Introduction to Prescription Drugs

ECON 372 · Economics of Health Care Markets

Ian McCarthy

Emory University

Pharmaceutical Spending

High spending per person

Relatively small share of health care

Prescription Drug Life Cycle

Three Broad Stages

  • Research and Development
  • Marketing
  • Sales

Research and Development

R&D Timeline

  • 10-15 years from discovery to manufacturing
  • Discovery: screening, target identification, pre-clinical testing
    • < 5% of candidate compounds make it to pre-clinical testing
  • Clinical Trials: official testing for FDA approval (up to 10 years total)

Clinical Trials

  • 20% of drugs in pre-clinical discovery make it to clinical trials
  • Pre-clinical: submission of investigational new drug application (IND)
  • Phase I: testing on healthy, human volunteers, focus on side effects
  • Phase II: testing on relevant patient population, focus on efficacy
  • Phase III: testing on large patient population, focus on safety and efficacy
  • FDA review and approval, submission of new drug application (NDA)

FDA Approval

  • Physicians can prescribe drugs for off-label uses, without FDA approval
  • FDA approval is required for marketing and insurance coverage
  • FDA approval can be narrow, and generally does not cover all uses
  • Companies often continue clinical trials after approval to expand uses

R&D Spending

New Drug Approvals

Marketing

Marketing Expenditures

Marketing Expenditures

  • About $6 billion per year on direct-to-consumer advertising (primarily TV and magazine), based on 2018 data
  • Nearly 3x that on detailing (sales reps visiting physicians), based on 2008 data
  • Over $20 billion per year on free samples, based on 2005 data

Sales

Supply chain (relatively standard)

  • Manufacturers (that’s easy)
  • Sell to wholesalers (e.g., McKesson, Cardinal Health, AmerisourceBergen) in most cases (60-70%) or directly to pharmacies (mainly large chains)
  • Sell to retail and non-retail (e.g., hospitals, nursing homes, home health care) pharmacies
  • Sell to patients

Flow of money (non-standard)

  • Manufacturers set list prices
  • Wholesalers negotiate discounts and rebates, sell to pharmacies at a markup
  • Pharmacy benefit managers (PBMs) administer formularies and negotiate discounts and rebates with manufacturers and insurers
  • Pharmacies sell to patients at a markup

What is the price?

  • Insurers pay PBMs to manage drug benefits
  • Manufacturers pay rebates to insurers and pharmacy benefit managers (PBMs)
  • Medicaid has mandatory rebates (over 20% of wholesale price)
  • For brand name drugs, rebates are sizeable and opaque. Hard to know what the price is.

Factors affecting price

  1. Manufacturer market power
    • Patent protection provides monopoly power for 20 years, applied for during discovery period
    • 10 years of effective monopoly power given R&D and approval time
    • Product differentiation
  2. Regulation and price controls
  3. Physician agency (already covered)