An open letter to Congressman Waxman on the subject of drug pricing

Dear Congressman Waxman (and anyone else concerned about the price of Sovaldi™),

I write to you in response to your letter to John Martin, Chief Excutive at Gilead, on March 20th this year.

With spiraling healthcare costs and government debt at an all-time high, taking aim at high-priced drugs seems certain to win public support, and on the face of it may seem to serve the public, whose mandate you represent, very well.  But  there are considerable dangers in attempting to influence drug pricing in this way.  It could conceivably cost millions of lives.

To understand the issue, you have to go back to the established institutions that allow Gilead to charge such a high premium over the cost of manufacture for Solvadi.  Principal among those is the concept of the patent.   Arguably, issuing patent protection for new inventions is the single most powerful tool stimulate innovation any government has ever devised.  And attacking drug pricing now threatens that principle.

The concept of a patent is simple: it is a bargain, a contract, between the state (representing the public) and the inventor.  In return for fully disclosing the details of your invention, you will be given a monopoly to make and sell that invention for a limited period (usually around twenty years).  Thereafter, for the rest of time, anyone will be able to make use of your invention in their products without further obligation to the inventor.

By creating a temporary monopoly, the patent allows the inventor to secure an abnormally high price (and hence margin) on his product which (in theory) pays back the risk capital that had to be invested to create the invention in the first place.  This pay-back needs to be substantial because many inventions cost a lot to create but often turn out as failures.  The successes have to bear the cost not only of their own creation but also that of the numerous failures that littered the route to success.

Monopolies (even temporary ones) are dangerous beasts. In the absence of competition, the supplier can set any price he chooses without fearing competition from a lower priced supplier of the same goods.  The price could go very high indeed, as it has with Sovaldi™ priced at $1,000 a pill, translating into $84,000 for a 12 week course required to cure patients with Hepatitis C.

Usually, though, prices don’t climb to such astronomical heights even in monopoly conditions.  Two factors act to limit price: firstly, and most importantly, the monopoly only applies to strict copies.  There are usually other options on the market that are nearly as good as the new invention, and if the price of the newcomer rises too high people will opt to buy the cheaper, slightly inferior, alternative.  The premium available to the monopoly-holder, therefore, is dependent on the degree of superiority he has over the next-best alternative.  Secondly, there is a limit to what anyone would pay for the particular benefit being delivered, even if it is the only alternative available.

The last point is less relevant for drugs.  History tells us that people will pay almost anything for even the hope of extending life.  And when states or insurers baulk at the cost of buying these treatments for us, they come under severe pressure from public opinion.

The danger, then, is that governments and insurers try to deflect that pressure off themselves and on to the drug companies.

Doing so risks breaking the central contract of the patent.  The monopoly holder should be free to set their own price, and the buyers (including the public) then have only two choices: buy it at the set price if they believe the superiority of the product justifies the price set by the supplier; or vote with their wallets and refuse to pay (giving up access to the benefit).  The third (and currently seemingly the most popular) option – to try and force the price down so as to gain access to the benefits of the invention without paying the price set by the monopoly holder – is manifestly a breach of the patent contract.

Breaking contracts and undermining essential business institutions are actions we have come to associate with third world governments – indeed it has often been argued that economic prosperity is built on the unshakable adherence to the concept of property.  Dictators in military uniforms stealing from their citizens rightly provokes condemnation from the US government.  But breaking the patent contract is as damaging, if considerably less visible.

The general public do not understand (and do not need to understand) how innovation is paid for.  But governments should.  And they should not disturb these key institutions in the name of political support, or the misguided belief that they are serving the public interest.  Your letter suggests that you are coming dangerously close to such a position.

Worst of all, not only are these actions dangerous because they undermine the principles of paying for innovation, but they are also largely unnecessary.  Gilead will soon face competition despite their monopoly position on Sovaldi™ – other innovators, such as AbbVie and Merck are coming to market with alternative treatments for HCV that may be as good as Sovaldi™.  The monopoly position for Gilead will be diluted long before the composition of matter patents that underpin their premium pricing expire.  We have seen this before – when Incivek™ from Vertex (an earlier generation HCV treatment) burst onto the market, only to be displaced very quickly by, most recently, Sovaldi™.  This is a very different situation from, for example, Microsoft Windows, where “technological lock-in” makes the monopoly very hard to shift once established.

Even if the newcomers prove not to be quite as good as Solvadi™, by chipping away at its magnitude of superiority they will surely threaten its current price premium nonetheless.  A slightly less effective drug that is considerably cheaper still represents an attractive option.

And there are other, more important, targets for your ire.  There is the issue of biosimilars.  Biological drugs have delivered real clinical benefit over the last decade, but the current regulations ensure that the innovation premium payable on these drugs is not as temporary as the patent monopoly.  The ability to charge high prices, and earn eye-watering margins, persists for far longer because of the challenging regulatory demands for competitors.

Then there is the “unearned premium” (as DrugBaron previously called it) for proprietary drugs that are little or no better than generic alternatives.  And there is no better example than the current travesty of billion-dollar sales of Crestor™ when generic atorvastatin is available at a tenth of the price.  There are many other examples of drugs whose sales owe more to marketing than clinical benefit.

But Sovaldi™ is not one of them.  Thanks to the innovation of the scientists behind its discovery and development, within a generation the scourge that is HCV will be consigned to the history books, like smallpox and polio.   This is a drug that really works – 95% cure rates are a paragon for the industry as it searches for cures for other currently incurable conditions, such as various cancers, heart disease, diabetes and Alzheimer’s Disease.  Paying a temporary premium, as the state contracted to do to incentivize the innovation in the first place, is quite simply the right thing to do.

If politicians, such as yourself, marshal public anger and direct it against the innovators to force a price cut, they are no better than masked militia enraging ethnic clashes and seizing property with machetes or machine guns.  And the long term consequences will be equally dire – innovators will cease to trust the patent contract to pay back their risk capital and the pace of innovation will slow dramatically.  That would be a black day for governments (particularly in the west, who increasingly rely on high technology sectors for tax revenues), for taxpayers and, worst of all, for patients – the very people you are trying to ‘protect’ by calling for price cuts.

Perhaps, having read this letter, you will reconsider the appropriateness of your intervention on drug pricing?

With best wishes,

DrugBaron