Sunday, January 24, 2010

Technology and Innovation

Hi everyone! I’m back from the holidays, so the blogging is returning. I had the honor of serving as best man at my older brother’s wedding! I also attended a week-long healthcare-focused investor conference in San Francisco. I appreciate the encouragement from those of you who’ve seen me around.

In the last post, we took a look at some various health systems around the world, but I wanted to point out one of their understated flaws. Many point to their lower costs and better health outcomes. One example of this is the better drug pricing that these countries receive because of their aggregated purchasing power with the drug makers. The economics from a negotiation standpoint makes sense; the marginal cost of a pill that already exists is fairly low. If the choice for a drug manufacturer is to make a smaller margin on larger volume or no profit at all, then obviously they will sell the drug at the lower price.

The US pays significantly more for their branded drugs than other countries. The most salient of which is Canada. Politicians even talk about allowing drugs purchased in Canada to be reimported into the US on a large scale (we’re not talking about families bringing drugs across the border, but making it an industry). Think about that…US manufactured drugs, shipped to Canada, only to be reshipped back to the US. I don’t even want to bother going through the laundry list of reasons why this is ridiculously stupid, but I’ll just go through a couple of the practical realities for the sake of argument. 1) Would the drug manufacturers allow Canada to purchase the type of volume required to be sent back to the US? 2) Does the Canadian government want to get involved with trying to control US healthcare costs? (I think both of these answers would be no). Okay, admittedly I don’t have the highest opinion of all politicians…I’ve definitely found rhetoric, grandstanding, and pandering to popular opinion to be more prevalent than true, honest thoughtfulness about the best policy for the long-term benefit of our country. I contend the real reason the US pays so much more for these drugs is that US law has carved out a monopoly for them. Patent law allows 17 years of monopolistic competition, which allows the manufacturer to charge an excessive premium for their product in the US. In theory, this excess profit is meant to encourage the initial investment into research and development.

Now, to be honest, (and I’ve been up front about this before), I’m a big believer in economic incentives and I think the patent protections and laws that encourage innovation have genuinely helped increase the funding to find the next big idea or create the next helpful drug or product. [It’s part of what make this country so great.] Granted, one of the legal side effects results in me-too type “innovative” products and gross abuse of intellectual-property law to sustain/hide-behind these patent protections far beyond the originally intended 17 years (that’s another discussion). Aside from these, I think the US healthcare system has ~funded~ many of the pharmaceutical drugs that we see today. Clearly the production cost of an additional pill is very tiny, so once you have one market that is making up for the losses in R&D (the US), the drug companies would be willing to slash prices for additional volume elsewhere. This is where countries like Canada and the UK can step in to be the beneficiary of being the marginal buyer as opposed to the initial buyer. Without the initial buyer willing to pay such a large premium, the investor may never fund the research costs required to discover new drugs.

The fundamental flaw of every government trying to be the marginal buyer should be pretty clear. It would be like every airline passenger refusing to pay more than the marginal cost of flying on a plane (peanuts, soda, and some meager fuel costs) without anyone helping to pay for the fixed costs (plane, pilot, flight attendants, airport fees, etc.). Now is there a solution to have countries other than the US funding the pharmaceutical innovation? Perhaps, but I can’t think of one that doesn’t have massive ripple effects. Can you imagine the international outcry if there were a tariff on US drug exporters? What if other countries just manufactured US-patented drugs? Seems like another case of underpaying for intellectual property – like the massive amounts of stolen software and movies that you can find in Asia or Chinatowns in the US. If you have a good suggestion – I’d love to hear it.


  1. You suggest in the passage that patent laws in the US are to blame for manufacturers charging a premium when selling into the US market versus selling into other markets. I thought I’d ask some questions to understand the issue better.
    1. Who do you consider the payer in this transaction? Why would the payer willingly agree to pay high prices to drug manufacturer knowing that foreign payers are paying less for the same drug? Is it because they don’t know how much higher the prices actually are or because they have no choice but to pay the premium?
    2. What are the patent laws in other countries that pay less for branded drugs? If patent laws are significantly less strict in foreign countries, then US payers should be trying to find some way around it or try to import foreign generics earlier. Why does that not happen?

  2. Hi Lydia,

    I hate to use the word 'blame' for the higher prices since I think innovation is a positive thing for society, but 'blame' has a negative connotation to it. In any case, some thoughts on the points you bring up...

    1. I think the ultimate payer is the American consumer. The conduit would be the US insurance companies. So I suppose - why do you or I willingly agree to pay a higher price for [Nexium or whatever drug] vs. the Canadian government? Well - we don't really have a choice. The choice is pretty much either to buy the drug or forgo it. I suppose the reason the individual consumer doesn't think of it that way is that the insurance companies spread the cost of usage among both the sick and healthy patients. So you're right in both cases - they don't know the real price of the drug and they don't really have a way to pay less.

    2. To sell drugs in the US at all, it must pass FDA approval. Since this will be a market that drug makers will want to access, this approval process is the key to bringing any large-scale drug to market. My original intended point was that we have been purposely paying more for drugs in order to encourage medical/drug innovation. Frankly, it's worked - there are hundreds of new drugs that I believe never would have existed otherwise.

    The US does import generics as soon as legally possible. You'd be quite amazed how quickly the changeover happens - the market share of a branded drug literally drops from 100% to around 40-50% overnight. To do it any sooner would require changing US law (which isn't something I'm trying to advocate here).

    There's a whole cottage legal industry dedicated to challenging (or extending) drug patents. Foreign generic manufacturers constantly file lawsuits to contend that their drug is actually a different drug from the existing branded drug - thereby getting around the original patent by creating a new one and increasing competition in the market.

  3. I tend to think it is a lack of transparency and effective regulation that causes the net result of US paying more for branded drugs than other nations. I'm sure I'm oversimplifying the issue, but I think if there was full disclosure of how much drug companies make off of each product in each nation and how much they charge respectively, the problem would be half way solved. Drug companies try to keep the pricing and profits vague in order to keep everyone guessing at what the true profit is. Then they cry about how development costs are skyrocketing when in reality, these added costs just gets pushed through the system. All the middlemen (distributors, insurance, etc) must make a profit too, so their "services" further adds to the overall spend that ultimately the consumer pays.

    Very interesting blog and points. Look forward to reading more :)