FOOL ON THE HILL
In a free market economy, businesses should be allowed to charge what the market will bear for their products. But with prescription drugs, it's just not that easy, since not being able to afford a certain drug could be a life-or-death problem. Drug companies are many times more profitable than other large companies, giving credence to the perception that they are profiteering over a captive market.
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Here's the thing that keeps my little free-market self awake at night: the upcoming battle over prescription drug costs. Over the last two decades the amount Americans have paid for drugs has increased by more than 15% per year, to an estimated $117 billion in 2001. This increase compares to an increase in GNP on average of less than 4%, which means, at least theoretically, that prescription drug costs could overwhelm certain portions of the U.S. economy if they are not brought under control. We're already seeing a clash between the costs and certain peoples' ability to pay for treatments. Novartis' (NYSE: NVS) leukemia drug Gleevec, for example, costs nearly $30,000 per year. The institutional payees, including governments, HMO's, and insurers, are screaming mercy. But those three words, "brought under control," that leave me absolutely cold. Controlled by whom? This may seem like an obvious answer to someone who is unable to afford a necessary prescription drug: The government should fix this, just like the governments of so many countries have done by issuing price controls. It's an attractive solution, certainly. But there should be no doubt that profit is a powerful motivator for our drug companies. Slap on price controls, and the incentive for drug companies to push themselves to discover what may be powerful but expensive therapies might suffer. It is an unavoidable fact that drug companies (as well as biotech firms, which are facing the promise of untold billions for their therapies) spend enormous amounts of money on research and development. Creating an environment that limits their ability to profit even on successful drugs strikes me as dangerous. But the "increase in drug costs" statistic cited above is way too simplistic. How much of that increase is generated by virtue of people having longer life spans (thus increasing the amount of time they need drugs)? How much is caused by people who rely on drugs to take care of a problem that they could prevent, such as cholesterol. Do bacon and Lipitor cancel each other out? How much is elective, like hair restoration drugs? The answer to all of these -- including the bacon/Lipitor conundrum -- is "not all of it." Drug companies as a group have net margins that are four times that of the average of the companies in the Fortune 500, according to a study by the Kaiser Family Foundation. And those margins have some people sharpening swords, preparing to do battle with the "greedy" drug companies. Certain behaviors of the drug companies make me wonder whether a dose of price regulation really isn't called for. Their most common rationalization for the expense of drugs is that they cost so much to develop. And yet, according to a Kaiser study, research and development expenses make up only 14% of total drug company revenues, less than both net profits (18%), and more damningly, marketing expenses (16%). Drug companies are businesses, and ought to be able to charge what they can get for their therapies, but doesn't anyone out there think that it's a little odd that drug companies are trying to get patients to ask their doctors for expensive drugs by name? We have just seen a classic case of this with Bayer's Cipro, which is labeled for anthrax. Ask any pharmacologist and you'll find that there are several equally effective drugs as Cipro that come at a fraction of the price. Americans are approaching a reckoning between our appetite for drugs and our ability to afford them. Drug companies have provided some drugs at cut rates for patients who are unable to pay, but at some point these companies are going to press their luck. A nation will not sit idly while its poor have no access to life-saving drugs as the companies that provide them earn 20%-plus profit margins. At some point, such a scenario threatens to back the government against a wall, which is the last place from which the drug companies would want them to start regulating. I'm afraid, though, that the drug companies are going to fail to take sufficient action to defuse the perception that they are profiteering. The argument that they deserve such big profit margins due to the risks they take in development seems somewhat hollow when one discovers that those risks never seem to take bites out of the bottom line. Already several states, most importantly Michigan, are trying to control drug costs for their Medicaid programs by forcing the drug companies to cut prices in order to get onto a state-approved preferred list. Six big companies, including Pfizer and Merck (NYSE: MRK) responded by suing the state of Michigan. I personally think that flat-rate price controls are a bad idea, and would prefer to see a tiered system where the co-pay paid by the patient is higher for brand name drugs when a generic or other alternative exists. As a shareholder of a pharmaceutical company, I'm concerned that if the drug companies ignore the problems inherent with existing pricing structures that a backlash is inevitable. This would hurt the companies, would impede their incentives to develop new therapies, and would ultimately harm the public as the opportunity cost of drug development becomes too high. There is nothing wrong in a free-market system with charging what the market will bear for any given product. But does it not seem a wee bit smarter to aim for high single-digit profit margins in the hope of preventing what could be massive price controls? And rather than spending those billions in consumer advertising, drug companies would be well served to focus upon a system that will alert doctors to potentially dangerous combinations of drugs, something that killed an estimated 100,000 Americans last year. It is perhaps a miserable reality that some Americans are not going to be able to afford drugs that they need, and there is unlikely to be a magic bullet that solves this problem. Yet pharmaceutical companies are playing with fire if they do not recognize the fact that these people who are without access to drugs are a constituency, and they vote. So do their relatives. It is therefore in the best interest of the pharmaceutical companies to take reasonable action to anticipate that there will be conflict if this group grows to be too large. Shareholders have come to love the big bucks their drug companies generate each year, but I am afraid that if the companies do not self-regulate in a hurry, that the eventual backlash against their enormous profit margins will be extremely expensive for all of us. Watch what happens in Michigan, because this is where it starts to get interesting. Bill Mann, TMFOtter on the Fool Discussion Boards Bill Mann's mother treated his childhood asthma with bourbon. No wonder, huh? Bill has beneficial interest in Pfizer. The Motley Fool is investors writing for investors.
There are no simple answers here. Americans demand cures for any and all diseases, shareholders cheer the returns and growth rates for the pharmaceutical companies' stocks, and yet, when it comes to payment, we cannot bear to think of someone being denied treatment for lack of funds. I'd call it schizophrenic, but someone might rush in to prescribe us some Geodon, Pfizer's (NYSE: PFE) new anti-schizophrenic drug.
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