ECONOMICS OF THE PHARMACEUTICAL INDUSTRY 25th March 2004

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ECONOMICS OF THE PHARMACEUTICAL INDUSTRY25th
March 2004

• Jon Sussex
• Office of Health Economics
• www.ohe.org

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Agenda

• The supply side RD
• Demand for medicines
• NICE the cost-effectiveness 4th hurdle
• Regulating medicine prices

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Characteristics of Medicines Markets

• Supply is RD intensive, which implies
• Intellectual property rights (patents)
• Long lead times
• High risk
• Dynamic competition as important as static
• Generic competition after patent expiry
• Demand is regulated governments and social
  insurers are major buyers of medicines
• Prices are regulated

4
Supply Side Main Characteristics (1)

• Patents are an incentive for dynamic efficiency
  by promising temporary monopoly if successful
• Patents last 20 years first 9-11 of which are
  spent getting the medicine to market, i.e.
  research development (RD)
• Commercial success in RD-based companies depends
  on finding blockbusters

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Supply Side Main Characteristics (2)

• Average RD cost of a new medicine up to launch
  is 800 million
• Includes costs of failures
• Out of pocket costs 50
• Opportunity cost of capital 50
• Only 30 of launched medicines earn revenues
  that exceed their lifetime costs

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Discovery and Development of a New Medicine
Final patent application
Marketing application

• Phase
• III

Development research
Post-mktng devel
Phase IV
3000 patients
Toxicology and pharmacokinetic studies
Attrition rates
Cost
800M
0
Source CMR International

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Cash Flow for a Successful Medicine
p.a.
Launch
0
Time
Patent expiry
_
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Supply Side Main Characteristics (3)

• RD costs are sunk (global) joint costs
• RD costs 17 of pharmaceutical sales p.a.
• But 31 of costs on net present value basis
• gt (even long-run) marginal cost ltlt average cost
• gt Price discrimination (based on Ramsey rule?)
  if non-linear pricing is impractical
• ? Parallel trade

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(No Transcript)
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Pharmaceutical Sales as of GDP 1998-2002
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Types of Medicines
OTCs over the counter (i.e. non-prescription)
medicines
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Demand Side Characteristics
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Measures Affecting Prescriber Price Sensitivity

• Primary Care Trust budgets
• Practice budgets and prescribing incentive
  schemes
• Provision of information (PACT, NICE guidance,
  pharmaceutical advisers, etc.)
• Generic prescribing targets

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National Institute for Clinical Excellence

• Covers England Wales
• Two main outputs
• Technology appraisals
• Clinical guidelines

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Technology Appraisal Criteria

• The Institute and Appraisal Committee will have
  regard to
• the broad clinical priorities of the Secretary of
  State for Health and the Welsh Assembly
  Government
• the degree of clinical need of patients with the
  condition
• the broad balance of benefits and costs
• any guidance from the Secretary of State for
  Health and the Welsh Assembly Government on the
  resources likely to be available and on such
  other matters as they think fit
• the effective use of available resources

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NICEs Guide to Methods of Technology Appraisal

• Below a most plausible incremental
  cost-effectiveness ratio (ICER) of 20,000/QALY,
  judgments about the acceptability of a technology
  as an effective use of NHS resources are based
  primarily on the cost-effectiveness estimate.
• Above a most plausible ICER of 20,000/QALY,
  judgments about the acceptability of the
  technology as an effective use of NHS resources
  are more likely to make more explicit reference
  to factors including
• the degree of uncertainty surrounding the
  calculation of ICERs
• the innovative nature of the technology
• the particular features of the condition and
  population receiving the technology
• where appropriate, the wider societal costs and
  benefits
• Above an ICER of 30,000/QALY, the case for
  supporting the technology on these factors has to
  be increasingly strong

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Completed Appraisals (- Jan 2004)

• 75 (including re-appraisals), of which 52 have
  been of pharmaceuticals
• restrictions in 32 appraisals
• e.g. Alzheimers drugs recommended in
  patients with mini mental state examinationgt12
• e.g. zanamivir, oseltamivir recommended in
  at-risk patients with influenza
• a technology has been rejected in 13 appraisals
• e.g. MS drugs
• anakinra for rheumatoid arthritis (except in
  a controlled long term clinical study)
• NICE has also issued 21 clinical guidelines (11
  inherited)

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Economic Evaluation Elsewhere

• Focused on pharmaceuticals
• Fourth hurdle i.e. reimbursement decisions
• Public reimbursement Australia, Baltic
  countries, Belgium, Canada (British Columbia,
  Ontario), Czech Republic, Denmark, Finland,
  France, Hungary, Netherlands, New Zealand,
  Norway, Portugal, Russia, Slovenia, Sweden
• US managed care formularies
• Pricing negotiations
• Australia, France, Italy, New Zealand
• Advice to health service
• England and Wales (NICE), Scotland
• Risk sharing arrangements
• Australia, New Zealand, UK (only MS drugs to date)

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Why Regulate? - Market Failure

• Public goods and the free-rider problem (e.g.
  research)
• Externalities
• E.g. your vaccination reduces my risk of catching
  an infection
• E.g. the caring externality Im happy if youre
  cared for
• Incomplete or asymmetric information
• Moral hazard ( hidden action)
• Selection problem ( hidden information)
• Principal/agent problems

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Monopoly Power

• Economies of scale and/or scope but NB
  contestability
• Natural (local) monopoly
• Input constraints
• Patents dynamic efficiency vs static monopoly

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Net Value of the Pharmaceutical Industry
Economic Rent

• Estimates for 2000
• million p.a.
• Producer rents (exports overseas) 500-1,500
• Labour rents 80-160
• RD spillovers to other sectors 120-360
• Total rent 700-2,000
• Terms of trade effect ?

Source Pharmaceutical Industry Competitiveness
Task Force (2001) Value of the Pharmaceutical
Industry to the UK Economy
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Options Types of Regulation

• No regulation Competition Act only
• Profit, i.e. rate of return, control
• Unbanded
• Banded
• Price control
• Baskets of products, as with RPI-X control of
  utilities prices
• Individual products, e.g. via reference prices,
  or cost-plus, or related to therapeutic benefit

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1998 Competition Act

• Came into force March 2000
• Based on EU Treaty - Articles 81 82
• Prohibitions
• Chapter 1 Agreements preventing, restricting or
  distorting competition
• Chapter 2 Abuse of a dominant market position
• Fines up to 10 of turnover 3rd parties may sue
  for damages

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Banded Rate of Return Regulation
RoR
?
?
Outturn RoR gt threshold gt repay excess
?
?
Target RoR
?
Outturn RoR lt threshold gt may increase prices
?
0
capital employed
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RPI-X Regulation of a Basket of n Products

• w1p11 w2p12 w3p13 .. wnp1n
• --------------------------------------------------
  - -1 x 100 ?RPI - X
• w1p01 w2p02 w3p03 .. wnp0n
• Where
• wi weight for product i (e.g. quantity sold
  in period 0)
• pti price of product i in period t 0,1
• ?RPI change in retail price index between
  period 0 and period 1
• X efficiency factor

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Regulation Criteria

• Static efficiency
• Productive efficiency
• Allocative efficiency
• Dynamic efficiency
• Benefit to UK plc economic rent
• Regulatory (administrative) burden
• Equity/other social policy objectives

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Exercise

• What, if anything, to regulate?
• On- and/or off-patent?
• Branded and/or unbranded?
• Prescribed and/or over-the-counter?
• Sales to NHS only, or all UK sales?
• If so, how?
• Rate of return control, unbanded
• Rate of return control, banded
• Price control basket, RPI-X
• Price control individual products, reference
  prices
• From 3 perspectives
• General public patients taxpayers
• Government
• Industry

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Key Questions

• How price-sensitive are the people making the
  consumption choices?
• How much competition is there between one
  medicine and another, or between medicines and
  alternative treatments?
• Do producers have incentives to keep costs down?
• Will production and consumption choices become
  increasingly distorted over time?
• Do producers have incentives to invest in the UK,
  especially in RD?
• Would the regulatory system be costly for the
  regulator to administer and the companies to
  comply with?

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Pharmaceutical Price Regulation Scheme 1999

• Have been variants of PPRS since 1960s
• Department of Health acts as regulator for whole
  UK
• Objectives of 1999 PPRS
• Secure the provision of safe and effective
  medicines for the NHS at reasonable prices
• Promote a strong and profitable RD-based
  pharmaceutical industry
• Encourage efficient and competitive development
  and supply of medicines
• Voluntary but (unspecified) statutory
  alternative scheme for firms that opt out

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PPRS 1999 (continued)

• Covers all branded medicine sales on-patent
  branded generics to NHS by companies selling gt
  1m p.a. to NHS (80 of total sales to NHS)
• Return on capital 29.4 gt repay excess to DoH
• Return on capital 8.5 gt may apply for price
  increase(s) to take RoC to 13.6
• RD costs allowed up to 20 of sales
• Promotion costs allowed up to 7 of sales
• Free pricing at launch but no increases then
  allowed unless company RoC falls to 8.5

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Multilateral, Ex-manufacturer, Price
Comparisonsat Market Exchange Rates
Source Department of Health (2003) PPRS 7th
Report to Parliament
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Understanding the methodological issues

• Manufacturers prices or final selling price to
  the payer?
• Brands or generics or molecules?
• Sample size and selection (value versus volume,
  degree of market coverage)
• Bilateral versus multilateral
• Match single pack, match product form or price
  per unit (tablet, DDD, IMS SUs, Kg)?
• Volume weights unweighted, own country (Paasche)
  or foreign weights (Laspeyres)?
• Choice of exchange rate
• What exactly is the question you are trying to
  answer?

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Pharmaceutical Price Regulation Scheme 1999

• Have been variants of PPRS since 1960s
• Department of Health acts as regulator for whole
  UK
• Objectives of 1999 PPRS
• Secure the provision of safe and effective
  medicines for the NHS at reasonable prices
• Promote a strong and profitable RD-based
  pharmaceutical industry
• Encourage efficient and competitive development
  and supply of medicines
• Voluntary but (unspecified) statutory
  alternative scheme for firms that opt out

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PPRS 1999 (continued)

• Covers all branded medicine sales on-patent
  branded generics to NHS by companies selling gt
  1m p.a. to NHS (80 of total sales to NHS)
• Return on capital 29.4 gt repay excess to DoH
• Return on capital 8.5 gt may apply for price
  increase(s) to take RoC to 13.6
• RD costs allowed up to 20 of sales
• Promotion costs allowed up to 7 of sales
• Free pricing at launch but no increases then
  allowed unless company RoC falls to 8.5