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The Unique Complexities of Pharmaceutical Pricing – An Interview With E. M. “Mick” Kolassa, Ph.D.

Dr. Kolassa holds academic appointments as Adjunct Professor of Pharmacy Administration in the School of Pharmacy and Adjunct Professor of Pharmaceutical Business at the University of the Sciences in Philadelphia. He is presently the chief executive officer and managing partner for Medical Marketing Economics, LLC, with offices in Oxford, Mississippi, and Montclair, New Jersey. Prior to forming MME, Dr. Kolassa was Associate Professor of Pharmacy Administration and Associate Professor of Marketing at the University of Mississippi. He previously served as Director of Pricing and Economic Policy at Sandoz, where he created and instituted that company’s first pricing and health economics departments, and has also held positions at The Upjohn Company, the Strategic Pricing Group, and Hastings Healthcare. Dr. Kolassa holds an MBA from Eastern Washington University and a Ph.D from the University of Mississippi. He has written and lectured extensively on pricing strategies and on the management of the pricing function and authored the book Elements of Pharmaceutical Pricing. A new update of the book is anticipated for release in 2009.

Q. In your book Elements of Pharmaceutical Pricing, you point out that in many ways, the pharmaceutical market may be “a different animal” from other economic markets. What are some of the big points of departure?

A. When a generic micro-economist or a generic academician who’s got a background in marketing comes in and looks at the pharmaceutical industry and tries to apply generic rules, things fall apart. That’s because the pharmaceutical industry differs from most “normal” industries in a number of very important ways. First, pharmaceuticals are subject to what is called “derived demand,” which means that the demand for pharmaceuticals isn’t based on the features of the product. It is based on the underlying disease. You can come out with a wonderful new antibiotic, and that’s not going to encourage people to go out and get infected.

Another big difference is that in most markets, the decision maker and the user and the payer tend to be the same one. What we’ve got in pharmaceutical markets is that the decision maker is the physician. He decides whether to use the product or not. But it’s usually an insurer involved in paying some portion of it, and then it’s the patient who uses the product.

Q. You also describe pharmaceuticals as a “negative good.” Tell us what you mean by that.

A. Relating to the first issue of derived demand, pharmaceuticals are also what are called “negative goods.” That is, they don’t provide the same type of utility, in economic terms, as what are called “normal goods.” What they do is help to overcome a disutility. If I go out and get a chocolate ice cream sundae, I’m starting at zero and going into positive. If I am getting a prescription filled, I’m starting at negative and trying to work my way towards zero.

People are never going to want to take pharmaceuticals, at least not for legitimate purposes. We know there are some folks out there who will abuse things, but by in large, people would rather not take the medicines; they would rather not have the disease.

Another issue with pharmaceuticals is that this is one of the most regulated industries around. You can’t say something about a product unless it’s in the package insert, and there’s been litigation alleging the companies have said things that are not in the insert. The distinction I like to draw is that when Volvo ran a series of television ads stating that the life expectancy in America has gone up because their cars are so safe that fewer people were dying on the highways, they got awards for that advertising campaign. If a pharmaceutical made the claim, they would get a letter from the FDA telling them to cease and desist. So you’ve got those levels of regulation that the [other markets] don’t have.

These things make the pharmaceutical industry very, very different, so in trying to apply generic [economic] models to them, [the models] get things wrong. Because of the differences in these products, pharmaceutical markets, for the most part, are relatively non-elastic in price. A change in price for a drug doesn’t change the underlying disease, doesn’t change the effectiveness of the drug for the physician, and for most patients, it doesn’t even affect the price they pay for it. So, again, those simple economic models just fly in the face of what really happens in the industry.

Q. How much of an impact can public policy debate have — even without new or additional legislation or regulation — on pharmaceutical pricing?

A. If you will notice on the cover of my book, “public policy” is on there four times, it kind of surrounds everything. It has a very important role. The companies think quite seriously about public policy issues when setting the prices of their product. Some decide, Okay we’re going to weather the storm, and we’ll figure out ways to deal with it. Others say, We’re going to avoid profit maximization to also avoid the distraction of getting called to Washington, D.C., and have to testify as to what we are doing. That’s currently going on right now [… A] couple of senators are trying to make their mark by identifying companies that have large increases on products, and there are perfectly good not only business reasons but public health reasons for the price increases, but that doesn’t matter. I once had a very influential senator say to me over a particular pricing issue when I laid the whole thing out, “You are right, that makes perfect sense. But that doesn’t matter because this is good politics, and you’re going down.” And that’s sad.

Lately, it has been the pharmaceutical industry’s turn to stand there and get punched, and they don’t punch back very well. So, I think when somebody wants to make it [pharmaceutical pricing] an issue, it becomes an issue. But most of the companies are cognizant of that, and that affects a lot of things. For example, the Clinton healthcare reform back in the early 1990s had a measurable effect on the industry. It really moderated price increases. Companies took the price pledge and didn’t increase prices as aggressively as they had before. It shows up in the new product pricing decisions for a number of companies that say “I don’t want this to get us into trouble.”

Q. In the book, you mention cultural differences among various manufacturers where pricing is involved. Are they really so different? What are some of the different drivers to be aware of?

A. Every company has different objectives, and that is another thing most economists fail to consider. Different companies look at things differently. Some companies want to set a price that it is profit-maximizing, some want to set a price that would allow them to maximize unit sales or market share. Those are different numbers. Some want to set a price such that the price won’t get in the way of selling. Routinely, when we work with companies we say, What’s more important: the first year of sales or the fifth year of sales? Because that could lead to a different price. What kind of company do you want to be? Just by their nature, some companies are more aggressive when it comes to setting higher prices, and some are much more timid — it’s just the personality of the company. Not only do no two companies price the same way, there are several companies that don’t price their own products in the same way.

Q. Can you briefly touch on why there can be such disparity in prices for similar drugs for similar markets?

A. Again, it has to do with company goals; it has to do with things like, if I’m the fourth entry into the market, even if I have a very, very good product, I’m going to have trouble getting people to pay attention to it. I might have to give up a little bit in price. So there may be any number of reasons. We can have two products of the same chemical class and in the same market, but because of differences in their label, they will be used for two different things. So do they set the price according to the label they have at launch, or do they set the price according to the label they think they are going to have after they get new indications approved? There’s just a number of things that need to be considered….

Q. That leads me to wonder if you can give us an overview of some of the different pricing considerations over the life of a drug?

A. Absolutely. You set an initial price once the product is launched. And then, over the years, the market will change. [Consumers] will learn more about your product, new competitors will come into the market, and it changes the market positions. Sometimes that requires or suggests a price change, sometimes it doesn’t, but it might change the way you manage your prices. It might mean that with the entry of new competitors, you don’t change your list price but you do more contracting. It might be that the competitor that comes in isn’t all that important, isn’t a direct competitor, so you don’t do anything at all. And it could be that the product has become less important to the company because new products have since been brought on, so you change your pricing approach just simply because I can go out and do a lot more contracting, just kind of let the product ride along, as opposed to aggressively marketing it. So there’s trade offs to be made….

Q. You mentioned that, as opposed to most products, the pharmaceutical “decision maker” can occur in three different places: who orders the drug, who pays for the drug, and who uses the drug. Where do you put payers in terms of pricing decisions with pharmaceuticals?

A. They are a very important consideration. The reimbursement environment is growing in importance. However, there are a couple of things that folks need to realize. A payer is never going to like your price; it’s either going to be acceptable or they don’t like it. More important, the payer is never going to do anything to help you sell your product. They will do things to hurt you and in turn might indirectly help a competitor — but people who try to go out and, through discounts, get managed care support, that doesn’t make sense. It is important to understand the steps that managed care may or may not take to limit the reimbursement and the use of a product, and price can be one of those things. Generally speaking, only when there are a number of close competitors will managed care be comfortable in saying, Okay we are going to put you at a disadvantage because the market doesn’t really need this. But, for instance, as much as managed care doesn’t like the price that a company might charge for an important drug, when there is no competition, they are not going to put barriers in the way of it — most aren’t — simply because it’s an important medication.

Managed care is not in the business of hurting patients. Now, if there were four other products with the same label out there, they could be very aggressive and, through the use of differences in co-pay, actually move patients within the market. And it’s not because they are out there telling the physicians they have to prescribe this; it’s because patients are saying, “Isn’t there something cheaper?”

So, it really depends on how critically important your medicine is, and that’s a function of the disease. It’s also a function of how many direct competitors are out there and whether they are really direct competitors. You know, there are categories such as the atypical anti-psychotics where, although there are lots of competitors in the market, those drugs aren’t anywhere near interchangeable. So payers say no, the physician needs all of them, and I can’t get dollars and cents in there to intervene and to upset this. It interferes with good patient care. So managed care needs to be considered more often. I like to say they are managing a lot less and caring a lot more when it comes to focusing on the patients. So it’s a function of how important your drug is out there. The less distinctive and the less important [the medicine,] the more you are going to have to let price play a role competitively.

Q. In your book you use the analogy “your money or your life” to put the pharmaceutical market into context. How does the nature of the underlying disease treated affect pricing decisions?

A. They both play a huge role. I’ve been involved in probably thousands of pharmaceutical pricing decisions, and I’ve never seen people who weren’t cognizant of the fact that we do have this power. Because of the importance medically and because of the economic value, I believe that almost all pharmaceuticals are underpriced relative to the value they deliver. Companies could charge more. They choose not to for a number of reasons. One of them being, they need to make sure they are affordable because the companies have a duty — most of them have this within their mission statements — that they want to make sure that patients who need their products aren’t denied their products. If you can’t pay for your electricity, the electric company shuts it off. If you can’t pay your taxes, the IRS will charge you more because of it. If you can’t pay for your drugs, the pharmaceutical company will figure out a way to give them to you. That’s always in the background. Andrew Solomon, who wrote a book about depression, called the pharmaceutical companies “idealistic capitalists” and everybody in the industry is sure that the next product they are associated with is going to be the one that changes everything.

We’ve been involved in the development, in the launch, of some products that are literally saving hundred of thousands of lives. It feels pretty good, but people also remember that Aunt Margaret is out there, and she’s got to afford her drugs.

Q. It sounds as though pharmaceutical manufacturers are sensitive to their pricing?

A. Absolutely. In fact, almost thirty years ago now, an economist named Duncan Reekie concluded that the pharmaceutical industry is much more price sensitive than its customers. That they are much more concerned about how price will affect their sales than they actually do.

Q. Where would you put product liability litigation in terms of pricing considerations?

A. It’s driving prices higher. It really is. It’s not moderating it. […] I actually sit with companies that say, You know, we are not doing anything wrong, but it’s almost an inevitability that somebody […is] going to come to us and sue us because they think they can. They [manufacturers] are building that in. They are setting prices higher because they have to. That’s a contingency — I actually had this discussion with Senator Pryor years ago when I was at Sandoz, and we set a price for a product that — it was a very toxic product that could kill up to 2% of the patients — and we put a monitoring system in place. And they said, This monitoring system is anti-competitive, you’re just charging people for it. Sandoz said, Okay, we can pull the monitoring system out, but we’ve got to be able to adjust the price to take into account the up to 2% of the people who are going to die; we are going to set sued for it, and we are going to build that in. And we were charging $10,000 a year for the drug and the monitoring, and they said, That sounds fair; what would that mean? I said we would have to charge $16,000 a year to cover it. That’s the reality of it, and people are thinking about it, so it’s driving up the cost tremendously. Frankly, [litigation concerns] make the industry less profitable, and profits are what drive new drug discovery, so there’s no [other] way for that to go. So those pricing controls are not very good, especially given the sort of legal theories that are floated out there, the loss of value theories and things along those lines that they’re trying to pull in from securities law.

Q. Dr. Kolassa, I understand that you’re presently involved in some of the nationwide average wholesale price (AWP) litigation, so I won’t ask you any specifics on that front. What other potential litigation pitfalls should pharmaceutical manufacturers be mindful of in the context of pricing?

A. As we’ve talked throughout, this is very complex, almost Byzantine sometimes, the way things are put together. We’ve got a combination of government requirements and government-imposed things coming down one way, market differences forcing things to be done differently in another way, and what happens when an aggressive attorney looks at that stuff and says, This doesn’t make sense to me; it must be wrong. I’m often reminded of two songs [from] the 1960s: “Louie, Louie” and Bob Dylan’s “Subterranean Homesick Blues,” both of which were banned from the radio. People couldn’t understand them, so they assumed they were dirty or about drug abuse. If you will look at the lyrics of both of those songs, they are very, very harmless, but because people couldn’t understand them, they had to be dirty and they were banned from the radio. Well, because many of these people choose not to understand the intricacies of pharmaceutical pricing, it tends to become a big legal Rorschach test.

But I think that the litigation the last few years has really caused many people to be much more concerned and careful about just the language they use, just shortening it because it can be misinterpreted but […] just because of the specialized language. [In] pharmaceuticals in general, because we are dealing with governmental and distribution and reimbursement and all these other systems in place, some bright young attorney can find a phrase and twist it to be whatever they want. So, you know, I wish I could say, Watch it, these are the pitfalls, but it gets spun the way people want to spin it.

Q. What do you see as the upcoming trends or “next big thing” with pharmaceutical pricing?

A. Well, I think the next big wave — and this has been predicted in the U.S. for years — is that we will have some level of technology assessment organization at the national level that will determine whether the price is appropriate relative to the value of the product. BlueCross BlueShield Institute has already got something like that in place. Whether that becomes the national standard, I don’t know. What that can do is […] bring some levels of rationality to the system, but probably not. The British have NICE, the National Institute for Health and Clinical Excellence, that was supposed to do that, and now they are overturning their decisions right and left, and patients are dying right and left. I don’t know other than let’s wait and see what the next round of litigation is about.

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