade balance. The disease is chronic rather than acute, and it cannot be cured overnight. Long-term control breeds long-term debility.
(3) Pricing Research
New
Products
from
So far, this paper has pleadedfor the pharmaceutical industry. Now, in discussing corporate pricing policies for new products from research, it has to
adopt a different industry.
stance:
25
one of pleading
u~it/z the
With rising costs and mounting pressures of competition and intervention, is not the right policy quite simply: ‘Charge whatever you can’? What the market will bear? What the authorities will wear? That, after all, is what a Company needs; and if it fails to get it, soon there vvill be no Company. Surely that is being realistic? Yes and No. It is realistic from the company’s point of view; but the company has to live in the reality of another world outside: that of pharmapolitics. Pharmapolitics is rather like dormant for years but, when condition is feverish and the dangerously high temperature. and it spreads like wildfire. accepted lesson. 7 Prevention is
malaria: it may be it breaks out, the patient soon runs a Ignore the causes And the generally better than cure.
Here is a particularly sick example of how to ignore that principle: Any resemblance to living persons is purely coincidental. A Marketing Director, with a carefully prepared brief running to at least 50 pages, proposes an introductory price of 100 for a new, research-based drug in a country with pricing freedom. It happens, however, that at that very moment, the Managing Director is hard-pressed to meet the budget for the year. Worse, his Board of Directors is shaking like a plate ofjelly at the thought of what the stock market is expecting from the Company next year. The Board makes an instant decision. It agrees that the price of the new drug should be fixed, not at 100, but at 150. That will apply to free-pricing markets. In the others, the Marketing Director is told, ‘do the best you can’. Apologies
to management.
Table 9. Pharmaceutical trade balance of EC member states with OECD countries, 1987 (Medicinal and Pharmaceutical Products: exports less imports, Surplus +/Deficit - (S million)) Country
Sm
Country
Germany United Kingdom European Community Denmark Ireland France
+ 1093 + 630 +624 + 250 +88 +2
Belgium/Lux. Portugal Netherlands Greece Spain Italy
Source: OECD, 1 98g5.
Spiral
The Price/Research
Sm -25 -150 -156 -162 -216 -730
The author is not trying
Long Range
26
Planning
Vol. 33
April 1991
to be facetious-surely some readers will recognize the situation-and he is not implying that the principles of rational price setting are being ignored everywhere. What is suggested is that the same short-term pressures that drive governments into short-sighted measures to contain costs, push pharmaceutical into short-sighted pricing decisions companies when, just for once, a new product from research allows management some elbow room for manoeuvre under pricing freedom. So the price is set in response to the Company’s needs. Whether that is the RIGHT price, depends on the answer to another question: for whose benefit should a new drug be priced? For the Company’s! the patient’s (if the patient pays, that is)? or for the health care provider’s benefit? Commonsense suggests that, as in any business deal, it will only work if there is something in it for all the parties. There are esclusively needs :
dangers in in response it ignores
pricing a new to a company’s
or underrates
product internal
fi
firstly,
competition;
a
secondly, it disregards ness of the drug;
*
thirdly, it can provoke the political reaction at the end of the Pricing/Research spiral (Chart 3).
the level of cost-effective-
Averting the first danger is a matter of elementary good management. To ignore competition never pays. Cost-effectiveness as a concept may still be regarded as virgin territory, but not for much longer. The measurement of health outcome in relation to drug input will be difficult, imperfect, but ultimately necessary to demonstrate medical ‘Value for Money’ of drugs sold at very high prices. Finally, the political dimension. Here arises the greatest danger from pricing policies that are designed mainly to satisfy the industry’s own financial needs. Pricing a new drug today is a political act. Even under pricing freedom, the highest prices have to be justified. There must be a rationale for such prices that can be defended when challenged. The cost of research and the company’s financial needs alorle will no longer suffice as a rational form of defence. The valve of new, research-based drugs will have to be expressed in terms of clinical performance, costeffectiveness, and competitive ‘value for money’ if
the industry is to live with the reality of pharmapolitics in the 1990s. From an ivory tower, the price can always be sent up into the clouds; but in the real world of health care, it will sooner or later have to come down to earth.
(4) Prices and Research: The Wider Implications for Management The intertwining of Prices and Research occurs in most industries in which project research and development occupy many years, with a high failure rate, and consequently a need for enough cash flow from successful projects to keep the Science-Finance Cycle moving. Pricing new products created by this type of research is a major planning discipline throughout the development period and the commercial life of the product. Rational pricing is important not only for positioning the new product relative to existing competition : in research-based industries that impinge directly on public opinion (health care, energy, the environment), or on public sector spending, pricing is a political act. Industry and politics have never mixed easily. The industrialist regards the politician as an opportunist and the civil servant as an advocate of controls over industry. In return, politicians and civil servants look on industrialists as the embodiment of profit greed, and on their organizations as vehicles that are made to have no other purpose than financial success, irrespective of society’s priorities. What industry often forgets is that government is usually in a position to have the last word. What government often forgets is that, without industry, few of the brightest discoveries would ever see the light of day as marketable products. These acts of forgetfulness can involve a high cost if, as a result of public polic,):, industries are enfeebled and eventually fail; or it, as a result of political industry mishandles Prices and maladroitness, Research. In short, where there is research, there is a need to build rational and ‘political’ pricing strategy into the planning process.
References (1)
OECD, Financing and Delivering Health Care-A Analysis of OECD Countries, Paris (1987).
(2)
WHO,
World
Health
Statistics
Annual
1987,
Comparative
Geneva
(1987).
Pharmaceuticals: (3)
Royal College of Physicians studies, reported by J. Grimley Evans, in EpidemiologyandAging, an International Perspective, Chapter 3, ‘The epidemiology of the dementias of the elderly’, Springer, New York (1988).
(4)
Scrip, Dementia Classification and Outlook. 16th August 1989, p. 23.
Therapy-a
(5)
OECD. Foreign Trade by Commodities
1987. Paris (1989).
(6)
Pharmaprojects, Surrey).
1988 issues (PJB Publications
Spiral
27
(7)
H. Redwood, The Price of Health-the Link Between Research in the Pharmaceutical industry and Health Care Systems in the Developed World, Adam Smith Institute, London (1989).
(8)
H. Redwood, Pharmaceutical Patent Term Restoration 1990s. Oldwicks Press Limited. Felixstowe (1990).
(9)
P. E. Barral, Douse ans de R&ultats de la Recherche Pharmaceutique dans le Monde (19751986). Prospective et Sante Publique, Paris (1987).
(10)
BEUC (Bureau Europeen des Unionsde Consommateurs),Third Survey of EC pharmaceutical prices, Scrip 7th July 1989, p. 5.
Pessimistic
Ltd. Richmond,
The Price/Research
for the