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Cutting Drug Prices Can Hamper Development of New Medicines, Shows New Study By ESMT Competition Analysis

Berlin, July 1, 2010 -Cutting pharmaceutical prices will severely reduce the number of new medications making it to market, according to a groundbreaking independent study from ESMT Competition Analysis (ESMT CA). For the first time, the study on ‘Pharmaceutical Innovation and Pricing Regulation’ clearly models and quantifies the direct link between strict regulation and low innovation. New medications likely to be hit hardest under tough pricing regulation include antibiotics, as well as treatments for cardiovascular disease and immune system disorders such as multiple sclerosis and chronic meningitis.

"Our study shows the consequences that pricing and reimbursement regulation can have on pharmaceutical innovation. It also shows that, incorrectly applied, regulation can reduce the value of pharmaceutical projects and curtail the resources available to carry them out," said Dr. Hans W. Friederiszick of ESMT CA. "Rational investors will naturally look for the most profitable investment choices, which is why regulation has a direct impact on the number and characteristics of the medications developed."

New antibiotics can see a 100% drop in expected profitability (known as Expected Net Present Value, ENPV) in phase one of clinical trials under a pricing model widely used in the EU. The ENPV is also lower, though less dramatically, through further stages of clinical trials. Other drugs with low margins and/or sales volume are similarly affected.

The ESMT CA study was commissioned by Novartis and is based on a unique simulation of a representative pharmaceutical firm’s decision-making process, calibrated using publicly available data. The model draws conclusions from the simulated actions of the pharmaceutical company, taking account of parameters including the costs of developing new products, the probability of failure during clinical trials, and the probability of a final product not being considered highly innovative by regulators.

European governments predominantly see pharmaceutical pricing models as a tool for cost control in the public health sector, but may not to the same extent acknowledge its implication on product value and, hence, on the development of new drugs. External Price Benchmarking (EPB), a model widely used across OECD countries, causes a 5.7% drop in the optimal pharmaceutical portfolio value of a representative company under the ESMT CA simulation. Internal Reference Pricing (IRP), used in 17 EU-member and 3 non-EU OECD countries, causes an 11.7% drop. Having some regions of the world under IRP and others under EPB magnifies the problem, since internal prices are then exported to external markets, leading to a 19.8% drop in portfolio value.

All forms of pricing regulation, when compared to market-based pricing, are found likely to reduce the value of projects and the resources available for R&D activities. Prices lower than market value in the cases of both IRP and EPB means that less money is available to invest in new products. IRP can lead to a failure to launch for one in ten products, half of them highly innovative. This is due to the fact that IRP may group innovative drugs that have just been launched with older drugs whose patent life has expired or is about to expire, effectively shortening the life cycle of innovative drugs and decreasing the incentive to innovate.

In addition, current pricing models are often shown to favor ‘breakthrough’ pharmaceutical innovations over ‘follow-on’ drugs, or incremental improvements. For instance, under a form of IRP introduced in Germany in 2004, later-in-class drugs always have their price referenced against the relevant first-in-class drug, even if they have new and beneficial characteristics. This can lead to a different understanding of “innovation” for patients and chemists. A statin, for instance, may be redeveloped to have fewer side effects or be more beneficial for one group of patients. This will seem like an innovative development to the patient but it will not necessarily be innovative enough from the pricing regulator’s point of view to benefit from favorable regulation. The report therefore demonstrates the need to support both ‘first in class’ and ‘best in class’ products, rather than drawing a regulatory distinction between ‘break-through’ products and everything else.

Press contact
Farhad Dilmaghani, Tel.: +49 (0)30 21231-1042,
Kristin Dolgner, Tel.: +49 (0)30 21231-1066,

About ESMT Competition Analysis
ESMT European School of Management and Technology is an international business school based in Berlin, Germany. ESMT Competition Analysis (ESMT CA) is the economic consultancy of ESMT which provides case-related advice and research on key topics in fields of competition policy and regulation. The study was commissioned by Novartis with the aim of improving understanding of the possible negative relationship between cost containing pric-ing and reimbursement regulation and global pharmaceutical innovation.

The full report can be downloaded here.

Background and definitions

The drug discovery and development process lasts on average ten years, and is risky because during clinical trials a drug candidate may prove unsafe or ineffective, or because the marketing authorisation process may consider the evidence gathered in support of a new drug application to be insufficient. It is estimated that at most one of 5,000 drug candidates is successfully developed and authorized for marketing. The research-based pharmaceutical industry invests €71.5 billion annually in research, which accounts for more than 19% of all global private-sector R&D expenditures.

Internal Reference Pricing (IRP): (Also known as Jumbo Group and Therapeutic Reference Pricing.) The price of or the amount reimbursed for a drug in a country is based on the price of chemically, pharmaceutically or therapeutically similar drugs in the same country, unless the drug is considered highly innovative.

External Price Benchmarking (EPB): (Also known as International Reference Pricing.) The price of a drug in a country is based on the price of the same drug in other countries. The basket of benchmark countries is selected on the basis of economic and/or geographic proximity. In particular, European countries tend to benchmark each other.

Market-based pricing: Health insurer is a "price taker." The maximum increment that a firm can charge for an innovative new product is the marginal difference in purchaser’s willingness to pay for the new product relative to the existing treatment or competitive alternatives. It is further constrained by its bargaining position relative to the health insurer that pays for the product.

Value-based pricing: The price of a drug in a country is based on a cost-effectiveness or cost-benefit analysis in which the cost of a drug is traded against its health benefits (quantity and quality of life). Pharmaco-economic assessment goes hand in hand with tailored drugs.

About the Methodology

The ESMT CA model simulates the drug-development decision-making process of a pharmaceutical company, giving the model company a representative amount of investment money and products in the pipeline. The simulation results tell us how this firm’s decisions to develop and launch a product and therefore its portfolio are influenced by the application of IRP, EPB or both schemes relative to a no-regulation benchmark. Parameters which must be assigned for each calculation are:

Therapeutic areas and number of projects by therapeutic area and development phase
For every development phase, development costs and probability of technical success
Development cost premium for highly innovative projects
Probability of external competition’s success
Discount rate
For every region and every therapeutic area, demand intercept and slope
Average/marginal manufacturing/marketing cost
Price discount for not highly innovative drugs in the region under IRP
Development budget constraint

Posted: July 2010