The biggest worry for MannKind (NASDAQ:MNKD) has been whether doctors would prescribe its inhaled insulin drug, Afrezza, which would take market share away from injected insulin currently prescribed by physicians. But there might be a bigger concern: whether marketing partner Sanofi (NYSE:SNY) can get a high enough price for the drug from insurers.

On its third-quarter conference call, then-Sanofi CEO Christopher Viehbacher noted that the company received greater than 90% unrestricted coverage from U.S. insurers and government programs for its flagship insulin Lantus. However, the company's earnings press release explained that "the level of rebates required to maintain these positions has increased significantly due to aggressive discounting by competitors."

That competition is likely Novo Nordisk (NYSE:NVO) which sells Lavamir, Lantus' biggest competitor. Shares of both Sanofi and Novo Nordisk fell on the news. Discounts aren't good for anyone.

Having to discount Afrezza would be a mighty blow for MannKind, especially since the drug-device combination is more expensive to manufacture than injected insulin.

Dreamboat

Afrezza inhaler. Source: MannKind.

Afrezza won't compete with Lantus, which is a basal insulin, designed to provide background insulin levels to control blood sugar throughout the day. Afrezza is a mealtime insulin that helps with the spike in blood sugar after diabetics eat.

But the only thing stopping a price war in mealtime insulin drugs is the drugmakers. As Viehbacher noted on the call, "You cannot have pricing pressure unless you have a competitor willing to reduce pricing in another market in the channel."

Who are Afrezza's competitors? Eli Lilly's (NYSE:LLY) Humalog and Novo Nordisk's Novolog. If one of them tries to grab market share by discounting its product, the others, including Sanofi and MannKind, will have to follow suit.

Even if one of the companies that make mealtime insulin isn't willing to play the price-war game, Sanofi and MannKind still might have problems obtaining the premium required to get a decent gross margin on Afrezza. Insurers are clearly revved up for a fight with drugmakers over prices. With other options available, insurers don't have to cover Afrezza if Sanofi is charging more than they think the drug is worth.

Drugs as commodities
It's bad news when drug companies must compete on price. Research and development of new drugs is expensive: The Tufts Center for the Study of Drug Development pegs the cost at $1.4 billion per approved compound, not including lost returns on capital while the drug is in development, which adds another $1.2 billion. And after a drug is approved, pharmaceutical companies spend an average of $312 million more doing post-approval clinical trials and other R&D on the compounds.

The good news for investors is there can't be a price war if drugmakers won't play along. Insurers can choose not to cover drugs, but if all the insulin makers hold their ground it's not like an insurer could refuse to cover any insulin. Unfortunately, it's tempting for the company on the bottom of the market-share chart to try to grab additional patients by discounting its drug, making up for lost profits with more volume.

The solution for investors is to find drugs that treat diseases for which there is little competition, or new drugs that are so much better than the current options that insurers must pay whatever drugmakers want to charge. Unfortunately for MannKind and Sanofi, Afrezza doesn't fit that description.

Brian Orelli and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.