Rafi Mohammed

Solving the $100,000 Cancer Drug Problem

Posted on May 2nd, 2013 (0 Comments)

Reprinted from the Harvard Business Review website. 

Last week over 100 leading cancer specialists signed their names to an op-ed in Blood, the journal of the American Society of Hematology, which lambasted the prices of cancer drugs that often exceed $100,000 annually. These researchers opined that high prices are preventing patients from being treated, and they questioned the ethics of pharmaceutical companies.

This isn’t a problem only facing uninsured patients: The op-ed claims that in the U.S., for instance, even insured patients pay an average of 20% of drug prices out-of-pocket, meaning these drugs can cost a patient $20,000 a year. Those numbers can be even higher because many patients suffer multiple ailments, requiring more than one pricey drug.

The key to solving this problem is to forget about regulation, charity, or public shaming and instead focus on how to help drug companies make even more money.

This may sound counterintuitive, but a win-win opportunity exists. Making expensive drugs more accessible and getting pharma companies on board involves adapting pricing tactics successfully used by other companies in similar situations to help them sell more. The key components that lead to a solution are as follows:

Understand the dynamics of a high fixed cost/low variable cost industry. While pharma companies spend billions on research, the actual cost of manufacturing a treatment (such as a pill) is minimal. This cost structure enables pricing flexibility. This is why Las Vegas hotels, for instance, have premium prices on weekends and rock bottom discounts during the middle of the week. As long as mid-week prices cover the low nightly variable costs (mostly the cost of cleaning the room), any higher amount is gross profit. With the current high prices, pharma companies are only serving weekend customers. Like other high fixed cost/low variable cost industries, they could make more money by learning to extend discounts in the right circumstances.

Understand that there’s profit in serving discount-oriented customers. Activating dormant customers through discounts is a common growth strategy. Coach, the manufacturer of fine accessories such as handbags, activates price-sensitive dormant customers via a network of outlet stores that offer up to 70% off full retail prices. In North America, for instance, over 30% of its stores are outlets, and 45% of its total retail square footage is dedicated to discount outlets. Even “dollar menus” at fast food restaurants generate enviable cash flows. For example, the incremental gross margin of a $1 McDonald’s double cheeseburger is 55%.

Understand micro-differential pricing. The dream of every pricing strategist is to somehow determine and charge the highest price that each customer is willing to pay. This is why, for instance, auto salespeople size you up by noting how you dress and asking questions such as “What do you do for a living?” They are trying to figure out how much you are willing to pay — this process results in different prices for different customers. Solving the $100,000 drug problem involves emulating car salespeople. Pharma companies should be encouraged to set prices based on a patient’s income as well as their other drug costs.

To implement smarter pricing that saves more lives, and brings in more revenue, the pharma industry should create a straightforward grid that specifies the annual maximum a patient should pay out of pocket on pharma expenses. Key variables that determine this maximum include income (verified by IRS data), family size, and their other pharma costs. Patients can submit this data to a third party agency, discounts will be applied based on these criteria. For instance, if it is determined that a 30% co-payment on a $100,000 annual treatment for a middle class family of four is too much, the patient can be reimbursed $15,000 by the drug company, which still nets a healthy $85,000 in incremental revenue (since this family wouldn’t have purchased the drug without the discount).

There are already several foundations and prescription assistance plans in place today to help low income patients. But the $100,000 drug issue is also a middle to upper-middle income issue — and the industry should address the problem in a way that helps create more revenue.

Discounting shouldn’t be thought of as charity. In fact, it’s smart business for pharma companies.

Drug companies already profitably implement differential pricing on a macro-level: This is why drugs are cheaper in third world countries than in the U.S.. Why not employ differential pricing on a micro individual-to-individual basis? The U.S. may be a rich country, but there’s a gigantic income difference between poverty-ridden inner city areas and, say, Beverly Hills. If a patient skips a treatment due to price, that’s not only a loss for the patient (whose health will suffer), but it’s a missed gross margin opportunity.

Micro-differential pricing is a win-win strategy: higher profits will be reaped and more patients will be served.

Doctors signed on to the Blood op-ed in hopes of starting a dialogue on high drug prices. It’s an important topic, and one that demands a solution. The key to solving the $100,000 drug challenge is to encourage the invisible hand actions of profit-seeking. The micro-differential pricing opportunities available due to the high fixed/low variable costs structure of drug companies would enable as many people as possible to benefit from pharmaceutical advancements.

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