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How Do Pharmaceutical Companies Set Drug Prices?

Revenue generated by US pharmaceutical companies from drug production, both domestically and internationally, has increased by 46%. The United States generated more than $425 billion in revenue in 2020. The key to this high revenue is consistent price increases.
Drug companies have an unusual ability to operate relatively unregulated and raise drug prices above the rate of inflation. Drug prices have increased by 35% since 2014, compared to inflation, which has increased by 21%. This allows drug companies to continuously increase their revenues, even if demand for one or more drugs is low. Prescription drug sales are expected to reach $1.18 trillion globally by 2024.

Important Takeaways
  • Prescription drug prices in the United States are relatively unregulated, allowing pharmaceutical companies to raise their drug prices above inflation rates and regardless of demand.
  • The majority of a pharmaceutical company's revenue is generated by steadily rising prices for drugs that have been on the market for a while.
  • Pharmaceutical companies consider a drug's uniqueness, competition from other companies, and effectiveness when pricing their drugs.
  • Companies also consider the enormous R&D costs incurred to bring a drug to market, which frequently leads to high prices for new drugs.

Exorbitant Drug Prices
  • The news media in the United States has focused heavily on pharmaceutical companies that have released new drugs at exorbitant prices. There has also been a greater emphasis on previously released drugs under new ownership that have experienced abrupt price increases. Of course, drug companies do this to generate revenue.
  • The majority of a company's revenue, however, comes from a pattern of steadily increasing prices of drugs that have been on the market for a while. The number of drugs in a drug company's pipeline will also affect the price of each drug.

How Are Drugs Priced?
  • Because of drug companies pricing power and ability to raise prices without regulation, the fear of sluggish demand is far down the list of pricing concerns. When it comes to drug pricing, pharmaceutical companies consider a number of factors.

Drug Distinctiveness
  • The drug's uniqueness must be considered. That is, how many other drugs exist that treat the same condition. If the market for drugs to treat a specific condition is oversaturated, new drugs for the same condition will most likely be priced lower.

  • Another factor that influences pricing is competition. Drug companies must consider the popularity and success of the drug's competitors, as well as whether new drugs provide additional benefits over competing drugs. Price increases resulting from additional benefits.

Drug Efficiency
  • Drug companies must consider whether new drugs have the potential (or have been proven in clinical trials) to change the current medical practice used to treat the conditions that the drugs target. Companies must also consider whether their drugs can eliminate the need for certain medical treatments, surgeries, or other procedures. Johnson & Johnson was the world's largest pharmaceutical company by revenue in 2020, with $82.6 billion.
  • Drugs that can reduce the cost of expensive surgeries, hospital stays, and doctor visits are frequently priced higher because of the savings they provide customers in the long run. Drug companies also charge more for drugs that can prolong or even save lives.
  • When it comes to drug pricing, pharmaceutical companies' primary goal is to maximize revenue. This frequently means facing competition, which serves to drive down prices; however, drug companies have balanced pricing drugs too low with the ability to implement price increases at regular intervals.
  • They may believe the drug is not worth the high price if it is likely to provide insufficient benefit to justify the cost. On the other hand, if a drug is priced too low, physicians may conclude that it provides a discounted form of therapy that is less effective than an existing more expensive drug.
  • Another hugely important factor in pricing is the research and development (R&D) surrounding each drug. When pricing a drug, the amount of time, effort, and money that a pharmaceutical company invests in R&D for each drug must be considered. This frequently results in higher prices to ensure that the revenue generated exceeds the costs of developing the drug.

Why Do Pharma Companies Increase Their Prices?
  • Pharmaceutical companies raise their prices to increase revenue. Pharma companies frequently claim that price increases are required to fund their ongoing research into new drug discoveries. Furthermore, because some patented drugs have no competition, pharmaceutical companies can raise prices without customers having adequate alternatives.

Who determines the price of a medicine?
  • Prices are set by pharmaceutical companies that manufacture drugs and other medicines. The government does not set prices; however, insurance companies and pharmacies that sell the products are responsible for the total amount that a customer will pay.

Why are generic drugs less expensive than brand-name drugs?
  • Generic drugs are less expensive than brand-name drugs because they do not incur the same costs in research and development or clinical trials as the company that developed the original (brand-name) drug. When a brand name company's patent expires, generic drugs can use the previously engineered technology that the brand name company discovered/created.

Important Punch Line for Pharmaceutical Companies
  • Pharmaceutical companies set their own prices when selling their own products. 
  • Pharmaceutical companies can set whatever price they want for a newly created or patented drug because there are no alternatives.
  • Pharmaceutical companies consider the uniqueness of the drug, competition, drug effectiveness, and research and development costs when determining how to price a drug.

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