In Search of Fair Balance

IN SEARCH OF FAIR BALANCE:
Prejudiced Attacks on the Research Based Pharmaceutical

Industry Can Result in Dangerous Policies
January 8, 2001
E.M. Kolassa, Ph.D.

Associate Professor, Pharmacy Administration
Associate Director, Center for Pharmaceutical Marketing and Management
The University of Mississippi
School of Pharmacy
219B Faser Hall
University, MS 38655
(662) 915-1020
mkolassa@olemiss.edu
DISCLAIMER: The views and assertions contained in this document are those of the
author, not those of the University of Mississippi or the School of Pharmacy
In Search of Fair Balance
TABLE OF CONTENTS
Executive Summary................................................................... i
Introduction .............................................................................. 1
The Role of Medicines in Contemporary Medical Care 2
Problems Confronting the Pharmaceutical Industry................... 5
Pharmaceutical Prices................................................................ 7
International Price Differences ............................................ 8
The Link Between Profits and Research .................................. 12
Patents and “Monopoly Power”............................................... 15
Pharmaceutical Promotion....................................................... 18
Specific Responses to Flawed Analyses................................... 21
In Search of Fair Balance
EXECUTIVE SUMMARY
The contributions of the US research-based pharmaceutical industry to our nation’s health

and economic prosperity are many, but misdirected attacks on the industry may threaten its
productivity, and slow or reverse the major advances in medical care, and the slowing of
medical care spending, brought about by the pharmaceutical revolution of the past few
years. The major findings, and assertions, of this report are:
• Pharmaceutical prices reflect their value, which has been documented many times. The
current focus on pharmaceutical prices ignores the real issue – the lack of appropriate
prescription drug insurance coverage for seniors and other underinsured Americans.
Reducing the prices of medicines would not solve the problems of those who truly cannot
afford them, but would put at risk the availability of new medical innovations that would
benefit all, clinically and economically.
• Profits reward and encourage risk, and the productivity of the US pharmaceutical industry
is a testament to that relationship. If pharmaceutical firms earned profit margins that were
equal to the overall industrial average, as some have advocated, their degree of risk taking
would approach the average as well. The result would be what we have seen throughout
Europe, Canada, and in Japan, a pharmaceutical industry that takes fewer risks, discovers
fewer innovative medicines, and contributes less to society as a result.
• The patent system in the US, and the exclusivity granted to innovative pharmaceutical
compounds, is essential to provide the returns on research and development investments.
The nation’s health, both physical and economic, is enriched and improved because of
patent exclusivity and the financial rewards it provides.
• The promotion of pharmaceutical is an important element of our health care system.

Without adequate promotional activities, society would be deprived of the benefits of most
new drugs for several years. The cost-effectiveness of pharmaceuticals, which reduce the
need for costlier medical interventions, is enhanced when promotion and other marketing
activities speed up the rate of their adoption into the medical care system.
• The many proposals to reduce the prices of pharmaceuticals in the US are based on naïve
and simplistic assumptions and, if implemented, would endanger the current productivity
and future viability of the research-based pharmaceutical industry in the United States.
Several proposals would put other sectors, such as retail pharmacy, at risk as well. Unlike
any other industry, the makers of pharmaceuticals have made efforts to assure that patients
will not be denied access to their products because of their financial situations. The failure
of insurers, and the federal government, to include the single most cost effective element of
medical care, pharmaceuticals, in basic medical care coverage plans points to their
narrow and short-sighted approaches to health care and their failure to stay current with
medical technology.
IN SEARCH OF FAIR BALANCE:
Prejudiced Attacks on the Research Based Pharmaceutical Industry
Can Result in Dangerous Policies
“I have yet to see any problem, however complicated, which, when you looked at
it the right way, did not become more complicated.”
Poul Anderson
INTRODUCTION
The research based pharmaceutical industry in the United States finds itself literally under
attack on several fronts. As the use of pharmaceuticals continues to increase, the scrutiny
under which the industry finds itself increases as well. New calls for price controls, price
reductions, importation of medicines from foreign markets and other “solutions” to the
pharmaceutical “problem” arise on a regular basis. Although well intentioned, many, if
not most of these calls to action are misguided and have the potential to do real harm, not
only to the pharmaceutical industry but also to patient health and the health care economy.
Over the past few months several “analyses” of the policies and activities of the research
based pharmaceutical industry in the US have been published. These have ranged from
reports by the Secretary of Health and Human Services of the Federal government, which
sought to understand pharmaceutical pricing, to analyses prepared and circulated by well
meaning but misinformed academicians who have attempted to scrutinize issues that are
well outside their own fields of expertise. These reports have been used to justify
proposed legislation, fuel campaign rhetoric, and vilify the pharmaceutical industry. Most
of these analyses lack balance; they were produced with a final “solution” in mind. Some
are based on assumptions that are either naïve or disingenuous. Others, especially those
produced by the Department of Health and Human Services, have omitted information that
has been readily available, but would have affected their conclusions.
When pharmaceutical companies promote their products they are required to provide “fair
balance,” listing all possible negative consequences of using a medicine and offering proof
of their claims, through the citation of clinical trial results published in peer-reviewed
journals and cleared by the FDA. Similarly, when academic researchers submit articles for
publication they are subjected to “peer review” to assure completeness, accuracy, and
reliability of the work. No such burden is placed on those choosing to criticize the
pharmaceutical industry in opens forums or in preparing documents for background use by
legislators or other public officials. In fact, a knowledgeable observer could conclude that
many of the “reports” purposefully omit important information and distort facts to make
their points. This document has been prepared to provide some balance in the debate over
the value, prices, and future of pharmaceuticals within the US medical care system. It was
neither commissioned by nor prepared for any sponsor, but prepared solely to provide the
balance necessary for appropriate policy making.
THE ROLE OF MEDICINES IN CONTEMPORARY MEDICAL CARE
The alarm over increased spending on pharmaceuticals is, at its roots, a societal failure to
recognize the great changes that have taken place in the medical care delivery system over
the past three decades, and the new role in that system played by pharmaceuticals and
other technologies. The advances made in pharmaceutical sciences and technologies over
the past decade are, quite simply, remarkable. Even the harshest critics of the
pharmaceutical industry will describe new medications as “modern marvels.” But the
simple acknowledgment of these marvels is insufficient to silence the critics and to help all
to understand the changed and changing role of pharmaceuticals in medical care. It can be
argued that the role, importance, and value of pharmaceuticals have grown greatly in
recent years, fueled by advances unequalled in the other areas of medical care. The
consistent bemoaning of the increases in expenditures for pharmaceuticals has not been
accompanied by a reasoned consideration of the imperative that we spend more on them,
and that by doing so we spend less on other, costlier interventions. Pharmaceuticals and
other technologies have moved from their former position as relatively minor elements of
support for the central figures in the traditional health care system, the physician and
hospital, to a more central position, as portrayed in the figure below.
The Changing Medical Care Paradigm: The Altered Role of the Elements
Traditional Emerging
Medical Care Paradigm Medical Care Paradigm
MD
Other HC Professions
Hospital
Pharmaceuticals and other technology
Three decades ago medical technology was rather primitive by today’s standards. The
availability of effective pharmaceuticals was quite limited and physicians and hospitals
provided the bulk of medical care in a very labor-intensive manner. The physician’s role
was that of cautious diagnostician as well as that of patient and family counselor. Because
of a lack of adequate tools and treatments, the physician was often left helpless to affect
the course of a disease. Today, physicians have at their disposal medications and
technologies that provide for the immediate diagnosis and treatment of most of the
disorders that affect modern man. These advances have been taken for granted; with little
consideration of the ways they have changes medical care delivery, patient outcomes, and
society itself.
In Search of Fair Balance 5

E.M. Kolassa, Ph.D.
Center for Pharmaceutical Marketing and Management
School of Pharmacy
This shift in the medical paradigm, and society’s failure to appreciate it, is at the root of the
problems facing the pharmaceutical industry. A recent analysis by researchers at the
American Enterprise Institute, entitled “The Productivity of Health Care and
Pharmaceuticals: An International Comparison,”1 found that the use of pharmaceuticals
has a “positive and significant effect on life expectancy, and a negative effect on cost”
while non-pharmaceutical health care consumption “appears to have no measurable
effect.” The other factors affecting life expectancy were either economic or life-style
elements. The authors of this study concluded that increased use of pharmaceuticals leads
to improved health and reductions in total spending on medical care. This alone provides a
compelling argument that the increasing share of the health care dollar dedicated to
pharmaceuticals is not only appropriate but also desirable.
A recent study at Columbia University has found that a $1 expenditure on

newer medicines is associated with a $3.56 reduction in hospital costs.
A 1991 study by the Battelle Institute estimated that new products brought about by
pharmaceutical research pharmaceutical research will save more than $750 billion in the
cost of treating just five illnesses over a 25 year period: Alzheimer’s, AIDS, cardiovascular
disease, arthritis, and cancer.2 Already, H2 antagonists such as Tagamet and proton pump
inhibitors like Prilosec have virtually eliminated the need for once common but costly and
dangerous ulcer surgery, saving billions of dollars and thousands of lives. The main effect
of many other medicines is to reduce or eliminate the need for more costly interventions,
reducing both costs and human suffering.
More recently Frank R. Lichtenberg, a researcher at Columbia University, used the data
from the 1996 Medical Expenditure Panel Survey (MEPS), which is collected and
administered by the federal government, to demonstrate that the use of newer drugs, when
compared with older drugs, results in lower total medical care spending and better patient
health.3 Among the major findings of this study was that a $1 expenditure on newer
medicines is associated with a $3.56 reduction in hospital costs, in addition to reductions in
physician’s office visits, emergency room events, and other services. Lichtenberg also
concluded that these newer agents saved much more money than generic drugs, which are
simply copies of older drugs.
Pharmaceutical technology has been shown over and over again to result in lower total
health care costs and better patient outcomes. The failure to recognize this changed role
for pharmaceuticals has led to the ongoing attempts to force pharmaceuticals and other
medical technology into the roles they played 30 to 50 years ago – as minor elements of
1 Frech III HE, Miller RD. The Productivity and Health Care and Pharmaceuticals: An International
Comparison, the AEI Press, Washington DC, 1999.
2 Brown RE, Elixhauser A, Scheingold S, Luce BR, The Value of Pharmaceuticals: An Assessment of Future
Costs for Selected Conditions, Battelle Medical Technology Assessment and Policy Research Center,
Washington, DC, 1991
3 LichtenBerg, FR, The Benefits and Costs of Newer Drugs: Evidence from the 1996 Medical Expenditure
Panel Survey, Columbia Unversity and The National Bureau of Economic Research, November, 2000
E.M. Kolassa, Ph.D.
School of Pharmacy
the medical care system. Increased spending for pharmaceuticals relative to other medical
care areas is a reflection of their value. Expenditures on pharmaceuticals are growing
faster than other components of medical care because they are the most efficient and
effective of those components. Attempts to limit pharmaceuticals to their former, minimal
role in medical care are, effectively, turning back the clock on medical progress. Our
society’s, and government’s, failure to understand this changed role for pharmaceuticals
leads many to attempt to artificially suppress the growth of pharmaceutical use. As
pharmaceutical science advances, the need for society to understand and appreciate this
new role will become paramount.
A major part of the controversy surrounding pharmaceuticals can be traced to their success
at curing, preventing, and controlling diseases for which there were no previous options.
Appropriate use of new pharmaceuticals helps people to live longer, and people who live
longer are likely to consume more medical care resources during their lives. So long as
our society values longevity as an outcome, and strives to reduce mortality from disease,
the funds we spend on health care will continue to increase. The only way to reduce
spending on medical care, for the foreseeable future, would be to turn our backs on modern
medicines, especially antibiotics and cardiovascular medications, and allow people to die
at younger ages. But we, as a society, appear to have decided that such an option is not for
us. Given that, we must acknowledge that health care costs will continue to increase and
we should budget appropriately. Trying to reduce health care costs by squeezing the most
efficient element, pharmaceuticals, that makes up less than 10% of total medical spending,
is a fool’s mission. Some may believe they are acting appropriately, or at least feel better,
by attacking research-based pharmaceutical companies, but such activities fail to address
the real issues in medical care and divert resources from the more important issues we
must face.
These facts do not provide an argument for the unfettered use of new pharmaceuticals
without regard for need and cost, but the evidence is overwhelming that the use of new
pharmaceutical agents is much better than non-use. And heavy handed attempts to
suppress use or slow pharmaceutical innovation or its diffusion into the medical care
system will ultimately lead to higher costs and inferior patient outcomes.
Still, the momentum of the current measures to control, or punish, the research-based
pharmaceutical industry is substantial, and many of those engaged in this area are relying
on faulty information. The following sections of this report are provided to those
interested in developing a more balanced view to the current debate.

E.M. Kolassa, Ph.D.
School of Pharmacy
THE PROBLEMS CONFRONTING THE PHARMACEUTICAL INDUSTRY
The roots of many of the problems facing the pharmaceutical industry can be traced to its
unique position within medical care. Pharmaceuticals differ from most other inputs and
resources within medical care because:
• They are the products of for-profit businesses. Unlike other major aspects of
medical care, medicines are produced by industrial concerns, rather than by
individuals (like physicians) or traditionally non-profit community-based concerns
(like hospitals). “The pharmaceutical industry” is often viewed as one large unit,
driven only by the profit motive, whereas most other aspects of medical care are
often seen as individual entities.
• Medicines constitute a large portion of out of pocket costs for seniors. Patients
bear the costs of pharmaceuticals more than other aspects of health care because
most other costs are covered through traditional insurance. Co-payments for
prescriptions are often higher than those for physicians’ office visits, and they are
usually paid monthly. For Medicare patients lacking additional insurance for
pharmaceuticals, the charges for prescriptions are usually the highest regular
medical expense to which they are exposed. Because these patients are responsible
for covering the costs of prescriptions, but not physicians’ office visits or their
hospitalizations, they see drug costs as exceptionally high. The Medicare system
benefits when these patients take their prescriptions, but pays heavily when they
don’t. The lack of a Medicare drug benefit, not drug prices per se, has brought
about the bulk of the protests over prescription costs.
• They are easily separated from other parts of medical care. Physicians fees and
hospital charges, which constitute the largest areas of medical care spending, are
paid for through major medical insurance, while pharmaceuticals are often “carved
out” and managed separately from other aspects of care. Because of this, those
charged with managing pharmaceutical costs focus only on those costs, ignoring
the benefits derived, in terms of reductions in surgical procedures and other
hospitalizations. The rewards from increased use of medicines are reaped in a
different part of the budget, with few attempts to link the benefits of medication use
to their own budget. Health systems managers pat themselves on the back for
“getting hospital spending under control” while complaining about increased
utilization of pharmaceuticals, which brought about the reduction in
hospitalizations.
These conditions, which are unique to pharmaceuticals, render the research-based industry
susceptible to scrutiny and criticism at levels far beyond what their share of medical care
spending warrants. As the criticism of the pharmaceutical industry has increased, many
within the medical care delivery system have rushed in to add to the faultfinding. Health
insurers, criticized for the past decade, have joined the chorus of vitriol, perhaps seeking to
take cover behind the pharmaceutical industry. In the November 20, 2000 issue of
Newsweek Magazine, Scott Serota, President and CEO of the Blue Cross and Blue Shield
Association, is pictured in a full page advertisement headlined “Why are your prescription
drugs so expensive?” The ad blames Direct-to-Consumer advertising, exclusive licensing

E.M. Kolassa, Ph.D.
School of Pharmacy
agreements, and patent protection for “high drug costs.” Although these factors may,
indeed, contribute to increased spending for pharmaceuticals, they also contribute to the
unique outcome of pharmaceuticals: if it were not for modern medicines we would be
spending more on medical care and patients would not be as healthy. Protestation of
increasing drug utilization by insurers could be interpreted as an attempt to deflect
criticism away from themselves, not as problem solving. Medicines save money and
improve lives, something the health insurance industry should embrace, not work to limit.
Why, then, are pharmaceuticals surrounded by controversy, and why are so many
criticizing the industry and supporting proposals to cut their prices and profits? Many of
the critics possess a naïve misunderstanding of the clinical and economic effects of
pharmaceuticals, choosing to find fault with the business of pharmaceutical rather than
seeking a better understanding of the issues. Such criticism is easy, well received by other
critics, and dangerous to the health of the nation.
Criticism of the pharmaceutical industry focuses on a few key issues:

• The level of pharmaceutical prices
• The profitability of the industry
• Market exclusivity granted by patents
• Selection of products for development
• Promotional practices
These areas interact; one cannot be evaluated fully without considering the others. Each
will be addressed in the following sections.

E.M. Kolassa, Ph.D.
School of Pharmacy
PHARMACEUTICAL PRICES
In December of 1999 President Clinton ordered the Department of Health and Human
Services (HHS) to undertake a study to determine how pharmaceutical prices were
determined. After several months and what was purported to be an “exhaustive” review of
the literature, the government’s researchers were unable to answer the basic question – but
they did find more “evidence” with which to pillory the pharmaceutical industry. 4 Rather
than seeking input from those involved in the field of pharmaceutical pricing, or even
consulting the only book written on the topic,5 the authors of the report simply accused the
pharmaceutical industry of unfair pricing.
..if the cost of using a product is lower than the cost of not using it, the
price is appropriate and the product delivers real value
The HHS report did point out that the bulk of the increase in spending on medications was
from increased utilization, rather than increased prices. It also pointed out that they did not
know how much of the difference in cost between older and newer drugs reflected changes
in the quality of the medicines – that is if the higher prices reflected higher value. As
mentioned earlier, the study by Lichtenberg demonstrated that new drugs do, indeed, bring
greater value. And value is the starting point for the pricing of pharmaceuticals (and
anything else, for that matter). The prices of new medicines reflect the value they bring to
the marketplace, relative to other drugs and interventions. In straightforward terms, if the
cost of using a product is lower than the cost of not using it, the price is appropriate and the
product delivers real value. Using the economic value of the drugs to assess their prices,
one could argue that many, if not most, new drugs are actually underpriced, relative to the
value they provide, in terms of reductions in the use of other medical interventions and the
improvements in patient health and quality of life.
Contrary to the beliefs of many, the cost of research, or anything else, is not directly used,
and does not belong, in the pricing decision. Research is what pharmaceutical companies
do, and profitable firms can conduct more research (this issue will be addressed in depth
later). We are indeed fortunate that the products of research-based pharmaceutical firms
are valuable, and provide the potential for the firms to be profitable and to continue to
discover, develop, and market new and more valuable medicines.
The prices charged for new medicines, although higher than those charged for older
medicines, are low when compared with their improved value, as documented by the
Lichtenberg study. But the exclusion of pharmaceuticals from Medicare, as already
discussed, means that patients over 65 must obtain additional insurance to obtain
medicines, or pay for them out of pocket, placing an undue, and unfair, burden on seniors
and others lacking comprehensive coverage. This situation, which brings many to
conclude that drug prices are too high, is a result of an outdated Medicare system, not high
drug prices.
4 U.S. Department of Health and Human Services (2000), Report to the President: Prescription Drug
Coverage, Spending, Utilization, and Prices, April. http://hhs.gov/health/reports/drugstudy/.
5 Kolassa EM, Elements of Pharmaceutical Pricing, Haworth Press, Binghampton, NY, 1997
E.M. Kolassa, Ph.D.
School of Pharmacy
INTERNATIONAL PRICE DIFFERENCES
Drug prices in the United States are fair and appropriate, given their proven value. Often,
prices charged for some medicines in the US are higher than those charged in other
nations. This, too, brings about charges of unfair pricing. But it is not appropriate to
simply compare the prices charged in the US with those charged elsewhere because of
government interference with markets, and the refusal of many nations to pay a fair price
for the medicines they receive. In fact, the reasons for the majority of differences in prices
between the US and other nations are totally out of the control of the pharmaceutical
industry, they are simply facts with which they must cope rather than situations that they,
themselves, have created. In fact, the Congressional Research Service, in an investigation
of international price differences in 1998, concluded that “..it appears that government
policy is a major factor giving rise to drug price differentials in these countries.”6
The traditions in many nations have resulted in government financed or owned health care
systems, with strict control over the prices charged for most components. Nations such a
Canada, France, Italy, and Australia force pharmaceutical companies to accept the prices
they allow. Because the governments in those nations exercise monopsony power (single
buyers in a market), they can refuse to pay for the value they receive. Moreover, because
they also have the regulatory power to approve new drugs, the firms have little recourse
other than to accept the prices offered. Their only other option would be to withhold their
new products from these markets. Knowing this option exists, the Canadian government
has the authority to effectively confiscate the patent for a new drug and order the firm to
allow another to produce it at a price acceptable to the government if they refuse to accept
the Canadian government’s offer.
The result of this level of interference with free markets is well documented: nations that
exert the highest level of control over prescription drug prices have destroyed their own
research-based pharmaceutical companies. A study by Thomas7 in 1992 found that
countries with the lowest prices, all of which had some form of government-imposed price
controls, also were the least productive in terms of pharmaceutical research. Nations such
as France, Italy, and Canada, which once had thriving research-based pharmaceutical
industries, have traded away research and innovation for price controls. Other nations,
particularly Japan, have also found that by artificially restricting pharmaceutical prices,
they endanger research productivity. In that nation, frequent mandatory price decreases
and short periods of exclusivity have caused that country’s domestic pharmaceutical
industry to adapt by developing few innovative compounds, choosing instead to focus on
minor improvements of currently available medications.8
6
David J. Cantor, Prescription Drug Price Comparisons: The United States, Canada, and Mexico,
Congressional Research Service Report to Congress 98-61E, January 23, 1998
7 Thomas LG, Price Regulation, Industry Structure and Innovation, PharmacoEconomics,1 (suppl. 1) 9-12,
1992
8 Hutin C, The Japanese New Drug Price Policy: A New Dynamic of Price Competition, The Journal of
Research in Pharmaceutical Economics, Vol. 6 no. 2, 1995, 21-34
E.M. Kolassa, Ph.D.
School of Pharmacy
This link between pricing and research productivity can be seen in Chart 1, which
compares price levels with research productivity. In this chart, other nations are compared
with the US, their prices are presented as a percent of the list price for the same products in
the US, and the number of new drugs developed in those countries in the past five years
are also presented as a percentage of US new drug discoveries. Note that nations with
lower prices are responsible for few of the new drugs discovered and developed.
CHART 1
Comparison of Price Levels with Research Productivity
120%
Percent of US Price
100%
80%
60%
40%
20%
0%
US Germany Sweden UK Canada Mexico France
Prices New Drugs
Sources: PhRMA Annual Survey, 1999, (New drug data) o
Canadian Patent Medicine Price Review Board, Sept. 1998, (price data)
CURRENCY FLUCTUATIONS
Even when firms attempt to set equal prices in all nations, the comparison soon changes to
favor non-US customers. The differences in prices between the US and other nations are
exacerbated by the strength of the US economy and our currency. Over the past several
Source: Data from Patent Medicine Price Review Board, Sept. 1998, p.14 and Dorland’s Biomedical, 1998, p. I-109.
months every major news source has reported on the weakness of the Euro, the unified
European currency. Since its establishment in 1999 the Euro has lost roughly one third of
its value relative to the US Dollar. Because many European currencies are fixed against
the Euro, the German Mark, French Franc, and Italian Lira, among others, have lost a third
of their value as well. For pharmaceuticals, this means that a product priced the same in
France, Germany, and the US in January of 1999 would now be approximately 35% more
expensive in the US simply because of the strong Dollar. Price differences such as this are
totally out of the control of pharmaceutical industry. Since 1996, every major currency has
lost value relative to the US Dollar. These devaluations in currency explain much of the
difference in international drug prices. Chart 2 shows that the majority of the price
differences are due to the strong US Dollar.
The differences in prices between the US and Canada are attributable more to their level of
government control than to exchange rates. Canada uses a two level “reference pricing”
system that compares the price submitted for approval by the company with prices charged
for the same product in other countries, as well as prices charged for similar products in

E.M. Kolassa, Ph.D.
School of Pharmacy
Canada. The government organization that makes these comparisons, the Patent
Medicines Price Review Board (PMPRB), of course, determines the groups of “similar”
products that will be used for the comparisons, as well as which prices charged in the
various other countries they will use. By deciding to force a comparison of a newly
developed product with an older product, the Canadian government can refuse to allow a
firm to capture the fair value of the product, and the improvements it offers.
CHART 2:
The Effect of Exchange Rate Changes and Inflation on Pharmaceutical Price
Comparison: Changes Since 1996
$1.20
$1.00
$0.80
$0.60
$0.40
$0.20
$0.00
US UK Canada Germany France Italy Mexico
Exchange Rate Fluctuations Price Levels
The price the Canadians choose to use for their own international comparisons has become
problematic for US firms. By law, the Canadian government will not accept a price that is
higher than the average of prices charges in 7 markets, which include the US. But the US
price now used for comparisons, and government price setting, is the Federal Supply
Schedule (FSS) price, which is a special, legally mandated, discount price made available
only to the US government. By law, the FSS price must be at least 24% lower than the
average price manufacturers charge their regular customers in the US. Calls by many
critics of the pharmaceutical industry to lower US prices to Canadian levels would lead to
a legally-mandated spiral as follows:
1. The FSS price MUST be at least 26% below the average price companies
charge other customers
2. Canadian law requires that the prices they pay cannot be higher than FSS
prices.
3. If prices to all customers in the US were lowered to match those in Canada, it
would trigger an automatic reduction in the FSS price, which would trigger an
automatic reduction in the Canadian price
4. This would bring about calls to lower US prices to Canadian levels and the
process would continue to drive all the prices down.
Although lower prices, for anything, appeal to most buyers, this dramatic a price decrease
would, quite literally, derail pharmaceutical research, reducing greatly the number and
degree of improvements in medicines for many years to come. Industry profitability fuels
the research engine that, in turn, leads to improved patient health and lower health care

E.M. Kolassa, Ph.D.
School of Pharmacy
spending. Repeating the mistakes of Canada would lead inevitably to a reduction in the
improvement of health and health economics, diverting money from the rest of the
economy and into health care.
Americans do, in general, pay higher prices than do the governments of other nations, and
our own nation, for that matter. But the remedy to the perceived inequity is not to force
US prices lower, it is to work to have our trading partners pay appropriate prices for the
value they receive. Americans get fair value for their pharmaceutical dollar, those in other
nations garner greater value because they refuse to pay fairly. Those nations do benefit,
but not at our direct expense. If they paid fair prices those in the US would not be likely to
decline, but the rate of discovery and development of even more new and valuable
medicines would certainly be increased.
Our imperfect market system brings forth valuable new drugs on a regular basis,
contrasting sharply with the controlled markets that rely on drugs developed in the US and
a few other markets to provide them with solutions to their health care problems. To force
our system to become as inefficient and economically inequitable as those in other nations
would be a dangerous precedent.
Pharmaceutical prices reflect their value, which has been documented many times. The
current focus on pharmaceutical prices ignores the real issue – the lack of appropriate
prescription drug insurance coverage for seniors and other underinsured Americans.
Reducing the prices of medicines would not solve the problems of those who truly cannot
afford them, but would put at risk the availability of new medical innovations that would
benefit all, clinically and economically.

E.M. Kolassa, Ph.D.
School of Pharmacy
THE LINK BETWEEN PROFITS AND RESEARCH
“It is not from the benevolence of the butcher, the brewer, or the baker, that we
expect our dinner, but from their regard for their own interest…Nobody but a
beggar chooses to depend chiefly on the benevolence of his fellow citizens.”
Adam Smith
Pharmaceutical companies work to produce innovative new therapies not only because
they are necessary, but also because they are profitable. These innovative products
enhance the profitability of the firms, which allows them to conduct more, and more risky,
research. Although the harshness of Adam Smith’s admonition (above) must be
interpreted in the tone of its time, the basic argument, that the necessities of life are
provided by people for reasons other than pure charity, is fact. The amazing productivity
of the US pharmaceutical industry is made possible because of its profitability.
The point is often made that pharmaceutical firms are among the most profitable
companies operating in the US economy, a point that is often used to support allegations
that prices are too high. The most comprehensive analysis of the relationship between
profitability and R&D investment was conducted by the Office of Technology Assessment
of the US Congress, in 1993.9 The report that came out of this study: “Pharmaceutical
R&D: Costs, Risks, and Rewards” sought to determine the true costs of research, the
appropriateness of the profitability of the industry, and an assessment of the impact of
public policy on these parameters. The major findings of the study were:
• The R&D process took on average 12 years from new drug discovery to market
introduction.
• The full after tax cost of R&D outlays, compounded to their value on the day of
market approval, was roughly $194 million (1990 dollars), although the authors
acknowledged that the costs at that time may have been as high as $359 million, to
bring one new drug to market.
• It is impossible to predict the cost of bringing a new drug to market today from
estimated costs for drugs whose development began more than a decade ago.
• Dollar returns on R&D are volatile over time.
• Economic returns to the pharmaceutical industry as a whole exceeded returns to
corporations in other industries by about 2 to 3 percentage points, after adjusting
for risk. This risk-adjusted difference is sufficient to induce substantial new
investment in the pharmaceutical industry.
• Over 80% of R&D spending by pharmaceutical companies is devoted to
developing new products; the remainder is spent on discovering new uses for
current products.
The link between pharmaceutical company profitability and research and development
cannot be overstated, they are two sides of the same coin. Pharmaceutical companies
9
USSS Congress, Office of Technology Assessment, Pharmaceutical R&D: Costs, Risks, and Rewards,
OTS-H-522 (Washington, DC, US Government Printing Office, February, 1993)
E.M. Kolassa, Ph.D.
School of Pharmacy
spend, on average, roughly 20% of their sales revenue on research and development. This
contrasts sharply with the overall industrial average of less than 2%. This commitment to
research yields benefits – valuable new products and higher than average profits. The
higher investment in research leads to a high level of profit, which provides the firms with
the ability to spend even more on research. This “virtuous cycle” was explored by Maven
Myers, Ph.D., in 1992 in an article “The Interrelationship Between Pharmaceutical R&D
and Profit.”10 In this study, Myers coined two phrases that are very useful in
understanding not only the relationship of R&D to profit but the important
interdependence. Myers termed the amount of research funding above the overall
industrial average “excess R&D,” and referred to the levels of profit above the industrial
average as “R&D profit.” Among Myers’ major findings were:
• The higher-than-average profits of pharmaceutical firms are a result of higher-than-
average R&D investment.
• The average return (for the companies studied) on “excess R&D” was roughly
12%, compounded annually, when profits were calculated based on shareholder
equity.
• The way to maximize research spending (as opposed to maximizing the growth of
spending) is to increase the profitability of the firms.
As mentioned previously, in nations that have, through price controls, reduced the
profitability of their domestic pharmaceutical companies, the result has been a dramatic
reduction in research productivity and innovation, leading to the destruction, or near
destruction, of their own pharmaceutical industry. Charts 3 and 4, below, provide vivid
evidence of this. These charts show the change that has occurred in the past decade as the
US has overtaken Europe as the dominant site of pharmaceutical R&D, and that US-based
pharmaceuticals firms have overtaken European firms in research productivity.
CHART 3
Comparison of US and European R&D Expenditures
18,887
20,000
R&D Spending, in
15,000
15,000
10,787
Euros
9,078
10,000 7,871
5,342
5,000
0
1990 1995 1999
Europe US
Source: EFPIA member associations, PhRMA, & Pharma Pricing and Reimbursement Review
10
Myers MJ, The Interrelationship Between Pharmaceutical R&D and Profit, Journal of Research in
Pharmaceutical Economics, Vol. 4(2), 1992.
E.M. Kolassa, Ph.D.
School of Pharmacy
As can be seen, the decade of the 1990s began with Europe accounting for nearly 50%
more in R&D spending than the US, while the decade ending with the US accounting for
more than 25% more research investment than in Europe. These figures include R&D
spending by US-based firms in Europe, under the European category, and European-based
firm’s spending in the US. Note also that between 1995 and 1999, R&D spending in the
US doubled, while the growth rate in Europe was less than 50% during that same period.
Obviously, the business and clinical environment in the US has become more appealing
that has the European environment, which is becoming more restrictive, and less
profitable.
In terms of research productivity, that too now favors the US, as Chart 4 demonstrates.
The number of US-sourced new medicines has increased by roughly 50% between the first
three years of the 1990s and the final three, while those from European firms have
declined.
CHART 4
The Origin of New Medicines and the Nationality of the Parent Company
60 52 54 50
47
33 36
40
20
0
1991-93 1994-96 1997-99
Europe US
Source: Pharma Pricing and Reimbursement Review, vol. 5, December 2000
Profits reward and encourage risk, and the productivity of the US pharmaceutical industry
is a testament to that relationship. If pharmaceutical firms earned profit margins that
were equal to the overall industrial average, as some have advocated, their degree of risk
taking would approach the average as well. Few industries are populated by firms that
routinely risk hundreds of millions of dollars knowing that the odds of any one project ever
reaching the market are less than 1 in 5,000, and that only one in three that ever reach the
market will earn back their investment. If prices were cut as dramatically as many call
for, the number of products that showed positive returns on their investment would go
down as well, reducing the funding available for research and development as well as the
incentive to take high risks. The result would be what we have seen throughout Europe,
Canada, and in Japan, a pharmaceutical industry that takes fewer risks, discovers fewer
innovative medicines, and contributes less to society as a result.

E.M. Kolassa, Ph.D.
School of Pharmacy
PATENTS AND “MONOPOLY POWER”
“…the only incentive to produce anything is the possession of temporary monopoly
power - because without that power the price will be bid down to marginal cost and
the high initial fixed costs cannot be recouped. So the constant pursuit of that
monopoly power becomes the central driving thrust of the new economy.”11
Lawrence Summers, US Secretary of the Treasury, July 2000
Critics of the research-based pharmaceutical industry often point to the patents granted
new drugs as a license for the companies to practice monopoly power. But without such
protection there would be little incentive to take the financial risks inherent in
pharmaceutical research and development. Without a high probability of recouping the
costs of research and earning a substantial profit, those who develop new technologies
would use their talents elsewhere.
THE PURPOSE OF A PATENT

Developed nations grant patents to the discoverers of new techniques, ideas, and
inventions as a means of stimulating innovation, to advance the economic and intellectual
wellbeing of the nation and its citizens. Nations with weak or unenforced patent laws, and
those that fail to assure adequate financial gains to patents holders, suffer from low levels
of innovation and poor economic performance. The principle intent of patents is to
encourage innovation so the nation can enjoy its fruits. When forces, including regulatory
delays, infringe upon the period of exclusivity granted by patents, the result is to weaken
the incentive for innovation and risk taking.
Contrary to popular belief, it now takes the FDA longer to

approve a new drug than it did 10 years ago.
The patent for a new medicine begins when the drug is discovered, and the longer the time
between discovery and approval for marketing, the less money the product will earn.
Many claim that the FDA is now approving new drugs much more quickly than in previous
years – but that statement is misleading. Although the FDA has shortened the period
between the submission of the New Drug Application (NDA) and final marketing
approval, the time between the submission of the research plan (IND) and the NDA, a
period also substantially under the control of FDA, has increased by an amount greater
than the approval time has shortened. The net result is that the total time for the approval
of new drug has increased by roughly 5 months while the FDA, and critics of the
pharmaceutical industry, claim the opposite. Chart 5 provides the data that demonstrates
the actual lengthening of time for FDA approval for new drugs over the past 10 years.
11
Lawrence Summers, "The New Wealth of Nations" Remarks by Treasury Secretary Lawrence H. Summers
Hambrecht & Quist Technology Conference San Francisco, CA,
http://www.treas.gov/press/releases/ps617.htm
E.M. Kolassa, Ph.D.
School of Pharmacy
CHART 5
Change in the Time Between First Clinical Testing and FDA Approval of New Drugs
TOTAL FDA Approval Time

(3 year rolling average)
Years
10.0
8.0
6.0
4.0
2.0
0.0
989 990 991 992 993 994 995

1 1 1 1 1 1 1
Clinical Testing NDA Approval

Source: Congressional Budget Office
Longer useful commercial lives for products lead to higher levels of innovation. The
Canadian system was changed several years ago to require the licensing of generic rights
prior to patent expiration. That, coupled with the low prices forced by the government,
virtually eliminated Canada’s domestic research-based pharmaceutical industry. 12 In the
wake of these changes, the Canadian government voiced concern over their growing trade
deficit for pharmaceuticals. To address these concerns the consulting firm of Palmer
D’Angelo was contracted to determine the cause of the trade deficit and offer potential
solutions. The ultimate report “Canada’s Balance of Trade in Pharmaceuticals,” was
published in February of 1997. The main finding was that Canada’s trade deficit in
pharmaceutical was directly linked to their patent laws, the deficit climbing when the laws
were weakened and slowing when they were strengthened. The report recommended that
the Canadian government further strengthen patent laws to bring them in line with those of
their major trading partners, to promote the growth of their own domestic pharmaceutical
industry.
In Japan, frequent mandatory price decreases and short periods of exclusivity have caused
that country’s domestic pharmaceutical industry to adapt by developing few innovative
12 Thomas LG, Price Regulation, Industry Structure and Innovation, PharmacoEconomics,1 (suppl. 1) 9-12,
1992
E.M. Kolassa, Ph.D.
School of Pharmacy
compounds, choosing instead to focus on minor improvements of currently available
medications.13 Long and viable commercial life is necessary for innovation to take place.
Once a drug’s patent expires, other firms have the right to produce and sell generic copies.
At that point most research-based firms will eliminate both the research and the promotion
done for the product. New discoveries about currently marketed products are made
frequently, and companies spend a large amount conducting research to gain approval for
new uses of a product, but only if they can be reasonably assured that the investment in
that research will be rewarded. Should there be insufficient patent life remaining, the firm
will not undertake the new research. Similarly, once the period of exclusivity has expired,
firms will cease promoting the product to physicians. The cessation of promotion usually
leads to a reduction in the use of the compound by clinicians. The relationship between
promotion and product use will be discussed in the following section.
The patent system in the US, and the exclusivity granted to innovative pharmaceutical
compounds, is essential to provide the returns on research and development investments.
The nation’s health, both physical and economic, is enriched and improved because of
patent exclusivity and the financial rewards it provides.
13 Hutin C, The Japanese New Drug Price Policy: A New Dynamic of Price Competition, The Journal of
Research in Pharmaceutical Economics, Vol. 6 no. 2, 1995, 21-34
E.M. Kolassa, Ph.D.
School of Pharmacy
PHARMACEUTICAL PROMOTION
“Any solution to a problem changes the problem”
R.W. Johnson
As noted throughout this document, the economic value of pharmaceuticals, realized
through the reductions in the use of other, more costly, medical interventions, is
substantial. The economic savings, and value, of pharmaceuticals extends beyond the
health care budget as well. For example, in 1997, Berndt demonstrated that claims
processors who received drug treatment for either depression, anxiety, migraine, or
hypertension were able to remain at work longer, and in the case of depression, migraine
and hypertension, be more productive while on the job.14 Without appropriate and
significant pharmaceutical marketing activities none of the savings could be realized. The
purpose, and result, of pharmaceutical promotion is to enhance and accelerate the diffusion
of new medications into the health care system. The vast majority of pharmaceutical
marketing activities center on the provision of information to physicians and other health
care professionals. Without significant promotion, most new medicines, or new uses for
medicines, would be unknown to many, of not the majority of, medical practitioners.
The profession of medicine is complex and very difficult, with increasing administrative as
well as professional demands on physicians. A medical practitioner, as would any other
individual, will seek to simplify, or provide order to, such situations.15 Fennellt and
Warnecke, in a detailed analysis of the diffusion of medical innovation noted that “doctors
are very conservative in the area of treatment innovation;” 16 and assert that physicians are
relatively slow to adopt new approaches to therapy. Avorn notes that “..no mechanisms
exist that require health care providers to remain at all current with the developments in
pharmacology that have occurred since the completion of their training.”17 Because
practitioners, in general, do not readily seek out new therapies, and no mechanism exists to
direct them to accumulate new and developing information on pharmaceuticals, the
marketing activities of firms is the only mechanism whereby the diffusion of information
concerning new therapies can be assured. The complexities of medical practice combined
with the inherent conservative nature of the practitioner and the lack of requirements to
acquire new knowledge without some other stimulus would lead most physicians and other
providers to focus on their immediate needs, seeking new information only when faced
with intractable problems and ignoring most lesser improvements.
Even when motivated to seek out information on new medicines on their own, most
medical practitioners would be faced with an insurmountable task. Schwartzman estimated
14 Berndt E, “Illness and Productivity: Objective Workplace Evidence,” MIT Working Paper, May 1997
15 Payne JW, Bettman JR, Johnson EJ, The Adaptive Decision Maker Cambridge University Press,
Cambridge MA, 1993.
16 Fennell ML, Warnecke RB, The Diffusion of Medical Innovation: An Applied Network Analysis, Plenum
Press, New York, 1988.
17 Avorn J, Harvey K, Soumerai SB, Herxheimer A, Plumridge R, Bardelay G, Information and Education
as Determinants of Antibiotic Use: Report of Task Force 5. Research in Infectious Disease, 1987;9(3):
S286-96
E.M. Kolassa, Ph.D.
School of Pharmacy
that in any one year there are more than 1,700 articles published on each of the leading 25
medicines in over 325 professional journals.18 No individual could be expected to stay
current with the literature and update their knowledge of scientific advances and new
information regarding the hundreds of medicines that are in common use. Pharmaceutical
marketing helps to provide health care professionals with the most current information on
new medicines, new uses for older medicines, and newly discovered problems with or
cautions concerning medicines. Because, as noted earlier, newer pharmaceutical products
have been shown to lower costs and result in improvements to patient health, when
compared with older medicines, activities that speed up the adoption of these new
medicines have the effect of saving even more and improving the lives of more people
The marketing of pharmaceuticals, unlike many other products, is strictly regulated and
subject to oversight. Materials presented must exhibit “fair balance” and complete
information, and promotional programs aimed at encouraging the use of medicines for
specific diseases must be consistent with the approved labeling of the product – firms are
not free to promote their medicines simply as they see fit, but must comply with FDA
regulations. Moreover, because pharmaceutical markets are quite competitive19,20, the
promotional message of one firm must compete with, and respond to, the messages of
firms providing similar products. Finally, contrary to the unspoken but implied view of
many critics, physicians do not simply absorb promotional messages and comply with
sales representatives suggestions, research demonstrates that physicians require the
validation of new products by trusted experts before they themselves adopt a new
medicine.21 The combination of regulatory oversight, competition in the marketplace, and
the standards physicians rely upon for adopting new products result in a system whereby
innovation is diffused quickly and safely into the health care system.
Those who criticize pharmaceutical promotion and suggest it be curtailed, it can be

assumed, view it as both wasteful and coercive. If promotional activities did not provide a
return on their costs, however, companies would not engage in them. The argument that
promotional spending drives prices higher, as a means of financing the spending, has never
been demonstrated in objective studies. Many have, in fact, concluded that products that
are promoted heavily have lower prices than those not promoted. As to the view of
pharmaceutical promotional activities as coercive, to hold this opinion requires the
simultaneous view that physicians, who are among the most highly educated and skeptical
members of our society, are incapable of resisting (or even evaluating) the messages of the
pharmaceutical sales representative.
The marketers of prescription medications are spending more time, effort, and money in
reaching consumers with their promotional activities. Together with this new emphasis on
18
Schwartzman D, Innovation in the Pharmaceutical Industry, Baltimore, Johns Hopkins University Press, 1976.
19
Kolassa EM, Growing Competition in the Pharmaceutical Industry: A Response to the PRIME Institute
Report - an academic critique of the PRIME Institute Report, "Competition and Pricing Issues in the
Pharmaceutical Market", University of Mississippi Research Institute of Pharmaceutical Sciences, 1995
20
The Boston Consulting Group, The Changing Environment for US Pharmaceutical, New York, 1993
21
Davies DA, Foz RD, editors, The Physician as Learner: Linking Research to Practice, American Medical
Association, Chicago IL, 1994. Page 38
E.M. Kolassa, Ph.D.
School of Pharmacy
consumer promotion has come new criticisms of the industry and its activities. Criticism
has emerged from sources as varied as the American Medical Association, members of
Congress, the lay press, and so-called “public-interest” groups. These critics have tended
to focus on the perception of promotion as manipulative and solely a profit-seeking
endeavor, without considering the potential social good of informing consumers about
medications and the disorders they treat, as well as other potential societal benefits of
informed consumers.
A recent article on the value of health care by Buck and colleagues argues strongly that
informed consumers are the foundation of a well functioning market economy. They state:
“The functioning of a market economy requires that citizens be reasonably well informed
about the goods that they wish to consume.”22 Stigler, in a classic treatise on the value of
information, asserted “Advertising is, among other things, a method of providing potential
buyers with knowledge of the identity of sellers. It is clearly an immensely powerful
instrument for the elimination of ignorance.”23
Many of the same people who criticize direct to consumer advertising argue for the so-
called “patient’s bill of rights.” But the patient’s right to be knowledgeable about his or
her disease and available treatments is a fundamental requirement of an informed and
responsible patient. In 1962, President John F. Kennedy proclaimed a “Consumer’s Bill of
Rights,” arguing that every consumer had:
• The right to be informed
• The right to choose
• The right to be heard
• The right to safety
One of the ways in which a patient, or consumer, can become informed, form questions,
and make rational choices begins with direct-to-consumer (DTC) advertising. By letting
consumers know about choices, directing them to information sources, and providing them
with the background to ask questions about their care, DTC helps fulfill three of the rights
laid out by President Kennedy.
The promotion of pharmaceutical is an important element of our health care system.

Without adequate promotional activities, society would be deprived of the benefits of most
new drugs for several years. The cost-effectiveness of pharmaceuticals, which reduce the
need for costlier medical interventions, is enhanced when promotion and other marketing
activities speed up the rate of their adoption into the medical care system.
22
Buck D, Eastwood A, Smith PC, Can We Measure the Social Importance of Health Care? International
Journal of Technology Assessment in Health Care, 15:1 (1999) 89-107
23
Stigler, G. T., the Economics of Information, Journal of Political Economics, Vol. 69, pp. 213-225, 1961
E.M. Kolassa, Ph.D.
School of Pharmacy
SPECIFIC RESPONSES TO FLAWED ANALYSES
“In this age, which believes that there is a shortcut to everything, the greatest
lesson to be learned is that the most difficult way is, in the long run, the easiest.”
Henry Miller
Many of the recent calls for pharmaceutical price reductions are based on flawed,
simplistic analyses and assumptions. Through the presentation of skewed data, and using
unsupported assumptions and simplistic calculations, advocates of simple price reductions
for pharmaceuticals have built their cases. Such reports make for great news stories, for
they are designed with soundbites in mind. Some have claimed that widespread and
massive price reductions would have little impact on pharmaceutical company profitability
and research productivity, others have not addressed these issues but assumed that
implementing selective regional price cuts are simply a matter of ordering the cuts through
government actions. Thomas Jefferson said, “Good men with the same facts are prone to
disagree.” This may be true, but when equipped with different facts, or assumptions, the
parties are guaranteed to disagree. In keeping with the intent of this report, to provide fair
balance, it is essential to add some new, or overlooked, facts to the debate over
pharmaceutical prices. The financial and logistical assumptions (or lack thereof) of recent
reports and initiatives are addressed in this section.
THE IMPACT OF PRICE CUTS ON THE FINANCIAL AND RESARCH

PERFORMANCE OF THE PHARMACEUTICAL INDUSTRY
A recent report that calls for price cuts for states in the Northeast, by Dr. Alan Sager and
Deborah Socolar of Boston University, is among the most dangerous and naïve, because it
is presented as scholarly work when, in fact, it is not. Although filled with charts and
footnotes, the report itself is based on naïve assumptions, flawed and simplistic analyses,
and the omission of important facts. These are, admittedly, harsh words, but the
consequences of allowing documents such as Dr. Sager’s to set a legislative agenda that
could result in the loss of thousands of jobs and unnecessarily delay the discovery many
new medicines for years are too great to allow that work to go unchallenged. Many of the
assertions and statements made in that report are ripe for rebuttal, and can easily be
exposed as naïve and lacking factual support. The most dangerous, and erroneous,
however, is the simple premise that massive price cuts would have no undue effect on the
financial performance and viability of the pharmaceutical industry. If those seeking to
impose severe price cuts on the pharmaceutical industry did so under the false assumption
that the pharmaceutical industry, and research productivity, would not be harmed, they
would be doing themselves and society a great disservice.
Dr. Sager, Professor of Health Services at Boston University published, in August 2000, a
report entitled: “Cutting Prescription Drug Spending by Paying Federal Supply Schedule
Prices.” In this document, it is claimed that the cutting of prescription prices by over 40%
would not result in any decline in pharmaceutical industry sales or earnings, and thus
would have no negative effect on pharmaceutical research and development. Citing
disparate studies, articles, personal conversation, and his own letters to the editor of the

E.M. Kolassa, Ph.D.
School of Pharmacy
Boston Globe as his sources, Dr. Sager makes a series of sweeping assertions without
performing the necessary calculations to support his conclusions.
In the summary of that report, Dr. Sager claims that “..the volume of prescriptions filled
would rise as prices fell because more people would be able to afford to fill their
prescriptions, offsetting much of the revenue lost at first.” In the body of the report he
goes on to suggest that the added sales volume may even result in an increase in profits.
To support this argument Dr. Sager cites 2 British studies and one US study that found the
elasticity of demand for prescription drugs to be between –0.10 and –0.64, which means a
price reduction of 10% would result in an increase in unit sales of between 1% and 6.4%,
which would fall far short of generating enough additional sales to offset such a price cut.
He then cites a Merrill Lynch report to suggests that elasticity may be as great as –1.125,
which means a 10% price decrease would result in an 11.25% increase in unit sales, and
rests on this assumption to build his case. The assumption by Merrill Lynch, and adopted
by Dr. Sager, is that the actual elasticity of the market is nearly twice the level ever
measured in an actual study.
Sager also argues that manufacturing costs for pharmaceuticals are equal to only 5% of the
selling price, but the only cost figure for which he provides documentation is one of 34%,
which he dismisses as being inflated by fixed costs.
Dr. Sager’s calculations require the assumption that those currently

lacking insurance coverage for prescription medicines would spend twice
as many dollars on them if the prices were lowered.
These 2 points, the assumption of elasticity of –1.125 and a cost of goods of only 5%, are
the basis for Sager’s conclusion that a government mandated price reduction of over 40%
would do no harm to either profits or R&D. But approximately 85% of prescriptions are
paid for through some form of third party insurance, and a price reduction would be
unlikely to have any appreciable effect on the use of prescriptions for that portion of the
market, because consumers would not be the direct beneficiaries of the lower prices and
thus would not be likely to increase their consumption of medicines. It would require the
currently uninsured and underinsured population to quadruple their current intake of
medicines for the price cut and resulting increase in use to generate the 45% increase
assumed by Sager (40% x 1.125). This also would require those same patients to more
than double their current cash outlays for pharmaceuticals, a very unlikely scenario.
As far-fetched as the preceding requirements are, let us assume that such a unit sales
increase would result from a 40% price cut. Using the 5% cost of goods assumption
(which will be debunked shortly) this means that 95% of current sales revenue represents
gross profit (which does not account for other operating expenses, only manufacturing the
product), and a 40% price cut would reduce per unit gross profit to the equivalent of 55%
of current revenue (95% - 40%). To earn the same amount of profit at the new, lower,
prices and margins, unit sales would need to increase by over 70% (95% ÷ 55%) for the
new price to be equally profitable. The 45% unit increase, even if it were attainable, would

E.M. Kolassa, Ph.D.
School of Pharmacy
result in a reduction in gross profit of over 20%, an amount nearly equal to the research
and development spending of pharmaceutical companies, not the equivalence Dr. Sager
assumes.
But the assumption that the cost of manufacturing pharmaceutical is only 5% of the selling
price is insupportable. Dr. Sager cites a figure of 35% in his report, but dismisses most of
it as allocations of fixed costs. Although the inclusion of fixed costs is a valid concern,
one must realize that, unless all pharmaceutical manufacturing facilities are operating at
less than 66% of their capacity, an increase in unit sales (and production) of 45% would
require the building of new plants and the expansion of other capabilities, which would
require the firms to incur incremental fixed costs.
Even discounting the 34% cost of goods figure to 25% and thus allowing for new fixed
costs, at this level of cost of goods the result of a 40% price cut and a 45% unit increase
would be devastating to US based pharmaceutical firms. In such a case, gross profit would
be equal to 75% of current selling prices, and a 40% price reduction would reduce that
figure to 35% of current prices. With this cost estimate it would require that unit sales
more than double (215% of current sales or 75% ÷ 35%) to generate a similar level of
gross profit. The 45% increase assumed by Dr. Sager would result in a reduction of gross
profits of over 33%. Under such a situation, jobs would be cut, research would be
suspended, and many potential products would not find their way to the market soon.
Dr. Sager’s assertions do not hold up under scrutiny, and his conclusions and
recommendations, in the report of August 5th 2000, should be disregarded.
REGIONAL PRICE CUTS

Several States in the Northeast have recently called for legislative or other regulatory
means to force pharmaceutical companies to offer reduced prices to their citizens. The
calls range from demanding prices equal to those offered in the Federal Supply Schedule to
attempts to enroll all of their uninsured citizens into a program that would provide them
with Medicaid-type discounts. Although a Federal court has determined that the way in
which the State of Maine first attempted to lower prices was not consistent with the law,
Maine and other States will, in all likelihood, continue in their efforts to lower the prices of
prescription drugs.
The problems with regional efforts begin with the logistics of any of the “remedies”
proposed so far. Although legislators may desire to lower prices for all of the voters, the
implementation of any such plan would be impeded by the lack of infrastructure.
These plans have all called for the selective discounting of prices to certain citizens,
particularly those lacking prescription drug insurance coverage. But reducing prices to
these individuals requires more than simply ordering it. Every current discount system has
some infrastructural support, either governmental or private, and none of these systems can
be used for the price cut schemes envisioned by the activists in the North East.

E.M. Kolassa, Ph.D.
School of Pharmacy
Discounts on prescription medications are provided to several different government
programs. One or more laws mandate the minimum discount for each of these. The
Omnibus Budget Reconciliation Act of 1990 (OBBRA ’90) required pharmaceutical
manufacturers to provide Medicaid, the joint State/Federal program for the indigent, with a
minimum discount of roughly 15% off the average price or equal to the lowest price
charged to any non-government customer, whichever is lower. Companies have no choice
in whether to offer this discount - it is mandatory. The Federal Supply Schedule, as
discussed earlier, also has mandatory minimum discount levels (approximately 24%),
required by the Veteran’s Health Act of 1992.
Medicaid patients are enrolled in the program, which the State government administers.
The State reimburses retail pharmacies for their cost, plus a fee, and submits
documentation to each pharmaceutical company to receive its discounts via a rebate
mechanism. In this way, only those products that were legitimately sold to Medicaid
patients will be subject to the rebate.
The Federal Supply Schedule (FSS) reflects prices paid by the federal government for
products that are purchased for use within the federal health care system, particularly
Department of Veteran’s Affairs hospitals. In this case, the government purchases the
products directly from the companies.
The various calls to offer either Medicaid or FSS prices to those outside of the systems
ignore the need to have patients registered within the system and for the State, in the case
of Medicaid, to reimburse pharmacies and in turn be reimbursed, through the rebates. For
uninsured citizens of Vermont or Maine to have access to these prices would require that
they be registered within the Medicaid program and that the State pay retail pharmacists
the full price for the medications, and then seek an additional rebates for those non-
Medicaid patients – from the companies and, presumably, the patients themselves because
they would be responsible for the remainder of the cost. This would necessitate the
appropriation of sufficient funds to cover the drug and resources needed to administer the
program.
The only other way in which such a mandated regional price cut could be implemented
would be to require retail pharmacists to sell prescriptions to the uninsured at prices far
below their own cost, then seek reimbursement from the individual pharmaceutical
companies, who would require proof that the prescription was actually dispensed to an
uninsured patient. The retail pharmacist would bear a tremendous financial and
administrative burden under such a system; maintaining records, requesting rebates, and
financing, through their own cash flow, the lag time between the submission of rebate
forms and the receipt of the rebates. Most independent pharmacists could not handle this
liability, and would likely choose not to participate, losing customers, and business
viability, in the process. Those that chose to participate would find the costs to be so
prohibitive that they too would find themselves veering toward bankruptcy. Any selective

E.M. Kolassa, Ph.D.
School of Pharmacy
discount system that does not provide the infrastructure and administrative assistance to
support such a scheme would inevitably bankrupt independent pharmacies.
Selective regional discounts are unworkable without significant infrastructure to handle the
administration of such a system, but the problem is even greater than this.
The truly poor, who cannot afford their needed medicines, would find little relief from
mandated price cuts. Many of those unable to afford $300 or more per month would find
little relief if the cost were reduced to $200, because the problem is not the prices charged
but the lack of coverage. As mentioned earlier, for the Medicare population the false
economy of the government system, which pays for hospitalizations but not the medicines
to prevent them, is sorely outdated and in need of reform. Until that system is repaired, or
until the research-based pharmaceutical industry is forced out of business and provides
their products free, there will be calls for lower prices for drugs because they are the only
component of their health care that otherwise insured patients must pay for.
In the meantime there are several options to assure people do not go without necessary
medicines. First, the White House has observed that roughly 60% of Medicare patients
who are eligible for Medicaid, which provides outpatient medicines, are not enrolled.24 An
outreach program to enroll these citizens, who account for 12% of Medicare beneficiaries,
would reduce greatly the burden that lack of comprehensive prescription coverage places
on these people. Although this would increase the rolls and expenditures of Medicaid
programs, the coverage of prescription drugs for these citizens, as demonstrated through
the studies cited throughout this document, would likely decrease the funds expended on
these same people through the Medicare program.
To provide perspective in this case, consider the testimony of Michael Hash, Deputy
Administrator of the Health Care Financing Administration (HCFA) who, in speaking
before the House Commerce Committee in September 1999, presented a case of a
Medicare beneficiary from New York City who couldn’t afford the $30 monthly cost for
his antihypertensive medication and stopped taking it. He then suffered a stroke that left
him without speech or the use of his right arm, and cost the Medicare program $10,000 in
hospital bills. For the many cases such as this price cuts, no matter how deep, will not
address the fundamental problem of the lack of coverage of prescription drugs under
Medicare, and the costs to the system brought about by that omission.
Another option for patients lacking insurance coverage or sufficient resources for
necessary prescription medications is the use of the many Patient Assistance Programs
offered by most research-based pharmaceutical companies. A recent General Accounting
Office (GAO) study of these programs found that patients who truly cannot afford their
medicines can receive them free of charge from the manufacturers. Even patients with
insurance who have exhausted their drug coverage for the year can qualify for this
assistance in over 80% of the programs. These programs, offered by nearly all major
24
National Economic Council/Domestic Policy Council, Disturbing Truths and Dangerous Trends: The Facts
About Medicare Beneficiaries and Prescription Drug Coverage, July 22, 1999
E.M. Kolassa, Ph.D.
School of Pharmacy
companies, were put in place voluntarily by the firms to assure that people lacking other
options will not be denied access to needed medications. The use of Patient Assistance
Programs has been growing by over 30% annually, in terms of the number of patients
served, and the GAO reports that companies provided over $500 million worth of
medication free of charge through these programs in 1998. A complete listing and
description of these programs can be found at: http://www.phrma.org/searchcures/dpdpap/
Such programs would not be expected of any other industry, even though many people
cannot afford to pay for their basic utilities or other necessities of life any more than they
can pay for their prescriptions. This safety net is needed only in the United States, where a
significant proportion of the population does not have adequate insurance coverage for the
most cost effective medical care resource -prescription drugs.
The many proposals to reduce the prices of pharmaceuticals in the US are based on naïve
and simplistic assumptions and, if implemented, would endanger the current productivity
and future viability of the research-based pharmaceutical industry in the United States.
Several proposals would put other sectors, such as retail pharmacy, at risk as well. Unlike
any other industry, the makers of pharmaceuticals have made efforts to assure that
patients will not be denied access to their products because of their financial situations.
The failure of insurers, and the federal government, to include the single most cost
effective element of medical care, pharmaceuticals, in basic medical care coverage plans
points to their narrow and short-sighted approaches to health care and their failure to stay
current with medical technology.

E.M. Kolassa, Ph.D.
School of Pharmacy

In Search of Fair Balance

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IN SEARCH OF FAIR BALANCE:

Prejudiced Attacks on the Research Based Pharmaceutical

E.M. Kolassa, Ph.D.

The contributions of the US research-based pharmaceutical industry to our nation’s health

• The promotion of pharmaceutical is an important element of our health care system.

In Search of Fair Balance 5

A recent study at Columbia University has found that a $1 expenditure on

In Search of Fair Balance 7

In Search of Fair Balance 8

Criticism of the pharmaceutical industry focuses on a few key issues:

In Search of Fair Balance 9

Prices New Drugs

Sources: PhRMA Annual Survey, 1999, (New drug data) o

In Search of Fair Balance 12

Exchange Rate Fluctuations Price Levels

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THE PURPOSE OF A PATENT

Contrary to popular belief, it now takes the FDA longer to

TOTAL FDA Approval Time

989 990 991 992 993 994 995

Clinical Testing NDA Approval

Those who criticize pharmaceutical promotion and suggest it be curtailed, it can be

The promotion of pharmaceutical is an important element of our health care system.

THE IMPACT OF PRICE CUTS ON THE FINANCIAL AND RESARCH

In Search of Fair Balance 24

Dr. Sager’s calculations require the assumption that those currently

In Search of Fair Balance 25

REGIONAL PRICE CUTS

In Search of Fair Balance 26

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In Search of Fair Balance 29

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