Just before the Memorial Day weekend, it was reported that AveXis, a Novartis division, was launching a new gene therapy treatment at a price of $2.125 million. Predictably, there were soon numerous articles and tweets bemoaning the price, calling the company evil, and demanding more regulation of drug pricing. My solution is simpler. Use the economic principles of supply and demand to reduce prices. Don’t buy treatments that don’t add value at high prices and increase competition among suppliers.
In every aspect of our lives, we must make trade-offs between what we would like to have and how much we are willing to pay for it. Sometimes it is a matter of what we can afford – I would like to own a home on the ocean, but I can’t afford it. Other times it is a matter of priorities – I could buy or lease a new car every year, but it costs more than I am willing to pay for small upgrades; and I don’t want to deplete my savings. I could fly first class, but I am too cheap to pay for it.
Those choices we all make in our personal and working lives help form the demand curves for products and services. On the other hand, providers of those products and services develop supply curves – they determine how much capacity they will offer at certain price points. Airlines would make their entire planes first class and they would buy more planes if we were all willing and able to pay $2,000 per seat for domestic air travel. Companies theoretically do the math (often by trial and error) to determine the price points that generate the best return on their investments in capacity, and they set prices accordingly. They are finding where the supply and demand curves intersect.
From a healthcare perspective, the demand side of that process is often broken. If our insurance company is paying the bill, we don’t really care how much something costs. We just want the treatment. And, if our life or a family member’s life is at risk, we just want the life saved regardless of the cost. In that case, our demand curve is flat, meaning the demand is the same regardless of the price; so, drug companies have the incentive to maximize their prices. This inelastic demand is exacerbated by the view that “healthcare is a human right”, which really means “I have the right to healthcare that someone else pays for.”
Before Obamacare, health insurance plans often had lifetime caps on benefits and exclusions of certain conditions. That meant they just said “No” to some high-priced treatments. Similarly, Medicare and Medicaid would not cover every treatment. (Countries with single-payer healthcare also limit the treatments they will pay for.) Those caps and exclusions helped to create somewhat downward sloping demand curves. ACA-compliant plans no longer have those caps, and the ACA has mandated coverage of a much broader array of conditions, so the only limits on demand are the number of people affected by the condition.
The $2 million AveXis therapy is named Zolgensma, and it treats a rare condition called Spinal Muscular Atrophy (SMA). Approximately 400 to 500 children are born each year who inherit the condition, and they die within two years if untreated. According to AveXis, there is an alternative treatment available, Spinraza, which is made by Biogen and priced at $750,000 for the first year and $375,000 annually for the rest of the patient’s life. After four years, a Spinraza patient will have spent more than the price of Zolgensma, which requires a single treatment. Since customer value is always determined by comparing to the next best alternative, Zolgensma is worth the $2 million (if Spinraza is worth its price).
Imagine what would happen if all the insurance companies and SMA victims said “No. I will not pay that price for Zolgensma.” With no, or very few buyers and the money to develop the drug already spent, Novartis would lower their price enough to get some buyers. Unfortunately, that would require someone taking the risk of never getting cured.
There is another risk to just not buying the expensive drugs – fewer may be developed. We continue to see pharmaceutical companies develop new drugs and therapies to treat previously incurable conditions and rare diseases, at seemingly ever-increasing price tags. Depending on whom you believe, the average cost of bringing a drug or treatment to market ranges from #320 million to $11 billion, including the costs of multiple levels of trials and expected litigation costs. If we divide the average cost of the drug by the number of patients and add a reasonable return on capital invested, we can come up with a breakeven price for the treatment. If the demand curve is flat (demand does not decrease with high prices), the equation works; and the drug companies will develop the treatments. However, if fewer patients buy the drugs due to the high prices, the math will not work and fewer drugs will be developed.
Another option for lowering the prices of treatments is to increase the supply. With more capacity and a fixed amount of need for the treatments, providers would have to compete for the patients, inevitably leading to lower prices. Shortening the period during which therapies are protected by patents would introduce competing therapies much quicker, putting downward pressure on prices.
It is possible that more competitors could result in reduced pharma company investment in R&D because the expected return on new treatments is lower, but I am skeptical of that. Computer hardware and software capabilities are constantly improving from innovations, which require massive investments. Despite the competition, limited lifespans, and high risk of failure, investments in technology startups continue to grow. The drive to make something better and solve problems is a foundation for that innovation, and I suspect the same would hold true in drugs and gene therapies.
We already make trade-offs all the time, individually and collectively. Our current healthcare system makes a trade-off to cover everyone for everything, and that results in skyrocketing costs for healthcare with higher premiums and taxes for those who can afford it and bigger subsidies for those who cannot.Those costs will continue to spiral upward as long as demand remains inelastic.However, we can use basic supply and demand principles to reduce those prices.It requires us to collectively make more trade-offs like putting limits on what our insurance will cover and limits on the prices of treatments.Likewise, prices could be reduced via increased competition by shortening patent protection, while simultaneously streamlining the regulatory process and providing protection from class action lawsuits.It’s just economics.
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