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Case study Pricing, patents and profits in the pharmaceutical industry This case study explains how the pharmaceutical industry. With profits of more than $6 billion, pharma industry uses the patent system to ensure it reaps companies, such as Pfizer and GlaxoSmithKline, rewards from the drugs that it develops. Increasingly, dwarf the likes of Unilever, Siemens or Coca-Cola. however, there is alarm at the high costs of these Yet, every year in the developing world, millions of drugs to the underdeveloped world, especially people die from diseases, such as malaria and tuber- against a backcloth of malaria and AIDS epidemics in culosis, which the rich developed world has eradi- Southern Africa. Whilst the pharmaceutical industry cated. Table 6.4 shows the scale of the problem. has responded with several concessions, the case In the past, the pharmaceutical industry has main- against the industry is that it enjoys a privileged posi- tained that many of the drugs that could benefit the tion, partly due to the patent system. Table 6.4 The scale of the AIDS epidemic Introduction in Southern Africa (% of adult population There is a story about a pharmaceutical executive on infected) a tour of the US National Mint who inquired how Botswana 23.0 much it cost to produce each dollar bill. On hearing Lesotho 23.3 the answer the man smiled. Making pills, it seemed, was even more profitable than printing money. Malawi 10.0 Whether true or not, the three most profitable busi- Mozambique 11.3 nesses in the world are reputed to be narcotics, pros- Namibia 13.4 titution and ethical pharmaceuticals. Studies by South Africa 173 Oxfam showing the scale of the AIDS problem in Southern Africa has brought the pharma companies Swaziland 26.0 into the spotlight. The allegation is that these compa- Zambia 12.5 nies exploit the poor in the developing world. With a Zimbabwe 14.9 median 35 per cent return on equity, pharmaceuticals SOURCE: UNICEF (2015) is far and away the world’s most profitable major HIV suffering in the underdeveloped world are expensive Ultimately, the company was shamed into offering and have taken yoars to research and develop. The her froe medicine, she moved to the United States. only way the pharmaceutical industry can claw back However, doctors concluded that the offer was prob its expenditure on research and development is by ably too late patenting their drugs, thereby providing them with a The developing countries are demanding changes. 20-year monopoly in which to generate sales and they argue that patent laws should be relaxed, allow- profits. The social contract underlying the patentingfor example, other for their own companies to system is based on an agreement that in rotum for produce cheaper generic versions of the expensive such investment and for publishing through patents anti-AIDS drugs or for the import of such generic tho details of the research results – a company is copios from other countries. The Indian company entitled to an exclusive right to the salo of the result Cipla offored to make a combination of AIDS drugs ing product for a limited period of time: 20 years. available at about one-third of the price being asked by companies in developing countries. This price is The case against the pharmaceutical already less than those in the West. If ever there was industry a good example of profitoring here it is. Worst of all. Most drug prices boar no relation to the very small rooms to be profitoring at the expense of the poor. cost of production because the industry has a con- The charge of unethical behaviour sooms to be ring. tract with society, enshrined in the patent system. For ing loudly. But for how long will the legal systems and a limited period (usually 10 years not allowing for courts in the world tolerate thousands of deaths clinical trials, etc.). pharmaceutical companies charge before one of them decides enough is enough? The monopoly prices for patented medicines. In return, pharmaceutical industry is aware of the strength of they invest huge amounts of research dollars in pur- public opinion and the mounting pressure it is under suit of the next innovation. and has made significant concessions, including cut- At a time when tho AIDS epidemic appears to ting the price of many of its drugs to the developing have stabilised in most advanced countries, thanks world. Will this, however, be enough? The whole Largely to the use of sophisticated drugs, the disease industry, it sooms, is now under pressure to justify is continuing to spread at an ever more alarming rate the prices charges for its drugs. If it fails to con through developing countries (see Table 6.4). With vince governments, it may see the introduction of only 5 per cent of the world’s population, Eastom and legislation and price controls Southern Africa is home to half the world’s popula in the UK the purchase of drugs is the responsi- tion living with HIV. Today, the region continues to be bility of the National Institute for Health and Care the epicentre of the HIV/AIDS epidemic. Excolonce Nicą, t frequently has to make difficult Yet those countries now suffering the most from decisions. For example, in 2015. cancer charities ont- the disease are also those lost able to afford the icised the decision by the NHS treatment watchdog drugs necessary to control it. The issue, of course. to rejoc an innovative new drug to treat ovarian can challenges the whole patenting system car on the grounds of cost. NICE said, in a draft guid- It is not just the underdoveloped countries that are ance, it was disappointed that it must turn down experiencing difficulties with intellectual property claparib (Lyrparza), but the price tag of more than laws and medicine. A 30-year-old London woman .000 a year was considerably higher than is col contacted Bristol-Myers Squibb, a US pharmaceuti-ing of 20,000 to £30,000. When tests to assess cal company, begging help to obtain Taxol. This drug patient suitability for the drug are included the price could have controlled her breast cancer, but her rises higher still National Health Service region did not prescribe it because of its exorbitant cost. There is no patent on The case for the pharmaceutical industry Taxol, as the US Government discovered it. But The pharmaceutical industry can claim that it has Bristol-Myers Squibb, because it performed minor boon responsible for helping to rid many parts of the work calculating dosage levels, holds the intellectual world of dreadful diseases. It is able to daim that the property rights on dose-related data, even though the enormous sums of money that it spends each year on data originally was collected by the Government. research and development is possible only because of the patent system. Any change in the system will The field of pricing pharmaceutical products is put at risk the billions of dollars that are spent on complicated because, in most countries, prices are research into heart disease, cancer and other killers. dotermined by what goverments, the main buyers in This is usually enough for most govomments and the industry, are prepared to pay. The same pill made others to back away from this very powerful industry. by the same company may cost half in Canada of Not surprisingly, the drugs industry is appalled at the what it does in the United States. In Mexico, it may prospect of price controls. Sidney Tauroi, chief exoc cost still loss. Such differential pricing is fundamental utive of the US drugs company Eli Lilly, has wamed, to the pharmaceutical industry. Because consumers ‘If we kill free markets around the world, we’ll kill are not paying for raw materials, but rather for intel innovation.’ lectual property. drug companies charge what they The industry clearly has a unique structure and dif- can get away with and governments pay what they fers markedly from many others, but whether there is deem affordable. The United States, however, is the evidence for supra-normal profits is questionable exception, as here prices are determined on the open Professor Sachs, director of the Center for market. International Development at Harvard University. argues that, if price controls were introduced, com. Conclusions panies simply would scale back their investments in it is the unique structure of the industry and the pat- research. This is often seen by many as a ‘threar that ent system that is at the crux of the problem. Europe. the industry uses against governments. Once again the United States and Japan account for virtually all there is limited evidence to suggest this necessarily the profits of the pharmaceutical companies. In most would happen. Sachs suggests, ‘This is an extremely other markets, profits are driven down by the power sophisticated, high cost, risky business with very and price sensitivity of customers. But in pharma- long lead in times and an extremely high regulatory couticals, neither the patient who consumes the hurdle.’ He continues, “My sense is that every rich drugs nor the doctor who prescribes them is price country that has said. “You’re making too much sensitive. Customers for medicines are not price son money and has tried to control prices, has lost the sitive because they do not pay for them. In Europe it R&D edge. is the taxpayer who foots the bill. The pharmaceutical industry has a powerful voice. Whereas most companies have profits capped by It is a largo omployar, invests large sum of money in aggressive industry buyers, the pharmaceutical firms science and technology and is, without doubt, an have to negotiate only with a vil servants and when industry that will grow in this century. Most govern- taxpayers’ money is available, commercial disciplines ments would like to have a thriving pharmaceutical frequently disappear. But, even in the United States industry and hence, try to help and not hinder their whore a free market exists, the pharmaceutical com- offorts. Moreover, there are thousands of people in panies are able to charge oven higher prices. Once the developed world whose lives are being saved and again, this is because the pharmaceutical companies extended by new sophisticated drugs that are being frequently are selling to private health insurers. Many developed every month. The industry has many US employers offer health insurance as part of the advocates and supporters. employment package Competition is another key force that drives down Price cuts prices in most industries. In electronics – an industry Britain’s biggest drugs company. GlaxoSmithKline. oven more innovative than pharmaceuticals – excess has reduced the cost to the developing world of profits from a new product soon disappoar as com drugs for treating malaria, diarrhoea and infectious Potitors bring out copies. But, in the pharmaceutical diseases. Merck and Bristol-Myers Squibb, two of business, it is the patent system that ensures high the world’s largest drugs companies, had already profits continue for an average of 10 years. The con- announced that they were supplying ADS drugs at sequence of this ability to negotiate very high prices cost price or loss to all dovoloping countries. Bristol and the absence of competitive throat is that the Myers Squibb also announced that it would not be giant pharmaceuticals have no incentive to compete enforcing its patent rights in Southern Africa. on price. It also helps to explain why the pharma companies have been unwilling to sell cheap medi- structures due to the enormous sums of money it has cines to the poor in Africa and Asia. The real worry is to invest in science and technology. Increasingly. that dropping prices to the developing world would however, the industry is spending more on marketing undermine the enormous margins being received in existing products than it is on developing new ones. Europe and the United States. Buyers would soon be Analysts argue that marketing costs are now typically reimporting medicines at a fraction of the official almost double the R&D spend. GlaxoSmithKline, for price, which may be the case soon in the United example, has 10,000 scientists but 40.000 salespeo States. ple! Even this well-rehearsed argument is now begin The industry’s justification for its high prices and ning to sound hollow. patent monopolies is that it encourages innovation, The pharmaceutical industry has enjoyed 60 years but to what extent is this true? In most other indus- of substantial growth and substantial profits and tries it is intense competition and a fight to survive many people have benefited. The patent system is and win market share that drives forward innovation intended to balance the interests of the individual and Without new and better products, companies such as society, increasing numbers of people are question- Hewlett-Packard and Canon know they will not main- ing this balance. The pharmaceutical companies tain growth and market share. As we have seen in need to consider every step carefully for they. Surely. Chapters 1, 2, 3 and 4, innovation is dependent on a do not want to become the unacceptable face of collection of factors and the patent system alone globalisation. cannot stimulate innovation. It is necessary, but not sufficient Sources: Doyle, P. 2001) AIDS and the pharmaceutical Industry. The Guardian, 10 March Make, J.2003) NHSS 30m from The industry’s most popular argument to defend drug forms in price fang cham, The Guardian, 23 December, 6; the patent system is that it has unusually high cost Goldenberg and Linton 2012, Questions 1 Explain how the pricing of drugs contributes to the acquisition of supra-normal profits in the pharmaceutical industry. 2 It is because drugs are absolutely essential to life that the pharmaceutical industry is able to justify large profits. Discuss the merits of this argument. Consider also that bread and milk companies do not make huge profits. 3 Explain why drugs are not price-sensitive. 4 Explain why the patent system may not be working as originally intended. 5 Use CIM (Figure 1.9) to illustrate the innovation process in this case. 6 Nobel Prize winning economist Joseph Stiglitz argues that prizes rather than patents could stimulate scientific competition. Explain how this might work.

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