If I told you that drug companies lean on their exceptional pricing power to grow their top and bottom lines, it probably wouldn't come as a shock in the least. If you've picked up a prescription from the pharmacy at any point over the past couple of years, you're probably well aware of the inflation tied to prescription drugs.
Drugmakers' reliance on price hikes is growing
What you may not be aware of is just how reliant drug companies have become on increasing the price of existing medicines in order to grow their businesses.
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According to a newly released 120-page report from Credit Suisse, drug price hikes wound up adding $8.7 billion in net income to the pharma industry in 2016. This $8.7 billion essentially accounted for all of the industry's growth, when looked at as a whole. The report found that list prices grew by 9.8% in 2016, down slightly from the 10.8% increase experienced in 2015, while rebates increased from 35.7% in 2015 to 37.3% in 2016. This suggests that net pricing growth came in right around 6%.
Last week we explored bifurcation between prescription drug price inflation and the Consumer Price Index for All Urban Consumers (CPI-U), courtesy of data from the AARP Public Policy Institute, and found a greater than 150% real-money increase in drug prices between the end of 2005 and 2015.
Here's why drugmakers can get away with charging an arm and a leg for their medicines
Why are drugmakers able to pass along such hefty price increases to insurers and consumers? It's due to a laundry list of inherent advantages that drugmakers are privy to in the United States.
For example, drugmakers are working with exceptionally long periods of patent protection. Patent protection begins once the Food and Drug Administration OK's the start of human clinical trials, and this protection usually lasts for 20 years. Given the time it takes to run human trials, most drugmakers with approved drugs net a decade, give or take a few years, of exclusivity.
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The U.S. also has no universal health plan, which means Congress can't cap drug costs, and it also has the highest pharmaceutical demand in the world. Growing demand for pharma products pushes costs higher.
Most insurance companies are also unwilling to stand up to drugmakers because they don't want to exclude a popular drug from their approved formulary and lose a lot of members over it. The result is many insurers accept pretty nominal rebates and discounts.
And, of course, drug developers utilize the high standard of living in the U.S. to help subsidize their emerging market ventures. In other words, drugmakers count on high prices in the U.S. to help pay for what can be the unprofitable sale of medicines in emerging and underdeveloped markets.
Added together, this equals a very unfavorable drug-pricing market for the consumer.
These seven drugmakers are very reliant on price increases to drive earnings growth
It's worth noting that not every pharma and biotech company analyzed by Credit Suisse leaned so heavily on price hikes last year. For instance, Gilead Sciences was busy boosting its rebates and discounts on its hepatitis C drugs in order to be more price-competitive with new competition in the space.
But for the following seven drug developers, earnings would have declined in 2016 had it not been for price hikes.
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1. Biogen
Biogen (BIIB -0.48%) has the leading global market share in multiple sclerosis (MS), so it shouldn't surprise investors one bit that it's leaning on its market share dominance to lift the prices of its drugs. In particular, Biogen is reaching a patient saturation point with oral MS medicine Tecfidera, so turning to price hikes helps mask its sales slowdown.
2. Eli Lilly
Eli Lilly (LLY 1.96%) has been hit by a double-whammy: a number of key late-stage products have come up short over the past five years, and generic competition is pressuring its established drug portfolio. Eli Lilly has had little choice but to turn to price increases on some of its established therapies, as well as its specialty indications. In fact, Eli Lilly was accused of fixing insulin prices (i.e., pushing them higher) according to a federal lawsuit filed back in January.
3. AbbVie
There's absolutely no secret where AbbVie's (ABBV 0.98%) price increases are coming from: anti-inflammatory drug Humira. Humira is the best-selling drug in the world and is approved for 10 indications. Last year, Humira generated nearly $16.1 billion in annual sales, and with its patent expiration date nearing within the next couple of years, AbbVie is aiming to squeeze every last cent of profit out of the world's best-selling drug.
4. Allergan
Ireland-based Allergan (AGN) is no stranger to being under the watchful eye of the public since it's been relying on hefty brand-name drug price hikes for years. These price increases have helped mask the top- and bottom-line bumpiness associated with Allergan's active merger and acquisition history. For what it's worth, Allergan made a pledge to raise its list prices by less than 10% in 2017 and held true to its word by the narrowest of margins with a 9.5% list price increase.
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5. Merck
Big Pharma giant Merck (MRK -0.05%) also relied on price hikes for all of its net income increase in 2016. Merck's focus on cancer drugs, such as cancer immunotherapy Keytruda, have given the company exceptional pricing power. However, Merck is also trying to hang onto every last shred of sales from type 2 diabetes drug Januvia. Merck may choose to continue increasing the list price of Januvia to offset the increasing competition it's facing from SGLT-2 inhibitors.
6. Pfizer
Another drugmaker that should come as no surprise whatsoever is Pfizer (PFE 0.23%), which has been increasing the list price of its drugs twice yearly. According to Morgan Stanley analyst David Risinger, Pfizer hiked its list prices between 7.4% and 10.4% on five occasions between June 2014 and June 2016, working out to an aggregate increase of 52% before rebates and discounting to insurers. Pfizer's increased focus on specialty indications has made it easier than ever for the pharma giant to pass along price hikes.
7. Amgen
As is somewhat the theme with these seven price-hike-hungry drug developers, Amgen (AMGN 0.60%) also leaned heavily on increases with its lead drug to drive its growth. Over the past couple of years, Amgen has pushed the price of anti-inflammatory drug Enbrel higher by approximately 20% per year. In fact, Enbrel units sold declined 6% in the fourth quarter, but total growth hit 14%, implying a 20% price bump making the difference.
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Danger, Will Robinson
Though drug pricing power is somewhat implied for pharma and biotech, it's not a given.
President Trump has, on numerous occasions since the election, suggested that he aims to lower drug prices in America. Though many of Trump's proposals have seemed a bit off-the-wall when it comes to fixing out of control price hikes (such as deregulating the FDA and allowing consumers to buy drugs in overseas markets), it's the mere fact that he hasn't swept the problem under the rug that should worry drugmakers.
Which company above would be most at risk? While I wouldn't absolve any drugmaker, I'd be particularly concerned about Allergan. The sale of Actavis to Teva Pharmaceutical Industries certainly helped reduce some of Allergan's debt, but it also made the company one-dimensional in that it's focus is on branded therapies. Given tougher tax inversion rules in the U.S., an attractive avenue of growth has also been taken away. If Allergan is forced to rein in its price hikes, the company could really struggle to grow its top-line and reduce its remaining $32 billion in debt.
