A Secret Revealed: Why Drugs Cost What They Do

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Few are the people who have not wondered why drugs cost what they do and, when the price tag has a pinch, sighed with exasperation. We’ve all read countless reports on the time- and resource-consuming labor of research and development (PDF). Elaborate studies have been done to count up (and debunk) all the dollars spent on creating new drugs. Even reports enumerating all the various pharma expenses still explain the price of prescription drugs by looking at what companies spend. And we’ve all read (or had our own) complaints: if only drug companies would advertise less, the price would go down. If only drug companies stopped wining and dining physicians, the price would go down. If only CEOs weren’t so greedy. But here’s the thing: none of this explains the price of medications.

So what is the great, big secret about why drugs cost what they do? Read on. 

Drugs cost what the market will bear. It’s that simple. Drug prices are set at whatever the market will bear.

So what does that mean? It means that if no one purchased a drug that cost $X, then the price would be lowered. Prices are set at exactly—and I mean exactly—at what the consumer/insurance infrastructure is able to carry.

It would be wrong to say that the prices reflect what we are willing to pay because for the most part, we don’t pay the price tag; we pay for our insurance and then the co-pay amount for a given prescription. Of course this insight is referring to prescription drugs. When it comes to, say, headache medicine on the drugstore shelves, then the price more closely reflects what the customer is “willing to pay,” the economic counterpart to “what the market will bear.” But once we get into the domain of prescriptions, prices are guided by the market.

As simple as that explanation is, the calculations behind the price are complicated. They factor in how many people will buy a drug, how many of those people are likely to be privately insured, how many are likely to have Medicare or Medicaid, how many will have no insurance at all, for how long will a given patient be on the drug (on average), how much it costs to make the drug (yes, this does matter), and even what’s at stake (is the drug treating a life-or-death condition, or is it treating something more mild?).

Also important is the number of years that a drug will have market exclusivity and whether exclusivity can be extended through any of a number of legal loopholes. Even patient assistance factors in. Everyone has heard the gently spoken words at the end of a prescription drug commercial: “If you can’t afford your medication, drug company X may be able to help.” These “patient assistance programs” are vital for assuring that people without insurance do not go without needed medications. But they are also part of the pricing strategy (a topic for a very juicy future post). There are companies that specialize in such forecasting, helping drug makers to decide on a price.

As convoluted as those calculations may be, the fact itself is simple: drugs cost what they do because that’s what they can. (As one insider once told me, cancer drug prices could be lower, but they don’t need to be.) This explains why different procedures cost different amounts in different places. It also explains why drug prices are different for taxpayer-funded insurance than for private insurance than for the uninsured.

The minute enough people stop filling prescriptions because they are too expensive, the prices will be lowered. The science is exact. Yes, there are plenty of people who do not fill their prescriptions because even with insurance, the price is still unaffordable. That’s not good, but in the clear-cut economics of market-driven health care, only when enough people can’t afford their co-pays to upset the profit margin will the price be lowered. And remember, private insurers are businesses, and are also part of the market equation.

Drug companies justify prices with the high cost of R&D because stating outright that the prices are simply what the market will bear would look very bad. But consumers complaining about advertisements, etc. is equally unproductive. Drug companies advertise because the amount of profits guaranteed by what the market will bear allows them to advertise, which of course in turn increases earnings. Consumers are still at the whim of the corporate wheels, but also need to acknowledge the fact of the role that consumers play in the market.

So there you have it, the big secret behind the price of prescription drugs: they cost what the market will bear. Interesting, isn’t it?

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