Prices, Profits and Prescriptions: The Pharmatech Industry in the New Economy
by Merrill Matthews on 10/16/2000
16 Pages
There have been many complaints about prescription drug prices lately; critics seem to think they are too high, and point to drug company profits as proof. But would imposing price controls on drugs be good policy for the public, states and the nation? Would such policies reduce or eliminate drug manufacturers’ research and development efforts? Are there deadly or debilitating diseases that won’t be treated or cured if price controls are implemented?
Some drugs are very expensive, others aren’t. What’s the difference? Research and development. Pharmaceutical companies will spend about $22.4 billion in 2000 developing and testing new drugs, as compared to about $4 billion for all other companies combined.
In fact, there are really two pharmaceutical industries: one that mass-produces aspirin, cold medicines, ointments and other over-the-counter drugs. The other pharmaceutical industry — the “pharmatech” industry — is a New Economy industry, where initial costs to create and test a patentable item are very high, but once achieved the reproduction costs are usually minimal.
While it is true that many prescription drug manufacturers are profitable, and several have been consistently profitable over the years, those profits are not out of line with other successful New Economy companies and industries that produce products in high demand. The fact is drug companies are not profitable because they charge so much for prescriptions; they are profitable because they produce products that doctors and their patients want.
While total spending on pharmaceuticals has been growing rapidly — averaging a 13.7 annual increase between 1995 and 1999 — most of that spending is due to increased volume of sales, not higher prices. For example, while prescription drug sales grew by 18.8 percent in 1999, 14.6 percentage points of that growth was due to increased volume and new products, while only 4.2 percentage points of the increase was due to higher prices.
Nevertheless, drug company profits have become a political issue as both Democrats and Republicans look for a way to provide seniors with a prescription drug benefit. However, it is not clear there is a prescription drug crisis — about 65 percent of seniors already have some type of coverage for prescription drugs — or that either of the primary plans proposed by Republicans and Democrats would work.
If politicians really want to control prescription drug prices, there is a better way to do it than by government fiat. It’s called competition. But can prescription drugs, many of which are protected by a patent, act like a real market? Yes. The drug industry is already very competitive, with no drug company having more than 7.2 percent of the market. And changes in the health care system and patients’ ability to access information are making the market even more competitive.
Take direct-to-consumer (DTC) advertising, for example. In just 10 years DTC advertising has increased from $55 million (1991) to an estimated $1.8 billion this year. However, most of that growth came after 1997, when the Food and Drug Administration loosened some of the restrictions on DTC ads.
True, the pharmaceutical industry will likely never be as competitive as some industries. Several factors, such as patent protection and the price insulation for consumers, will necessarily limit the industry’s ability to act like a real market. However, steps such as reforming Medical Savings Accounts that would reduce insulation from the cost of health care or eliminating the FDA’s “efficacy” requirement would go a long way in making the industry more competitive. And with that competition would come more choice and lower costs. And if drugs are available and easily affordable, who cares how much money drug companies make?
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