The pharmaceutical industry is awash in pricing scandals. New reports of abuses appear so often that anything we write here is likely to seem like ancient history by the time the book appears. When we composed the first draft of this chapter, no one had heard of Martin Shkreli, the now-infamous “pharma-bro.” Shkreli’s company, Turing Pharmaceuticals, gouged AIDS patients by raising the price of a drug called Daraprim from $13.50 to $750 per pill. Shkreli, who briefly became the most hated man in America, reveled in the attention and enjoyed trolling his critics. When he held a charity raffle in which the holder of the winning ticket got to punch him in the face, he boasted of having received an offer of $78,000 for the privilege.1 Shkreli reportedly paid $2 million for the only copy ever made of the Wu-Tang Clan’s album Once Upon a Time in Shaolin.2 Then he threatened to destroy it so that no one would ever be able to hear it but him.
The press couldn’t get enough of Shkreli, but other drug company execs insisted on sharing the spotlight, so he was pushed to the back pages. One of his successors was Michael Pearson, the CEO of Valeant Pharmaceuticals. Pearson presided over annual double-digit price increases for all of Valeant’s drugs. Heather Bresch, the CEO of Mylan, likewise demanded her 15 minutes of fame. Under her leadership, Mylan priced EpiPens, which are used for the treatment of anaphylactic shock and cost no more than $30 to manufacture, at $600 apiece.3
Other pharmaceutical executives wanted the public to believe that Shkreli, Pearson, and Bresch were deviants whose exceptional greed unfairly tarnished the reputation of the entire industry. This public relations strategy had an obvious shortcoming: there was nothing exceptional about Shkreli, Pearson, or Bresch. They used the same business strategy that all major drug companies have employed: gain control of the supply of a drug and then jack up the price. That is why, when other drug company CEOs pilloried Shkreli, he fired back in kind, asserting that they were as guilty as he was. And, as Bloomberg reported, “Shkreli Was Right: Everyone’s Hiking Drug Prices.”4
Many of the price increases have been spectacular. Over short periods of time, one diabetes drug quadrupled in price, while another rose by 160 percent. Bloomberg.com listed 73 branded drugs whose prices rose by 75 percent or more. Leading the pack was Xyrem, a narcolepsy treatment manufactured by Jazz Pharmaceuticals. Its price increased by a stunning 841 percent.5 A 2014 article noted that drug prices seem to “defy gravity,” with “prices doubling for dozens of established drugs that target everything from multiple sclerosis to cancer, blood pressure and even erections.”6 A 2017 article similarly noted that “prices for U.S. made pharmaceuticals have climbed over the past decade six times as fast as the cost of goods and services overall.”7
The effect of price increases has been to move enormous amounts of wealth from consumers to drug companies. Americans spent $457 billion on prescription drugs in 2015 and are on pace to increase that amount by 6.7 percent every year through 2025.8 A recent RXPrice Watch report by AARP found that older Americans who take an average of 4.5 brand-name prescription drugs per month incurred retail costs of more than $26,000 in 2015—more than the median annual income for Medicare beneficiaries.9 Younger people are also caught in pharma’s net: “prescription drug costs for Americans under 65 years old are projected to jump 11.6 percent in 2017. By comparison, wages are expected to rise just 2.5 percent in 2017.”10 Drug companies’ profits reflect these wealth transfers. “After paying all research costs and other costs of doing business, pharmaceutical manufacturers earn profits that average close to 20 percent of sales. The industry has consistently ranked as one of the most profitable industry sectors with returns that are more than double the median return for all industries.”11
It is not surprising that drug makers use their control over the supply of medications to gouge consumers and payers. The companies are not charities, and the executives who run them are not philanthropists. Pharmaceutical companies are businesses, and like other businesses, they are run so as to maximize their profits.
That is why it is dangerous to give drug companies monopolies. Give a business—any business—a monopoly and it will extract wealth from consumers by charging the monopoly price. And that is what patents do: they give drug companies monopolies on the sales of new medications. No wonder an article recently published in the Journal of the American Medical Association concluded, “the primary reason for increasing drug spending is the high price of branded products protected by market exclusivity provisions granted by the U.S. Patent and Trademark Office and the Food and Drug Administration.”12
Pharmaceutical companies spend lavishly to preserve their market advantages too. In California alone, the industry poured over $100 million into a campaign to defeat the Drug Price Relief Act, a ballot initiative that would have limited what the state paid for drugs.13 At the federal level, drug companies are just as busy:
Open Secrets data show that, between 1997–2015, Congress accepted $3.3 billion in campaign contributions from the pharmaceutical/health products sector, 43% more than they received from insurance, the second most politically influential industry. That averages out to about $181 million annually over that 18-year period.14
Although large in absolute terms, these dollars are chump change for Big Pharma. That is why reforms with real potential to bring down drug prices are never seriously proposed at the federal level, despite the number of scandals in which drug companies are involved. The industry and its army of lobbyists nip them in the bud.
Examples compiled by Alfred Engelberg, a former counsel to generic drug makers, show how large the stakes are relative to the amounts that pharma companies spend on lobbying. Consider Lipitor, a cholesterol-fighting statin, to pick just one. An extension of its patent term and a second extension for pediatric testing gave Pfizer, Lipitor’s manufacturer, an additional 1,393 days of marketing exclusivity, during which it took in $24 billion extra in sales revenue. Across the industry, patent extensions for statins generated $60 billion in extra revenue, while extensions for pediatric testing generated $5 billion on top of that.15
At root, the strategy that Mylan used to turn the humble EpiPen into a cash cow is the same as that used by the rest of the industry: gain a monopoly and exploit it. The EpiPen is a decades-old technology for injecting epinephrine, a medicine that helps people who suffer from dangerous allergic reactions to things like peanuts, insect bites, milk, or bee stings. When a person is experiencing anaphylaxis, an allergic reaction that can cause the throat to swell and the airway to close, an EpiPen can make the difference between life and death. Fortunately, epinephrine is cheap. The medicine inside an EpiPen costs about $1.
Mylan sells millions of EpiPens a year. Its customers include schools, emergency medical technicians, and parents whose kids have allergies. Amie Vialet DeMontbel was one such parent. Her son’s milk allergy was so severe that he wore a mask to protect himself from accidental exposure. She needed two EpiPens for him—one to take to camp and one to keep at home. The price? More than $1,200 for the pair. Mylan asked her to shell out more than her monthly mortgage payment for injectors that contained $2 worth of epinephrine.16
EpiPens were not always so pricey. They used to sell for less than $100. But from 2004 to 2016, Mylan raised the price by more than 450 percent, after adjusting for inflation. Why? Not because the cost of epinephrine or the injectors had gone up. They had not. If anything, Mylan’s product costs should have declined, owing to improvements in manufacturing processes and economies of scale.
The simple truth is that Mylan raised the price of EpiPens because it could. The market was not competitive because Mylan held a patent on the design of the injector. Injectors made by a competing manufacturer experienced dose-regulation problems. There was no generic substitute either, partly because Mylan had used a lawsuit and a “citizen petition” to delay generic entry.17 Armed with a monopoly, Mylan could force buyers to fork over every last dollar—so it did. Then its managers and shareholders pocketed the extra cash. Bresch, Mylan’s CEO, saw her total compensation rise from $2.4 million in 2007 to $18.9 million in 2015, a 671 percent increase that followed on the heels of Mylan’s acquisition of the right to make EpiPens.18 In 2016, Mylan’s chairman, Robert J. Coury, received nearly $100 million in salary, plus another $59 million in retirement benefits and other payments.19
Although the real explanation for EpiPen price gouging was simple greed, Mylan ran a sophisticated public relations campaign to deflect attention from the truth. Its position was that the price hikes were justified because of “the value the product provides.” This is an argumentative gambit that many drug companies use. Trouble is, it only works with people who don’t understand basic economics. The “value a product provides” sets a ceiling on the amount that a consumer would rationally pay for it, but it does not dictate what the price should be and has little bearing on the price a product will command in a competitive market. The competitive price is the smallest amount that a manufacturer can accept while still making a profit. That is why competitive markets are good for consumers. They force prices down to the lowest levels that sellers will accept for the last unit produced, not up to the highest prices that consumers will pay.
Suppose that a diner who loves steak would willingly pay up to $100 for a steak dinner. Now suppose that any of a dozen local restaurants could charge $25 for the meal and still make a profit. When restaurants compete, which price will prevail: $100 or $25? The latter. Why? Because the restaurants will try to gain the diner’s business by undercutting each other’s prices, and this will continue until they all charge $25. That the meal produces $100 in value for the diner does not matter. And the price would remain the same if the diner actually valued the meal at $500 or even $5,000. Competitive markets favor buyers, not sellers, because they drive prices down to the lowest sustainable levels.
Mylan did not have to charge a competitive price, however, because it had no competition. Neither did Kaleo Pharma, the maker of Evzio, an injector for the opioid-overdose preventive naloxone. It had a monopoly, so it raised prices too. In January of 2016, the injector twin-pack sold for $937.50. Three months later, the price was $4,687.50.20 The increase had nothing to do with research costs or any other costs. Generic injectable naloxone has been on the market since 1971.21 Kaleo charged more for Evzio because it was the only injector supplier.
Other commentators agree that pharma companies raise prices because they can. Dr. David Belk, who blogs at True Cost of Healthcare, studied the average price that retail pharmacies paid for more than 100 branded medications from 2012 to 2015. Their prices rose an average of 56 percent, roughly 16 times the rate of inflation over the same period. “So, why are the prices of these drugs going up as quickly as they are?” Dr. Belk asked. “One reason is that there’s nothing to stop the pharmaceutical companies from raising their prices.”22
Findings like Dr. Belk’s put the lie to the pharmaceutical sector’s claim that executives like Shkreli, Pearson, and Bresch are outliers. In the first quarter of 2016, “more than two-thirds of the 20 largest pharmaceutical companies said [that] price increases boosted sales of some or most of their biggest products.” The companies involved were industry leaders, including Pfizer, Biogen, Gilead Sciences, Amgen, and AbbVie.23 Pfizer raised the prices on 133 brand-name drugs in 2015 alone, with more than three-quarters of the increases exceeding 10 percent. Merck & Co. raised the prices on 38 drugs.24 Exploiting monopolies is the name-brand pharma sector’s business model.
Monopolies are not new. Aristotle’s Politics explains how the Greek philosopher Thales cornered a market more than 2,000 years ago:
Thales, so the story goes, because of his poverty was taunted with the uselessness of philosophy; but from his knowledge of astronomy he had observed while it was still winter that there was going to be a large crop of olives, so he raised a small sum of money and paid round deposits for the whole of the olive-presses in Miletus and Chios, which he hired at a low rent as nobody was running him up; and when the season arrived, there was a sudden demand for a number of presses at the same time, and by letting them out on what terms he liked he realized a large sum of money, so proving that it is easy for philosophers to be rich if they choose, but this is not what they care about. Thales then is reported to have thus displayed his wisdom, but as a matter of fact this device of taking an opportunity to secure a monopoly is a universal principle of business. . . .25
Few pharmaceutical execs have heard of Thales, but they all know how to corner markets. They often use patents to do this, but they find other ways too.26 A 2016 Senate report describes one time-tested strategy:27
The Senate report describes how four pharmaceutical companies used this strategy to gouge consumers for drugs that had been off-patent for decades. None of the companies spent any money on R&D or did anything to make the drugs better. They simply gamed the system, which paid whatever price the pharmaceutical companies set.
Martin Shkreli used this strategy repeatedly. He first employed it at a company called Retrophin, which raised the price of Thiola, a drug used to treat kidney stones, from $1.50 per pill to $30. Then he acquired Turing Pharmaceuticals and increased the price of Daraprim from $13.50 per tablet to $750. In Great Britain, Daraprim sold for less than $1.28 When asked why he set the price so high, Shkreli said, “the ugly, dirty truth” was that Turing’s “shareholders expect me to make the most profit.”29 Shkreli owned the lion’s share of Turing’s stock, of course, so the expectations he reported were mostly his own.
The owners of Novum Pharma expected to make money too. They raised the prices for three skin treatments—Aloquin, Alcortin A, and Novacort—after acquiring the rights to make them. In 2015, Aloquin cost $241. By late 2016, the price was $9,561, an almost 40-fold increase. The price hikes for Alcortin A and Novacort were similarly spectacular.30
There are variations on the basic five-step approach. Questcor, a subsidiary of Mallinckrodt, used one to raise the price of Acthar Gel, a life-saving treatment for infantile spasms of multiple sclerosis, by 85,000 percent. Questcor acquired the rights to make Achtar, a drug that was off-patent, in 2001 and began increasing the price. Then, in 2013, it outbid its competitors for the right to make Synacthem, a competing medication. Since in controlled the entire market, Questcor was free to charge whatever it wanted. And what it wanted was $34,000 per vial for a medicine that previously cost $40. The Federal Trade Commission got wind of the problem and intervened. It fined Mallinckrodt $100 million and required it to allow a competitor to make Synacthem.31
Economic theory says that, for old drugs, the strategy of cornering the market shouldn’t work. Producers can’t overcharge consumers if competitors can enter the market and make money by undercutting those excessive prices.
Yet this strategy has worked over and over again. Prices for many old drugs have risen spectacularly. The cost of tetracycline, an antibiotic that’s been around for decades, went from 3.4 cents per tablet to $2.36—a 67-fold increase in just one year. Erythromycin, another antibiotic, “had three separate price increases of at least 100 percent, with the price of the drug increasing from $0.24 per tablet in the first quarter of 2010 to $8.96 per tablet in the first quarter of 2015.”32 These aren’t isolated examples. According to one report, 222 old drug groups saw prices at least double from November 2013 to November 2014. For 17 groups, prices rose by a factor of 10 or more.33
An economist might explain the increases just reported by suggesting that barriers to entry prevented potential competitors from offering these products, so that existing manufacturers had de facto monopolies even though the drugs were old. That may sometimes be true, but it cannot be the whole story. Spectacular price increases occurred for old generic drugs that were made by several companies. Eight of the 10 drugs with “the biggest percentage price hikes in 2014 were generic medicines made by multiple manufacturers.”34
The story of ursodiol, a generic treatment for gallstones, is particularly vexing. It is a decades-old drug that is made by eight companies and that used to be cheap—45 cents per capsule. Then, in 2014, Lannett Co. raised its price to $5.10 “and one by one its competitors followed suit—with most charging nearly the same price.” One of those competitors was Mylan—the maker of the EpiPen is also one of the largest producers of generic drugs in the world. It had stopped manufacturing ursodiol in 2012 but got back into the market after the price spiked. And when it did, it didn’t undercut other sellers. Instead it charged $4.95 per capsule, about the same price.35
Why does competition exert less influence in drug markets than it does elsewhere? One likely explanation is “parallel pricing,” which occurs when supposed competitors maintain or raise prices in lockstep. We call it “erectile pricing,” rather than parallel pricing, because we observed it when studying Viagra and other erectile dysfunction (ED) drugs.
In the late 1990s, Pfizer’s “blue diamonds” sold for $7 apiece. But they didn’t stay that cheap for long. Over the ensuing decade, Pfizer raised the price repeatedly. For a few years, it did so every January. Then, after encountering little resistance, it did so twice a year and made the increments larger. By 2009, the price had doubled. By 2011, it had tripled. By 2012, Viagra went for $24 per pill.36
Most of these steep price increases for Viagra occurred after Eli Lilly brought Cialis to the market in 2003. The arrival of a competing ED drug should have exerted downward pressure on prices. Viagra and Cialis work by a similar mechanism, so men who responded well to one drug should have been happy to buy the other.37 Many should have bought whichever drug was cheaper, and their willingness to change drugs should have encouraged Pfizer and Lilly to compete on the basis of price. It didn’t. Pfizer and Lilly short-circuited comparison-shopping by charging similar amounts and raising prices in tandem:
Cialis . . . was introduced in November of 2003 at a wholesale base cost of $8.10—the exact price of Viagra at that time. Since then, Pfizer and Lilly have raised the cost of Viagra and Cialis at about the same rate. Since 2005, however, Cialis has been slightly more expensive than Viagra, with a maximum difference of $1.50 per pill. Currently [in 2009], the wholesale base cost for Cialis is $16.67, or about 47 cents more per pill than Viagra. Since its introduction, the cost of Cialis has risen 105%.38
Erectile pricing even survived the arrival of a third big ED drug: Levitra. This is truly perplexing. With Pfizer and Lilly marching in lockstep, Bayer AG, Levitra’s manufacturer, could have stolen the market by selling Levitra for less. It didn’t. Instead, it matched Pfizer and Eli Lilly move for move. “When Levitra was introduced in 2003, it cost pharmacies $8.49 per pill,” almost exactly the same as Viagra and Cialis.39 In 2012, Levitra’s price was over 300 percent higher, just like the other two. Bayer AG understood how the game was being played, so it marched in lockstep with the others.
Can this behavior be explained on any basis other than that the manufacturers coordinated their prices? AccessRX, an online pharmacy that is the source of some of our pricing information, offered two hypotheses. One was that charges went up because “consumers [were] willing to pay high prices. None of the top ED drugs ha[d] yet reached a price ceiling above which consumers won’t go.”40 This explanation is unpersuasive, for a reason already explained. Competition is supposed to drive prices down to the lowest levels that sellers will accept. Consumers might be willing to spend more, but that is irrelevant to the price at which a drug should change hands in a competitive market.
AccessRX’s second hypothesis centered on patents. Because only Pfizer could sell Viagra, only Eli Lilly could sell Cialis, and only Bayer AG could sell Levitra, each manufacturer could gouge its customers. This explanation for erectile pricing is no better than the first one. Its glaring flaw is that patents create exploitable monopolies only when there are no adequate substitutes for a drug. Viagra, Cialis, and Levitra are substitutes for one another. Consequently, men should have shifted to whichever drug was cheaper, exerting pressure on Pfizer, Lilly, and Bayer to compete for business by charging less. That each company had a patent on its particular ED drug should not have prevented competition from working.
To see the point, suppose you had a patent on Gala apples. Could you charge $100 a bag for them? Not when Fuji, Red Delicious, Ambrosia, Envy, and a host of other varieties sell for a whole lot less. If a bag of tasty Ambrosia apples costs $8, you might be able to charge a bit more for Galas—say $9—if consumers like them more. But if you tried to charge $100, you would get no buyers at all. Consumers would purchase other varieties, and your apples would rot on the shelves.
The same goes for Viagra, Cialis, and Levitra. Because the drugs are close substitutes, each manufacturer would have risked losing customers by charging more than the others. The only way they could all raise prices and hold onto market share was by acting in concert. And that is what they did. The fact that the drugs were patented doesn’t explain how they were able to march in lockstep for so many years.
Erectile pricing occurs with other medicines too. Insulin is a drug used by millions of Americans afflicted with diabetes. It is off-patent and made by three companies, so it should be reasonably priced. It is not. The past two decades have seen stunning price increases. Short-acting insulin, which cost about $21 in 1996, went for about $275 in 2017.41 And, just as with ED drugs, the prices went up in lockstep, even though there were two companies making short-acting insulin. Prices for long-acting insulins, which also had two makers, rose in tandem too.42
Why does erectile pricing happen in drug markets? Many medicines are made by only a few companies, all of which are repeat players in pricing games and have learned to employ a strategy known as “tit for tat.” Whatever one company does, the others do in turn. When one raises prices, the others follow suit, knowing that if they play follow the leader, they will all get rich. The incentive to steal the market by charging less disappears because every manufacturer knows that other makers will cut their prices too, if it does. An outbreak of price competition would leave all manufacturers poorer—so they all raise prices instead of reducing them.
Ideally, tit-for-tat pricing would be unsustainable, and efforts to keep prices high would collapse, because individual producers could increase their profits by reducing their prices and stealing market share from their competitors. That appears to happen in the pharmaceutical market sector less often than it should.
Third-party payment contributes to this failure of competition. Heavily insured patients who fork over the same copays regardless of which drugs they use will not respond to rising prices by switching to lower-cost alternatives. They will buy what their doctors recommend, and their doctors will not care much about price, knowing that their patients are insured. Third-party payment may weaken drug makers’ incentive to compete for market share.
Competition among pharma companies may also be less robust than it should be because they have learned not to invade each other’s turf or, perhaps, because they face costs that discourage them from doing so. When Turing bought the rights to Daraprim, Shkreli bet millions of dollars that his company would make enough money by raising the drug’s price to justify the investment. He would not have taken that gamble had he thought that another company would rush in and undercut Turing’s price.
Why was Shkreli so confident that no other company would compete? One reason was that the market for Daraprim was small. Only about 9,000 prescriptions for it are written each year. That is probably the main reason why, even before Shkreli showed up, only one company was making the drug. Plus, any company that wanted to enter the market with a generic version of Daraprim would have had to spend time and money obtaining FDA approval. These factors probably led Shkreli to conclude that potential competitors would take a pass.
Shkreli’s confidence may also have reflected the fact that extraordinary price increases had become old hat for generic drug companies. A 2016 federal government report found that 315 of 1,441 established generics had “at least one extraordinary price increase of 100 percent or more between first quarter 2010 and first quarter 2015.”43 (Because manufacturers had hiked the prices for some of these drugs more than once, the total number of extraordinary increases was actually 351.) Many of these increases were truly enormous. “Out of the 351 extraordinary price increases, 48 were 500 percent or higher and 15 were 1,000 percent or higher.”44 Shkreli may have figured that competitors wouldn’t undercut Turing’s price on Daraprim because they hadn’t started price wars when other generic companies engaged in price gouging.
Mylan, of EpiPen infamy, provides a nice case study of the power drug manufacturers have to raise prices on generic drugs. In the first half of 2016, Mylan raised prices for two dozen drugs by more than 20 percent and boosted prices for seven others by more than 100 percent. It raised the price of ursodiol, used to treat gallstones, by 542 percent; the price of metoclopramide, a treatment for gastroesophageal reflux disease, by 444 percent; and the price of dicyclomine, which combats irritable bowel syndrome, by 400 percent.45 Other generics that experienced price hikes were captopril, a blood pressure treatment, which jumped more than 2,700 percent; the asthma drug albuterol sulfate, whose price rose more than 3,400 percent; and the antibiotic doxycycline, which increased by a whopping 6,300 percent. All three increases occurred over a period of just one year.46
For present purposes, the important point is not just that these extraordinary price spikes occurred; it is that prices stayed high long after they were raised because other makers did not compete. The simple story of competition driving down prices did not play out the way it usually does. As the Government Accountability Office (GAO) observed in the report on generics quoted above, “the extraordinary price increases generally persisted for at least 1 year and most had no downward movement after the extraordinary price increase.” “Most” is an understatement. Of the 248 extraordinary price hikes that occurred between 2010 and 2014, 242 (98 percent) persisted for at least a year. Thus, after manufacturers raised the prices for these generic drugs by a factor of two or more, the prices stayed high, apparently because potential competitors refrained from starting price wars.
The frequency of extraordinary price increases is rising too. In the 2010–2011 period, 45 generic drugs had extraordinary price increases. From 2014 to 2015, 103 did—more than twice as many. Evidently, generic makers are learning that they can raise prices with impunity.
Is any of this illegal? Not necessarily. Antitrust law prohibits manufacturers from entering into anti-competitive agreements, such as fixing prices and dividing markets. But producers can legally play follow the leader when setting prices, and they can also voluntarily decline to compete with other manufacturers on any given product.
Whether illegal collusion occurred is currently under investigation.47 Near the end of 2016, two former executives of Heritage Pharmaceuticals, Inc., pled guilty to price-fixing charges,48 and 20 states filed a civil suit against Heritage, Mylan, Teva, and three other generic-drug makers, alleging that the defendants engaged in price fixing in the markets for antibiotics and diabetes treatments.49
Before closing this section, it is worth noting that Shkreli’s gamble didn’t pay off. He was indicted on securities fraud charges for unrelated wrongdoing, resigned his position at Turing, and was fired from the CEO position he held at another company, KaloBios. Also, soon after he raised Daraprim’s price, Express Scripts, the country’s largest pharmacy benefits manager, convinced a compounding pharmacy to sell a substitute product for $1 per pill.
Tim Worshall, an economist, offered the last development as evidence that drug markets continue to work, and competition certainly seems to have brought down the cost of Daraprim.50 But the evidence shows that, when pharmaceutical companies raise prices for generic drugs, the increases usually stick. The puzzle is why, in the case of Daraprim, Express Scripts bothered to sponsor a competitor. Cost does not seem to be the answer. Express Scripts is an enormous company—number 22 on the Forbes 500 list in 2017. Turing’s price for Daraprim would not have registered in Express Scripts’ bottom line, even had it been much higher than it was.
So why did Express Scripts stick a finger in Shkreli’s eye? Paraphrasing an old MasterCard ad:
The cost of Daraprim? $750.
The publicity to be gained by beating up the poster boy for pharma’s pricing abuses? Priceless.
Companies that make branded drugs like having monopolies and will do almost anything to protect them. A common strategy in the pharmaceutical game—known as “evergreening”—is to obtain a second patent before the first one expires.51 Drug companies can obtain these secondary patents by tweaking their drugs in various ways. For example, the original patent on Prilosec, a remedy for heartburn, expired in 2001, but the manufacturer effectively extended its monopoly by getting a second patent on the pill’s coating. The second patent lasted until 2007.52 Another common tactic is to develop and patent a timed-release formulation. In each case, the drug manufacturer aggressively markets the new drug to physicians, switching as many patients as possible to the new pill. Once patients have been switched, generic entry (which is, by law, limited to the previous version of the drug) has a far smaller impact on the drug manufacturer’s profits.
Some drug manufacturers take this strategy one step further. They withdraw the original drug to “encourage” physicians to put all of their patients on the new one. This “hard switch” version of “product hopping” effectively eliminates the impact of generic competition, because the old drug is no longer available. Although generic drug manufacturers and antitrust enforcers can go to court to challenge evergreening and product hopping, doing so is costly and time-consuming. In the interim, brand-name drugs will continue to fetch high prices, at the expense of taxpayers and ordinary consumers.
Evergreening is widespread. According to the National Institute for Health Care Management, roughly two-thirds of the 1,035 drugs approved by the FDA from 1989 through 2000 were modified versions of existing drugs. Looking at the period running from 2005 to 2015, researchers Robin Feldman and Connie Wang found
a startling departure from the classic conceptualization of intellectual property protection for pharmaceuticals. . . . Rather than creating new medicines, pharmaceutical companies are recycling and repurposing old ones. Every year, at least 74% of the drugs associated with new patents in the FDA’s records were not new drugs coming on the market, but existing drugs. . . . Of the roughly 100 best-selling drugs, almost 80% extended their protection at least once, with almost 50% extending the protection cliff more than once. . . . The problem is growing across time.53
Patents are supposed to encourage drug makers to take big risks by investing in the original research that is needed to discover new drugs. Far more often, though, they enable manufacturers to forestall generic competition by tweaking branded drugs that already exist. In other words, drug makers are gaming the patent system to generate additional profits on drugs that are already known to work. The deadweight social losses caused by the high prices that these evergreening strategies help maintain offset whatever benefits the tweaks may confer on patients.
The study by Feldman and Wang “definitively shows that stifling competition is not limited to a few pharma bad apples. Rather, it is a common and pervasive problem endemic to the pharmaceutical industry.”54 A business practice this common must be profitable, and this one certainly is. A study of popular brand-name drugs found that prices remained high and even increased when manufacturers obtained line extensions after the original patents expired.55 The gains were large. To pick but one example, during a 12-month period, Cardizem CD, a calcium-channel blocker used for the treatment of hypertension, generated more than $735 million in retail sales, the majority of which “could have been avoided if generic versions were used in lieu of expensive new extensions.”56
Evergreening isn’t the only way that branded companies keep out generic competition. They can use “pay-for-delay” settlements to accomplish the same end. A recent Supreme Court case shows how the strategy works. In 2003, Solvay Pharmaceuticals obtained a patent on a testosterone drug called AndroGel. Later that year, two other drug companies, Actavis, Inc., and Paddock Laboratories, applied to the FDA for approval to sell a generic equivalent. Paddock later sold a part interest in its application to Par Pharmaceutical, another generic drug manufacturer.
Congress wanted to encourage generic drug manufacturers to challenge patents that might be invalid, so it gave the first generic manufacturer that files a certificate with the FDA 180 days of marketing exclusivity if it proves in court that a patent is invalid. For example, if Actavis had successfully challenged Solvay’s patent on AndroGel, it would have received the exclusive right to sell a generic equivalent for six months.
But Actavis didn’t do that. Instead, after locking horns with Solvay in patent litigation, Actavis and Solvay voluntarily settled the litigation on the following terms in 2006:
Actavis agreed that it would not bring its generic [version of AndroGel] to market until August 31, 2015, 65 months before Solvay’s patent expired. . . . Actavis also agreed to promote AndroGel to urologists. The other generic manufacturers [i.e., Paddock and Par] made roughly similar promises. And Solvay agreed to pay millions of dollars to each generic [maker]—$12 million in total to Paddock; $60 million in total to Par; and an estimated $19–$30 million annually, for nine years, to Actavis.57
Got that? Solvay promised to pay Actavis, Paddock, and Par hundreds of millions of dollars to stay out of the market for nine years, during which time they would encourage urologists to prescribe Solvay’s AndroGel. Drug monopolies are so valuable that brand-name manufacturers are willing to pay enormous bribes to keep potential competitors from invading their turf. The money for these bribes came from taxpayers and everyone else who paid artificially high prices for AndroGel.
But why couldn’t another generic drug company just start making testosterone and steal the market from Solvay? That would be illegal. As noted above, Congress gave the first company that files a certificate and challenges a patent (here, Actavis) the exclusive right to market generic testosterone for 180 days—and the 180-day period begins to run only when that company enters the market. Because Actavis agreed to postpone its entry for nine years when settling with Solvay, other generic drug companies would have to wait nine and a half years to start selling their versions. By bribing Actavis, Solvay blocked all competitors, and preserved its lock on the market.
Working together, Solvay and Actavis were more powerful than either was alone. Solvay’s patent gave it control of the market for testosterone gel. Actavis’ FDA filing gave it the power to prevent other companies from competing with Solvay, even if Solvay’s patent was invalid. Solvay’s lawsuit against Actavis was really a means of creating a contract—the settlement agreement—that ensured lasting cooperation between the two. Solvay showered Actavis with riches because Actavis helped it preserve a monopoly on testosterone gel that was worth far more.
If you think Solvay’s pay-to-delay settlement smells fishy, you’re in good company. The U.S. Federal Trade Commission (FTC) sued all of the companies involved in the deal, accusing them of engaging in an illegal restraint of trade. The federal district court dismissed the FTC’s complaint, but the Supreme Court reinstated it in 2013. A trial will eventually decide whether the FTC prevails. The central factual question is whether the companies sought to impede competition or attempted in good faith to resolve a lawsuit over patent validity.
Many settlements raise this question. From 2005 to 2009, there were 66 such deals, according to a 2010 FTC report entitled “Pay-for-Delay: How Drug Company Pay-Offs Cost Consumers Billions.”58 Back then, the FTC estimated that these competition-stifling agreements cost consumers $3.5 billion a year in higher prices for prescriptions drugs. In more recent years, the number of settlements has risen—there were 40 pay-to-delay settlements in 2012 alone—and the burden on consumers has multiplied. In 2013, two consumer advocacy groups estimated that pay-to-delay settlements involving 20 popular name-brand drugs cost consumers $98 billion by delaying sales of generic versions.59
Unfortunately, the Supreme Court used the wrong standard when assessing the Solvay litigation. The Court asked whether the brand-name manufacturers that paid generic drug companies to stay out of their markets were trying to limit competition or settle lawsuits in good faith. The brand-name drug companies that are involved in these lawsuits are seeking to maximize their profits, first by patenting the products and then by keeping the patents alive as long as possible, using pay-for-delay settlements (and other means). Any settlement that keeps a patent in place necessarily prevents generic competition. It follows that all these companies are, in fact, trying to limit competition. But, when an original patent, which also prevents generic competition, is obtained in good faith, how can an attempt to preserve the monopoly in the face of a legal challenge differ qualitatively from the earlier attempt to get the patent itself? Finally, even if the FTC prevails in this case, its victory will come more than a decade after the settlement between Solvay and Actavis.
It should be clear by now that pharmaceutical companies will use all available tools to gain pricing power. And there are more tools than just patents and cornering markets for generics. Another option involves proving that existing drugs work. We are serious. A drug maker can gain a monopoly on the supply of an existing drug just by showing that it helps patients.
A famous example of the use of this strategy involves colchicine, a medicine widely used to treat gout, rheumatism, and other inflammatory illnesses. Colchicine was first described as a medical treatment around 1500 BCE. Benjamin Franklin, himself a gout sufferer, is said to have brought Colchicum plants back to the United States after serving as envoy to France. The medicine has been widely available in pill form here since the 1800s.
Colchicine used to be cheap. For years, a pill cost about a dime. Then, in January 2011, the price suddenly increased to $5.60 At the same time, generic manufacturers exited the market. The only version available in the United States was a branded drug named Colcrys, manufactured by Mutual Pharmaceutical, Inc. (MP). Overnight, colchicine was transformed from an inexpensive medicine with many producers into an expensive drug with only a single source.
How did a drug company gain a stranglehold on the market for this ancient medication? By proving that it worked. You might think there was never any doubt about this, and many gout sufferers would agree. Because colchicine was so old, no company could patent it, so no company had ever tested its efficacy in the sort of clinical trials the FDA requires for new drugs. Although the FDA requires proof of effectiveness for drugs brought to market after 1961, drugs already being sold to the public at that time were grandfathered. Consequently, many old drugs had no formal FDA approval. Colchicine was one of them.
The FDA wanted to do something about these unapproved drugs, so in 2006, it launched its Unapproved Drugs Initiative. It warned manufacturers that, because colchicine and other old drugs were technically unapproved, their grandfathered status could be revoked at any time. It then offered the companies a bribe in the form of a three-year exclusive on the right to sell any old drug they proved to be effective.
MP took the bait. It conducted a small study of the effect of colchicine involving 185 patients who were followed for one week, and then it applied for approval with the FDA.61 In late 2010, the FDA granted MP’s application and warned all other manufacturers to stop shipping colchicine.62 Having become the sole supplier, MP raised the price from 10 cents to $5.63 MP incurred little cost and effectively no risk in obtaining its monopoly position. As Dr. Edward Fudman, a rheumatologist, observed, “There [were] over 16,000 articles on Pub Med for colchicine, with 254 indexed as clinical trials. . . . Doing one trial in patients and a few drug interaction studies [did not] justify marketing exclusivity and a 50-fold increase in price.”64
When it comes to marketing exclusivity, colchicine is actually a twofer. It is both an old drug and an “orphan” drug. Orphan drugs are medicines that treat rare diseases. They are called orphans because when an illness affects few people, the market is too small for most drug companies to take on the expense of developing and obtaining approval for new treatments. To encourage the development of drugs to treat these orphaned populations, Congress enacted the Orphan Drug Act (ODA), which gives manufacturers seven years of marketing exclusivity plus other incentives, including federal grants, tax credits for clinical trial costs, and a waiver of application fees.65
In the case of colchicine, the rare disease is Familial Mediterranean Fever (FMF), a painful and potentially lethal autoimmune illness that afflicts about 100,000 people worldwide. By holding clinical trials, MP gained a lock on sales of colchicine to FMF victims as well. Again, MP did not invent colchicine; it just tested its efficacy and safety. This modest expense justified a modest reward. But, instead, the FDA provided three years of marketing exclusivity for all purposes other than the treatment of FMF and a seven-year monopoly for FMF.
Not surprisingly, MP’s gambit harmed both patient populations. Researchers at the Harvard Medical School studied about 217,000 enrollees in an insurance database who were diagnosed with gout or FMF from 2009 to 2012. They found that, owing to the price increase, the likelihood of receiving a prescription for colchicine dropped by 0.5 percent per month for gout suffers and by 7.6 percent per month for sufferers of FMF. At the same time, medical spending for the two groups rose by 55 percent and 38 percent, respectively. In other words, “the FDA action resulted in a reduction in colchicine initiation and an increase in cost.”66 Giving MP a monopoly caused a huge social loss.
A more recent orphan drug example involved deflazacort, a treatment for muscular dystrophy that has long been available in other countries for about $1,000 a year. After Marathon Pharmaceuticals gained FDA approval for deflazacort as an orphan drug in 2017, Jeffrey Aronin, the company’s CEO, announced that the drug would henceforth cost $89,000 a year in the United States.67
No one should have been surprised. “In 2014, the average annual price tag for orphan drugs was $111,820.”68 When Express Scripts, the pharmacy benefits manager, analyzed the orphan drugs in its formulary, it found four that cost $840,000 a year and another 29 that cost more than $336,000 a year. That is why applications to have the FDA designate medicines as orphan drugs have gone through the roof. In 2015, the agency received a record 472 such requests and awarded 354 designations, 22 percent more than in the previous year.69
Researchers contend that drug makers are gaming the ODA by using it to obtain monopolies on drugs they expect to be prescribed widely. As evidence, they offer the fact that 7 of the 10 drugs that achieved blockbuster status in 2014—meaning that their sales exceeded $1 billion—were approved as orphans but were then prescribed by physicians for off-label uses.70 For example,
rituximab, which was initially FDA approved for use in the treatment of follicular non-Hodgkin’s lymphoma, is the number 1 selling medication approved as an orphan drug. It is currently used to treat a wide variety of conditions, ranks as the 12th all-time bestselling medication in the United States, and generated over $3.7 billion in US sales in 2014.71
In the words of Martin Makary, a professor of health policy at Johns Hopkins School of Medicine,
What’s happening is that a drug company develops a medication to treat a specific cancer [that afflicts a small population], and will submit [it] to the FDA as intended for a very targeted subset of the cancer population. . . . Once a drug is approved, companies can seek additional indications for populations [that are far larger]. And this is a pattern with most of the orphan drugs approved by the FDA.72
In short, drug makers are gaming the orphan drug approval process. They are using it to gain monopolies over drugs that are used to treat much larger patient populations than the ODA was intended to help.
Colchicine is hardly the only old medication whose price skyrocketed after FDA approval. The price of potassium chloride, used to treat low potassium levels in the blood, nearly doubled after Endo obtained the exclusive right to market the liquid version. When Flamel Technologies secured FDA approval for neostigmine methylsulfate, a medicine that reverses the effects of anesthesia, it raised the price from $17 a vial to nearly $100. The price of vasopressin, a medication used in cases of cardiac arrest, increased 10-fold after Pan Sterile obtained FDA approval for it in 2013.73
An especially interesting story centers on 17OHP, a drug that helps prevent premature births. It was available from compounding pharmacies and was exceedingly cheap.74 Until 2011, that is. That’s when the FDA approved K-V Pharmaceutical Company’s (K-V) application to manufacture 17OHP as an orphan drug.75 Obstetricians and patient advocacy groups like the March of Dimes (MOD) welcomed the approval because they expected K-V to standardize the manufacturing process and broaden access. They weren’t aware of K-V’s plan to maximize its profits, which it acted upon the moment the FDA’s approval gave it the exclusive right to market the drug. Overnight, K-V raised the price of 17OHP from $300 for a 20-week course to $29,000. This took the annual cost of treating the 130,000 or so women who need 17OHP from $41.7 million to $4 billion. The vast majority of the extra money was pure profit for K-V, a fact that its stock price reflected. It went from $1.50 a share to nearly $13.76
But K-V didn’t collect the money. In fact, the company went bankrupt in 2012.77 In a stunning turn of events, the FDA reversed course and allowed compounding pharmacies to sell 17OHP too. Two days after the FDA announced that decision, K-V cut the price of 17OHP in half.78
Why did the FDA act? Much of the credit belongs to senators Sherrod Brown (D-OH) and Amy Klobuchar (D-MN), who called for a price gouging investigation after patients and physicians complained that K-V was ripping them off. At a hearing before the Senate Appropriations Committee, they raked FDA Commissioner Margaret Hamburg over the coals.79 Presumably, Hamburg then told her subordinates to make the problem disappear.
K-V’s checkered history didn’t help either. The federal government had previously investigated K-V for making and distributing adulterated and unapproved drugs, leading to a consent decree that bound the company, two of its subsidiaries, and its principal officers.80 Then, in March of 2011, as the FDA’s 17OHP ruling was causing a ruckus, K-V’s former chairman pled guilty to violations of the Food, Drug and Cosmetic Act for manufacturing oversized morphine pills.81 His punishments included $1.9 million in fines and forfeitures and a 30-day jail term. As if this wasn’t enough, the Justice Department was concurrently investigating K-V’s Ethex subsidiary for defrauding Medicare and Medicaid by misrepresenting that two of its drugs were FDA approved when, in fact, they weren’t.82 We’re guessing the FDA preferred opening the market for 17OHP to explaining why it put preterm babies at risk by helping a sketchy drug company with a criminal past fleece pregnant women.
K-V’s use and abuse of the MOD added fuel to the flames.83 K-V was a large contributor to the MOD. So, when it sought FDA approval for its brand of 17OHP, the MOD supported its application. Then, after the stunning price increase was announced, the MOD found that it had helped a greedy corporation put premature infants at risk. To salvage its reputation, the MOD’s president demanded prompt action by K-V and threatened to “pursue alternative strategies” to ensure ready availability of 17OHP.84 This appears to have been code for urging the FDA to allow other companies to enter the market.
Pregnant women. Premature infants. An angry March of Dimes. A dodgy and scandal-plagued drug company. A criminal guilty plea. Morphine. Absurd corporate greed. Politicians sensing blood in the water. This was a perfect storm—and nothing less could have prevented K-V’s owners from becoming rich.
We know that it took extreme circumstances to stop K-V because other drug companies with similar exclusive rights over old drugs have fleeced consumers with impunity. Adams Respiratory Therapeutics reportedly raised the price of guaifenesin (i.e., Mucinex) 700 percent after gaining its stranglehold.85 ACTH, a treatment for infantile spasms used since the 1950s, rose in price from $1,650 to $23,000 for a single vial “in what the company described as an ‘orphan-style pricing model.’”86 The best gauge for the impact of market exclusivity? Forty-three orphan drugs achieved blockbuster status—with sales exceeding $1 billion—after being approved by the FDA.87 With revenues like these to be had, no wonder so many orphans were being adopted.
Marketing exclusivity hit asthma sufferers especially hard: “Pulmicort, a steroid inhaler, generally retails for over $175 in the United States, while pharmacists in Britain buy the identical product for about $20.”88 A month’s worth of Rhinocort Aqua cost more than $250 here when it sold for less than $7 in Europe.89
Again, none of this should surprise anyone. When a private drug company has a monopoly on a product, it will charge monopoly prices. That’s how it maximizes profits, and maximizing profits is what companies do. That’s an observation, not a judgment. Businesses that produce pharmaceuticals are neither better nor worse than businesses of other sorts. Give a business a monopoly on air travel, electricity, cable TV, or groceries and it will behave like a monopolist. (If you noticed that every time you asked for a higher salary your employer promptly obliged, what would you do?) Drug companies are no different. The mystery is why anyone expects them to behave differently.
Consider a famous example involving albuterol, another widely used treatment for asthma, which afflicts about 40 million Americans. Albuterol is dispensed by means of inhalers—hand-held pumps that deliver measured doses of mist for people to breathe in. Prior to the mid-2000s, all inhalers were powered by chlorofluorocarbons (CFCs). These inhalers worked just fine, but CFCs were found to be depleting the ozone layer, and there was strong international support for banning their production and use. Of course, inhalers accounted for a tiny fraction of the CFCs that were being released into the atmosphere—less than 0.01 percent.90
Manufacturers typically hate environmental regulations that require them to redesign their products, and many of them did oppose restrictions on CFCs. But not the pharmaceutical industry. It supported the CFC ban. Eight pharmaceutical firms even formed an organization called the International Pharmaceutical Aerosol Consortium (IPAC) to come up with a new ozone-friendly propellant.91 Why was the industry so gung-ho? Because the need to develop new inhalers that operated without CFCs meant that pharmaceutical companies could get new patents on inhaler-delivered drugs that were about to go generic. The CFC ban thus gave drug companies a perfectly legal and practically mandatory way to evergreen their patents.
Perversely, the new inhalers they came up with were powered by hydrofluorocarbons (HFCs). HFCs don’t break down the ozone layer, but they do contribute to climate change. Seeing this, several scientists and one generic drug company proposed that the old CFC-based inhalers be exempted from the international ban. Given the tiny quantity of CFCs that inhalers released into the air, an exemption would have made perfect sense. But it would also have spoiled the drug companies’ plan to evergreen their patents, so the drug companies lobbied against it.92 Got that? Drug companies spent money to ensure that the government would force them to redesign their products. It worked, too. In 2005, the FDA approved an outright ban on CFC-based inhalers.
The result? Generic drug companies were kept out of the market for inhaler-delivered medications, and the prices for those medications went through the roof. “Albuterol, one of the oldest asthma medicines, typically costs $50 to $100 per inhaler in the United States, but it was less than $15 a decade ago, before it was re-patented.”93 Nationwide, the FDA estimated that the switch to new inhalers increased health care spending by $8 billion over a ten-year period, while conferring a trivial benefit on the environment. And whatever minimal good may have been done for the ozone layer was offset by the aggravation of climate change stemming from the use of HFCs. Everyone lost. Except Big Pharma.
Six states allow people with terminal illnesses to end their lives on their own terms, using drugs prescribed by physicians.94 Secobarbital, a generic drug that has been on the market for decades, is commonly used for this purpose. It should therefore be cheap, and it once was. “In 2009, a lethal dose of secobarbital (100 capsules) cost less than $200 (less than $2 per capsule).”95 Today, however, the same amount of the drug costs $3,000. Why? At first, the price crept up slowly, rising to $1,500. Then Valeant Pharmaceuticals acquired the rights to make secobarbital and doubled the price. The timing coincided with the introduction of California’s End of Life Option Act. From Valeant’s perspective, people in straits so desperate that they want to end their lives are just one more group of buyers waiting to be gouged.
Rising prices for drugs (both branded and generic) are impoverishing Americans. Although there are many reasons why “drug prices keep defying the law of gravity,” monopolies obtained by patents and other means are a primary cost driver.96 We let drug companies acquire monopolies in a system that is designed to pay whatever they ask, then we are surprised that they act like monopolists and take us for every thing they can. We suggest some fixes for these problems in later chapters. For now, the main lesson is that health care providers do and always will seek to maximize their profits, just like businesses of other kinds. Any suggestion to the contrary is patent nonsense.