ECONOMICS OF THE PHARMACEUTICAL INDUSTRY 25 th March 2004 Jon Sussex Office of Health Economics

Agenda 1.The supply side – R&D 2.Demand for medicines 3.NICE – the cost-effectiveness ‘4 th hurdle’ 4.Regulating medicine prices

Characteristics of Medicines Markets Supply is R&D intensive, which implies: –Intellectual property rights (patents) –Long lead times –High risk –Dynamic competition as important as static –Generic competition after patent expiry Demand is regulated – governments and social insurers are major buyers of medicines Prices are regulated

Supply Side – Main Characteristics (1) Patents are an incentive for dynamic efficiency – by promising temporary monopoly if successful Patents last 20 years; first 9-11 of which are spent getting the medicine to market, i.e. research & development (R&D) Commercial success in R&D-based companies depends on finding ‘blockbusters’

Supply Side – Main Characteristics (2) Average R&D cost of a new medicine up to launch is $800 million Includes costs of failures Out of pocket costs ≈ 50% Opportunity cost of capital ≈ 50% Only ≈ 30% of launched medicines earn revenues that exceed their lifetime costs

Phase III Development research Discovery and Development of a New Medicine Final patent application Marketing application Attrition rates Cost Post-mktng devel patients Phase IV 5, $800M 0 Chemical development Pharmaceutical development Long-term animal testing Toxicology and pharmacokinetic studies Source: CMR International 1993 Discovery research Investigational new drug application 1990 Phase I Phase II Synthesis Biological testing & pharmacological screening voluns patients 1999 Marketing approval product launch 2001 Regulatory review Regulations Time (years) Phases of drug development Basic research Clinical phases

Cash Flow for a Successful Medicine Launch Patent expiry £ p.a. + _ 0 Time

Supply Side – Main Characteristics (3) R&D costs are sunk (global) joint costs R&D costs ≈ 17% of pharmaceutical sales p.a. But ≈ 31% of costs on net present value basis => (even long-run) marginal cost << average cost => Price discrimination (based on Ramsey rule?) if non-linear pricing is impractical  Parallel trade

Pharmaceutical Sales as % of GDP

Types of Medicines OriginalbrandBrandedUnbrandedOTCs* On-patentOff-patentgenerics NHS Private * OTCs = over the counter (i.e. non-prescription) medicines

Demand Side Characteristics ChoosesConsumesPays Normal market Consumer Prescription medicines market PrescriberPatientGovernment / insurer

Measures Affecting Prescriber Price Sensitivity Primary Care Trust budgets Practice budgets and prescribing incentive schemes Provision of information (PACT, NICE guidance, pharmaceutical advisers, etc.) Generic prescribing targets

National Institute for Clinical Excellence Covers England & Wales Two main outputs: 1.Technology appraisals 2.Clinical guidelines

Technology Appraisal Criteria The Institute and Appraisal Committee will have regard to: –the broad clinical priorities of the Secretary of State for Health and the Welsh Assembly Government –the degree of clinical need of patients with the condition –the broad balance of benefits and costs –any guidance from the Secretary of State for Health and the Welsh Assembly Government on the resources likely to be available and on such other matters as they think fit –the effective use of available resources

NICE’s Guide to Methods of Technology Appraisal Below a most plausible incremental cost-effectiveness ratio (ICER) of £20,000/QALY, judgments about the acceptability of a technology as an effective use of NHS resources are based primarily on the cost-effectiveness estimate. Above a most plausible ICER of £20,000/QALY, judgments about the acceptability of the technology as an effective use of NHS resources are more likely to make more explicit reference to factors including: –the degree of uncertainty surrounding the calculation of ICERs –the innovative nature of the technology –the particular features of the condition and population receiving the technology –where appropriate, the wider societal costs and benefits Above an ICER of £30,000/QALY, the case for supporting the technology on these factors has to be increasingly strong

Completed Appraisals (- Jan 2004) 75 (including re-appraisals), of which 52 have been of pharmaceuticals: –restrictions in 32 appraisals e.g. Alzheimer’s drugs recommended in patients with mini mental state examination>12 e.g. zanamivir, oseltamivir recommended in at-risk patients with influenza –a technology has been rejected in 13 appraisals e.g. MS drugs anakinra for rheumatoid arthritis (except in a controlled long term clinical study) NICE has also issued 21 clinical guidelines (11 inherited)

Economic Evaluation Elsewhere Focused on pharmaceuticals Fourth hurdle i.e. reimbursement decisions: –Public reimbursement: Australia, Baltic countries, Belgium, Canada (British Columbia, Ontario), Czech Republic, Denmark, Finland, France, Hungary, Netherlands, New Zealand, Norway, Portugal, Russia, Slovenia, Sweden –US managed care formularies Pricing negotiations –Australia, France, Italy, New Zealand Advice to health service –England and Wales (NICE), Scotland Risk sharing arrangements –Australia, New Zealand, UK (only MS drugs to date)

Why Regulate? - Market Failure Public goods and the free-rider problem (e.g. research) Externalities –E.g. your vaccination reduces my risk of catching an infection –E.g. the caring externality: I’m happy if you’re cared for Incomplete or asymmetric information –Moral hazard (= ‘hidden action’) –Selection problem (= ‘hidden information’) –Principal/agent problems

Monopoly Power Economies of scale and/or scope – but NB contestability Natural (local) monopoly Input constraints Patents: dynamic efficiency vs static monopoly

Net Value of the Pharmaceutical Industry – Economic Rent Estimates for 2000: £ million p.a. Producer rents (exports & overseas)500-1,500 Labour rents R&D spillovers to other sectors Total rent700-2,000 Terms of trade effect ? Source: Pharmaceutical Industry Competitiveness Task Force (2001) ‘Value of the Pharmaceutical Industry to the UK Economy’

Options: Types of Regulation ‘No regulation’ = Competition Act only Profit, i.e. rate of return, control: –Unbanded –Banded Price control: –Baskets of products, as with ‘RPI-X’ control of utilities’ prices –Individual products, e.g. via reference prices, or ‘cost-plus’, or related to therapeutic benefit

1998 Competition Act Came into force March 2000 Based on EU Treaty - Articles 81 & 82 Prohibitions: –Chapter 1 – Agreements preventing, restricting or distorting competition –Chapter 2 – Abuse of a dominant market position Fines up to 10% of turnover; 3 rd parties may sue for damages

Banded Rate of Return Regulation Target RoR Outturn RoR > threshold => repay excess Outturn RoR may increase prices %RoR £ capital employed 0 ▲ ▲ ▲ ▲ ▲ ▲

RPI-X Regulation of a Basket of ‘n’ Products w 1 p w 2 p w 3 p …….. + w n p 1 n x 100 ≤ ΔRPI - X w 1 p w 2 p w 3 p …….. + w n p 0 n Where: w i = weight for product ‘i’ (e.g. quantity sold in period 0) p t i = price of product ‘i’ in period t = 0,1 ΔRPI = % change in retail price index between period 0 and period 1 X = efficiency factor { {

Regulation Criteria Static efficiency: –Productive efficiency –Allocative efficiency Dynamic efficiency Benefit to UK plc – economic rent Regulatory (administrative) burden Equity/other social policy objectives

Exercise What, if anything, to regulate? –On- and/or off-patent? –Branded and/or unbranded? –Prescribed and/or over-the-counter? –Sales to NHS only, or all UK sales? If so, how? –Rate of return control, unbanded –Rate of return control, banded –Price control – basket, RPI-X –Price control – individual products, reference prices From 3 perspectives: –General public: patients & taxpayers –Government –Industry

Key Questions 1.How price-sensitive are the people making the consumption choices? 2.How much competition is there between one medicine and another, or between medicines and alternative treatments? 3.Do producers have incentives to keep costs down? 4.Will production and consumption choices become increasingly distorted over time? 5.Do producers have incentives to invest in the UK, especially in R&D? 6.Would the regulatory system be costly for the regulator to administer and the companies to comply with?

Pharmaceutical Price Regulation Scheme 1999 Have been variants of PPRS since 1960s Department of Health acts as regulator for whole UK Objectives of 1999 PPRS: –Secure the provision of safe and effective medicines for the NHS at reasonable prices –Promote a strong and profitable R&D-based pharmaceutical industry –Encourage efficient and competitive development and supply of medicines Voluntary – but (unspecified) statutory alternative scheme for firms that opt out

PPRS 1999 (continued) Covers all branded medicine sales – on-patent & branded generics – to NHS by companies selling > £1m p.a. to NHS (≈80% of total sales to NHS) Return on capital ≥ 29.4% => repay excess to DoH Return on capital ≤ 8.5% => may apply for price increase(s) to take RoC to 13.6% R&D costs allowed up to 20% of sales Promotion costs allowed up to 7% of sales Free pricing at launch but no increases then allowed unless company’ RoC falls to ≤ 8.5%

Multilateral, Ex-manufacturer, Price Comparisons at Market Exchange Rates Index UK= at 5-yr av ex rates France8583 Germany10994 Italy Spain UK100 USA Source: Department of Health (2003) PPRS 7 th Report to Parliament

Understanding the methodological issues Manufacturers’ prices or final selling price to the payer? Brands or generics or molecules? Sample size and selection (value versus volume, degree of market coverage) Bilateral versus multilateral Match single pack, match product form or price per unit (tablet, DDD, IMS SUs, Kg)? Volume weights: unweighted, own country (Paasche) or foreign weights (Laspeyres)? Choice of exchange rate What exactly is the question you are trying to answer?

Pharmaceutical Price Regulation Scheme 1999 Have been variants of PPRS since 1960s Department of Health acts as regulator for whole UK Objectives of 1999 PPRS: –Secure the provision of safe and effective medicines for the NHS at reasonable prices –Promote a strong and profitable R&D-based pharmaceutical industry –Encourage efficient and competitive development and supply of medicines Voluntary – but (unspecified) statutory alternative scheme for firms that opt out

PPRS 1999 (continued) Covers all branded medicine sales – on-patent & branded generics – to NHS by companies selling > £1m p.a. to NHS (≈80% of total sales to NHS) Return on capital ≥ 29.4% => repay excess to DoH Return on capital ≤ 8.5% => may apply for price increase(s) to take RoC to 13.6% R&D costs allowed up to 20% of sales Promotion costs allowed up to 7% of sales Free pricing at launch but no increases then allowed unless company’ RoC falls to ≤ 8.5%