Pricing Lessons from the Pharmaceutical Industry

canstockphoto0200394_pharma pricesOver the past several months, pricing strategies and practices of the pharmaceutical industry have been a subject of discussion, many times for the wrong reasons.  In particular, Valeant has come under extreme criticism for raising the prices of its drugs.  Another company, Turing Pharmaceuticals raised the price of Daraprim from $13.50 to $750.00, an increase of more than 5000%.   Last year Gilead set the price of its Hepatitis C drug, Sovaldi, at $84,000 for a 12-week treatment.  All of these cases resulted in politicians calling for more regulation of drug pricing.  However when we look back at them, Gilead’s pricing of Sovaldi looks smart, whereas Valeant’s and Turing’s actions look regrettable.  So let’s try to learn from their pricing successes and failures.

There are many things to be learned from studying the pricing actions of others, but there are three critical take-aways from these:

  1. Take the time to determine the real value of your product up front and get pricing right the first time
  2. Communicate your complete value proposition to your customers
  3. Make corrections in logical increments over time

Too often companies have a ready, fire, aim approach to pricing new products.  They may take a cost-plus approach which has nothing to do with value, or perhaps shoot for quick market share with low prices, or respond to external pressures to provide more benefits for less.  When one of these approaches is taken, the company invariably makes less money than expected or fails to sell as many units as their market research would have predicted; and they disappoint their shareholders.  Worse yet, they have to try to adjust having set an inappropriate reference point.

Sovaldi is an example of a drug launch where the company took the time to determine the real value.  Although the price for Sovaldi was high, the Gilead team did the work to understand how their drug helped patients and what the economic impact would be.  Then they priced it so both the customers and shareholders benefitted.  In a similar example many years earlier, Amgen introduced Neupogen (a drug that reduces infection in patients undergoing chemotherapy) at an apparently high price, which reflected its life-extending value.  In both cases, the companies sold large amounts of the drugs at high prices and were not forced to make significant adjustments later.

Unfortunately, customers will not automatically figure out what a product is worth.  They will attempt to do so by comparing the product to whatever frame of reference comes to mind.  The company’s job is to identify for potential customers what the appropriate benchmark is, and identify all the aspects of additional value provided by the new product vis -a-vis the benchmark.  Gilead was quite effective in this for Sovaldi.  They made clear that their new drug was not just an evolutionary advancement of existing hepatitis drugs, but could actually cure the disease.  So the real value included avoiding the long-term use of maintenance drugs, significant reduction of additional future conditions which are by-products of having hepatitis, and significantly improving the quality of life.  Although insurance complained about the price, they have continued to pay for it, because Gilead has clearly demonstrated that the benefits exceed the price of the drug.

For companies who have not done the appropriate value-identification work up front, or those who tried but missed the mark, price adjustments are needed.  In our experience, changes in prices are best done gradually.  Customers generally accept modest price increases, but get very upset with large increases.  As Reed Hastings recently said in the wake of Netflix price increases, “People don’t like price increases.  We know that.”  Nonetheless, Netflix raised their price and expect only modest customer defection.  Conversely, when Valeant and Turing significantly increased their prices, some more than 100%, their customers complained so loudly that company management was called before Congress to explain themselves. The politicians are now looking at increasing regulation of drug prices, and the stock prices of the drug companies have tanked.

Instead of large changes, the smarter pharmaceutical companies have been instituting more moderate price increases.  Eli Lilly, Merck, and Bristol Meyers Squibb have hiked prices 2 – 3% in the past year (see Drug price increases lower so far in 2016) and still others have implemented 7 – 9% increases.  The drugs and circumstances for each are different, but the price increases do not seem egregious and customers are generally accepting them.

Over the past year or two, we have seen examples of smart and not-so-wise pricing decisions from the pharma industry.  Let’s try to learn from them.  Do the work to get it right up front, communicate all the elements of value to your customers, and make adjustments gradually.  You will avoid much of the drama and enjoy greater long-term success.