As Drug Price Scrutiny Rises, Pressure Builds to Define Value

An interview with Dr. David Friend, Chief Transformation Officer at The BDO Center for Healthcare Excellence & Innovation

Drug pricing is one of today’s most hotly debated and deeply complex topics, influencing and being influenced by the healthcare and pharmaceutical industries’ paradigm shift from fee-for-service to value-based care and reimbursement. In this Q&A, Dr. David Friend, who advises both drug developers and healthcare providers on pricing, quality measurement metrics and validation, digs into the roots of the issue and how the market is changing.

Q: Drug companies are under attack for what is seen as exorbitant pricing on new drugs, or for raising prices dramatically on drugs that have been in the market a while. Why are we seeing this scrutiny now?

Dr. Friend: The heart of the drug pricing debate centers on value. Warren Buffet has a favorite phrase: “Price is what you pay, and value is what you get.” Looking at price in isolation doesn’t give you the full story on a drug’s value. But until now, there has really been no market pressure for drug manufacturers to demonstrate their value or for physicians to prescribe medications based on value.

While it’s standard practice in nearly every other industry, this explicit tying of a payment to an outcome is new in healthcare, prompted in part by unsustainable costs, the Affordable Care Act and other factors. We’re seeing drug manufacturers in the news as part of a much bigger conversation about healthcare pricing. Recent events have brought attention to what has never really been discussed: How do we price? The opaque system has provided significant opportunity for many participants to maximize their profits. With as much sunlight as is now on this, organizations must understand and explain their pricing strategies much better.

That’s going to have a significant impact on health businesses’ earnings power going forward. So, it’s incumbent upon everyone in the space who invests, who works in the companies, who has any kind of financial interest to understand these changes in both the pricing and reimbursement landscapes.

Q: How does the changing healthcare reimbursement environment relate to drug pricing?

Dr. Friend: The healthcare system is moving more aggressively toward reimbursing healthcare providers based on their performance. The Center for Medicare & Medicaid Services (CMS), which is one of the system’s biggest payers spending trillions of dollars, is setting the tone. Their objective is to drive healthcare costs down and improve the quality of care, which is leading to more standardized care and a focus on best practices. How does this play out with prescription drugs? If there is a “best drug” for an illness, it’s more likely that it will be favored by CMS and other commercial insurance payers, and less effective drugs won’t be reimbursed.

This shift toward performance, or value-based payments, has an enormous impact on pricing across the entire healthcare spectrum. Producers and manufacturers of healthcare products can no longer use the old approach of scanning the market to determine what competitors are charging. Pricing must be much more involved to stand up to the scrutiny coming from multiple directions. How does the product perform against competitors? What value will payers and consumers put on that difference? How can you get a significant and fair return for shareholders? There is not going to be as much room for second best, mostly because no one ever took the time before to measure what was best and validate why.

Q: Can value really be measured?

Dr. Friend: There’s no scale that says what’s best, or what’s value. It’s still a debate up for grabs. We think there’s a lot of opportunity on the part of our clients to think about the value propositions they bring. Value is determined by a variety of factors—consumers, institutions that manage and produce care, drug manufacturers, investors. And their points of view are constantly evolving.

One of the many ways to think about value is through outcomes. Consider hepatitis medications, which have come under scrutiny for their expense. Let’s say a patient is charged $100,000. That’s an extremely high price, but what if the pill permanently cures hepatitis? Society might otherwise spend $1 million or more for that patient’s treatment over their lifetime. In that context, is $100,000 a good value?

What about the value of a drug that minimizes side effects, or is easier to administer? The FDA already has a very involved process to validate drug effectiveness and safety. How will drug manufacturers further validate that their product has greater value than another product to justify its price?

It’s a challenge to everybody along the healthcare supply chain because you have to get it right. Your premise for your price is becoming contingent on what you’re saying the outcome is, and those outcomes can be looked at retrospectively by authorities. If you say, “Our drug should command a higher price because the readmission rate is lower,” someone will be able to verify that and hold you to it. We’re seeing more and more enterprises demanding specific performance guarantees from their vendors and penalizing them when they’re not met.

Organizations are going to have to continuously monitor performance to prove their value as new competitors enter the market and to justify their costs as regulators and others compare their performance claims with outcomes. Measurement will have to be built into the core business and into the economics of pricing. The finance group will likely be tasked with not only measuring and monitoring financial data, but clinical data as well. As dollar payments become explicitly linked to clinical reported outcomes, there will also be a need for someone within organizations to verify the accuracy of the clinical data.

And measurement, again, takes us directly back to business value. If your product creates a lot of value and you can demonstrate that, you should be thinking about how to get a significant and fair return for your shareholders. That may mean that your prices should in fact increase. On the other hand, if your product is really not as good as your competitor’s, it may not be enough to lower the price. You may be excluded entirely from the network. If I make the cheapest jet engines out there but they catch fire every couple of hours, Boeing is never going to put my product on their plane.

Q: Many drug providers attribute costs to research and development. How will these new pricing factors impact drug innovation?

We are really in a golden age of science as far as our ability to create new medications, but it’s extremely expensive to do so, and we believe that roughly nine out of 10 products that are attempted fail. Investors need to be able to get a sufficient return to absorb nine failures for that one success.

Pricing, then, is also a function of how much innovation we want as a society. The more the market is willing to pay for drugs, the more money there is to put toward taking risks to innovate. U.S. citizens are paying higher prices than anyone else in the world for medications because we’re paying for innovation that benefits the rest of the world. How much are we willing to pay? How do companies recoup the investment they made across 10 products to get one successful one? One lever we can pull is price; another is patent length.

Q: Are investors comfortable with such a high level of risk taking, given the current environment?

Dr. Friend: There is still tremendous opportunity in healthcare and life sciences. However, it’s absolutely critical for investors to understand what’s happening with pricing and reimbursement, because they are central to driving earnings. Over the next 10 years, there will be around $10 trillion of value created in healthcare, but $4 trillion will also be destroyed. Investors on the winning end will be those with a much better handle on pricing.

Smart investors have to evaluate the value proposition that a company brings. If a company can generate superior outcomes, it needs to be able to tell that story in an economic way and in a clinical way to justify their price and generate shareholder returns. On the other hand, there must be an understanding of how companies respond to having products lower down the value-chain profile—will the price of the drug be lowered? Will the company only charge people for whom the drug was effective?

New questions will be introduced in healthcare in coming years that are common in other industries but which haven’t been asked of this sector before.