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The Complexity of Drug Pricing

July 17, 2015

San Diego—As companies set drug pricing, many direct and indirect factors go into determining its ultimate price. During a session at the ACMP meeting, led by Jeffery Moe, PhD, adjunct associate professor, Fuqua School of Business, Duke University, and Howard Tag, JD, chief executive officer, Tag & Associates, Inc., explored these factors and the manufacturer, payer, prescriber, and patient perspectives during the pricing process that either create upward or downward pressure on drug prices.

The United States encourages drug discovery by providing exclusive rights to the discovery of a new drug for a period of time, resulting in few or no competing products in the market after its initial release. When this period of exclusivity occurs, the manufacturer has increased market power to demand high prices.

But exclusivity is not the only factor that can influence prices. According to Dr. Moe, nondrug characteristics can also determine pricing. For instance, if the drug is treating a condition with a high prevalence, the price pressure is down often resulting in a lower price compared to conditions with a low prevalence where the costs are often driven up. Other factors known to push the price pressure up: if the drug meets an unmet need, treats a symptomatic condition, is targeted at young patients, has a high perceived disease severity, or is used to treat an acute illness.

The mode of administration can also influence prices with intravenous drugs often demanding higher prices than oral medications. Chemical drugs may also be less costly than biological medications. According to Dr. Moe, those drugs that have a clear and large differentiation from their competitors also often drive a higher price point. When setting their launch prices, manufacturers usually use referents to help determine the price within the market. But even if there are other similar medications on the market, Dr. Moe noted that often consumers, payers, and providers will prefer a newer product even if it carries a higher price tag.

As more interchangeable products enter the market; however, the more prices for products within that group go down. Pricing can also differ based on buyer segments. While the government is often more transparent, drug prices are negotiated privately with various buyer segments including managed care, institutional, and wholesale/pharmacy. Dr. Moe argued that if transparency was increased in pricing, the net prices would actually go up.

According to the presentation, payers also play a role in the process and make reimbursement judgments based on relative efficacy, cost versus health benefit, and budget impact of a given drug. They can also use tactics like step therapy, formularies, and exclusion lists to limit access to certain drugs.

Complexity of Setting Drug Prices

Mr. Tag spoke during the session about the complex process between payers, manufacturers, and the government to set prices. The process is often complex because prices are set depending on their use and not all price adjustments affect all prices equally. There are also retroactive adjustments that further add to the confusion.

“[Pricing] is a thing that pieces have been grafted onto in order to serve new needs, new requirements, and the grafting has needed to satisfy both political and commercial objectives,” he said.

When considering any changes to payment policy there are 20 different prices that must be understood and considered, according to Mr. Tag. Manufacturers create the average wholesale price (AWP), suggested wholesale price, wholesale acquisition cost (WAC), and direct price . While another stakeholder, the government, is responsible for creating other prices including the average sale price (ASP), average manufacturer price, federal upper limit, and the state allowable maximum cost. A third stakeholder, or private entities, create predictive acquisition costs, retail survey prices, and maximum allowable costs.

There are some prices, however, that are negotiated. These include the average acquisition cost, federal supply schedule, federal ceiling price, and VA contract. Even once prices are created, they can be adjusted through discounts, which occur at the time of the sale, rebates, or chargebacks.

The prices used most often as benchmark prices are the WAC and ASP. Medicare, Medicaid, and private insurance use these 2 prices. But, even though they are used most frequently they are not without their problems. Mr. Tag said there can be a lag between price changes and payment changes for the ASP. The ASP also cannot be used in every scenario. It is only available for a small quantity of self-administered medications or drugs administered by a clinician.

Dr. Tag said the challenge with WAC is that it is essentially a sticker price the manufacturer creates but does not reflect rebates or discounts. It is used by Medicaid and various private insurers for reimbursement but that was never the intended purpose of the price.

“WAC is being used for something other than it was created for. WAC wasn’t created as a mechanism to reimburse physicians or hospitals or pharmacists or anyone else,” he said. “It was created because you had to have a starting price from which to negotiate, so now it is being used for an entirely different purpose, an important and complex purpose

Finally, Mr. Tag said that trends can influence pricing and payment. Outcomes-based risk sharing agreements, fixed prices for episodes of care, and single treatment genetic cures are all factors in today’s healthcare market that could impact drug pricing and payment.—Jill Sederstrom


1. As companies set drug pricing, many direct and indirect factors go into determining its ultimate price.

2. The process to set prices is often complex between payers, manufacturers, and the government.

3. Twenty different prices must be understood and considered when considering any changes to payment policy.

4. Outcomes-based risk sharing agreements, fixed prices for episodes of care, and single treatment genetic cures are all factors in today’s healthcare market that could impact drug pricing and payment.


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