Brits May Bludgeon Drug Companies

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Drug companies across the board may see decreased revenue in the coming months, but not from the increased pressure of generic competition. Instead, the squeeze may come from one of the agencies footing the bill for the drugs.

The U.K.'s National Health Service (NHS) is considering a 10% drop in the rate that it pays for drugs, to help it reach its goal of a 3% reduction in the nation's overall health-care bill. That's a shock for drugmakers; just a few years ago, they agreed to a 7% cut intended to hold drug costs stable through 2010.

The companies may try to strike a deal by discontinuing the sale of branded drugs that already have generic competition, but they'll want something in return -- like higher prices on patented drugs, or a quicker setup of the repayment system once drugs are approved for marketing in the European Union.

From an investment standpoint, a 10% cut in revenue from one country won't hurt GlaxoSmithKline (NYSE: GSK) or Pfizer (NYSE: PFE), or even much smaller Onyx Pharmaceuticals (Nasdaq: ONXX), too badly. Most companies don't break out sales by country, but sales just inside the U.K. probably represent less than 10% of revenue for pharmaceutical companies. When you look at the bottom line, an even smaller fraction comes from the U.K., given the lower margins in countries with managed care. But companies should start worrying if other countries follow suit.

Dangling a carrot in front of the drug industry, rather than a stick, is the clear way to spur innovation in this sector. Potential enticements might include longer drug patents or just a wad of cash. But cutting the prices paid for drugs won't help anyone. In addition to hurting the the pharmaceutical industry in the short run, they'll also result in cuts to R&D spending, leading to fewer life-saving drugs in the long run.