Dollars Behind the Dollars of Medicine
Decision-making is necessary in every aspect of life whether it is a daily decision of what to eat for breakfast or if it is a more complex decision of in what direction should a company or organization move in. In organizations, decision-making becomes vital when the organization is in times of financial growth, financial stress, or under scrutiny. In order for organizations to continue to grow financially, recover financially, or regain trust: operation managers need to identify and analyze the situation or problem. After identifying the issue, operation managers need to obtain information to analyze alternatives for deciding an implementation plan for the most appropriate alternative for the organization to continue to be successful or to recover.
Recently, health care and insurance has been a hot topic for debate. Deep within this debate is the price of medication and drugs and who is at fault for the increasing prices of medicine. The price of medicine came under scrutiny by the media reporting the cost of an EpiPen rose drastically. This made Americans more aware of the pharmaceutical industry. Most Americans believe that pharmaceutical companies determine the price of medicine. However, one third of the list price of a drug is given back to middlemen in the supply chain such as insurance companies and pharmacy benefit managers. Pharmacy benefit managers (PBMs) are for-profit companies responsible for negotiating drug price discounts for insurance companies and employers. In the drug supply chain, PBMs sit between the patient and the pharmaceutical company.
In order to address the problem of increasing drug prices, the problem needs to be correctly identified. However, that becomes difficult when pharmaceutical companies blame PBMs for the increasing prices and PMBs state that pharmaceutical companies are responsible for raising the prices. As a result, Americans are attempting to fully understand the supply chain of drugs in order to understand what is happening in the supply chain to cause the prices of drugs to increase. Pharmaceutical companies and PBMs have recognized the public scrutiny of the rising drug prices by implementing changes such as limit the price increase of drugs already on the market and providing information to physicians about the specific costs of the drug they are prescribing. Pharmaceutical companies and PBMs have made the decision to address the public scrutiny over drug prices by looking to make changes in how the cost of drugs is conveyed to physicians and the patients.
The example of the decision-making process in determining drug prices is unique. Drugs can have the ability to drastically change one’s life and some individuals will pay large amounts in order to improve their way of life. Therefore, the value in use of drug can be different depending on the demographics of customers. Pharmaceutical companies need to take into consideration the many different demographics and markets of the United States when determining a price of a drug.
This past summer, I interned at a pharmaceutical company that had a drug approved by the FDA and was in the process of putting the drug on the market over the course of my internship. One of the most challenging aspects of putting this drug to market in the United States is determining a price since the US government does not regulate drug prices. As we learned in class, when making decisions operation managers need to consider the value in use from the customer’s view and the firm’s view. The most important aspect of determining the price of drug is the drug’s clinical value or the value in use from the customer’s view. Will the drug improve people’s quality of life and increase their life expectancy? How does the drug compare to similar drugs on the market? The value in use of drugs from pharmaceutical companies’ view is taken into consideration when a deciding whether or not to develop a drug not when the drug is already developed. The costs of researching and developing drugs are already taken into account when a pharmaceutical company is determining the list price of a drug. In addition, when the pharmaceutical company is determining the list price of the drug, the company needs to consider whether or not insurance companies will pay for the drug at that price. They need to find a price that will maximize the company’s profit but a price that insurance companies will also cover. Here, break-even analysis and a payoff table become necessary. As consumers and employers are beginning to unveil the pricing of drugs, the pharmaceutical and the PBMs are walking on thin ice. As they walk through the process, pharmaceutical companies, PMBs, medical professionals, and patients need to consider the value of the customer’s life. The decision needs to be health versus wealth.
Information on the pricing of drugs: http://www.newsweek.com/prescription-drug-pricing-569444
Erin,
The drug industry is a great example of an industry that has a completely different approach to operations management due to the nature of their product. I did not know that the US government does not regulate the price of drugs. I suppose this is what has allowed drug prices to increase. However, I am interested to here more about if the drug prices are so high because of the extreme costs of R&D, or due to these companies trying to increase their profits.
Either way, this question needs to be addressed. I am curious to learn more about the supply chain of the medical industry, and how this effects drug prices and the consumer.
Erin,
This is a very interesting topic you have brought up! There will almost always be controversy with medicine. In my ethics course last semester, we discussed how it is difficult to find the middle ground where you don’t make patients feel like they’re being taken advantage of, and where the shareholders of the company are happy because they are seeing as much profit as possible on the financial statements. As you have mentioned, that is where the key skill of decision making comes in. I hope you can continue a job in this field because it appears you have that skill! Great topic.
Erin –
I found your post particularly interesting because a couple weeks ago I was reading on the explosion of certain healthcare companies in 2017. The Morning Brew (an email list), sent out an article on the Best S&P 500 Stocks of 2017. I linked it for you here: (https://seekingalpha.com/article/4134576-best-worst-performing-s-and-p-500-stocks-2017) As you can see, 2 of the companies in the top 3 reside in the healthcare sector. Both of these companies show annual returns of over 100%. In simpler terms, the value of their company more than doubled in one year. Personally, I cannot even capture in my mind what growth of this size would look like for a company.
I think it is important to note, however, that this is the nature of the healthcare industry as you duly noted. I think it is fair to assume that as prices to consumers are increasing steadily, costs to these companies are not increasing nearly as proportionally. With healthcare companies, we tend to see an upfront R&D expense of high value when a drug is in its ‘working stages’. Under GAAP tax reporting, healthcare companies in the US must expense R&D as incurred, differently from in countries that don’t use GAAP. For this reason, it is easy to see that the longer a drug is on the market, the larger a healthcare’s margins will get (assuming they have no other large R&D projects). My question is then, why are the prices of these drugs increasing, if they already knew the costs associated with the drug before it was released onto the market and should’ve priced it accordingly during that time?
I think it would be interesting to look further into the workings of healthcare companies and see if 130% growth is associated to drugs and their usefulness to mankind or if it is more largely associated with healthcare companies being able to exploit the overpricing of drugs, knowing that people cannot live without them.
Thanks for sharing!
Excellent topic Erin.
The media attention that has recently been given to drug pricing highlights the importance of operations management in business and how it affects consumers in their everyday lives. An operations manager for a pharmaceutical firm determines the price of a drug by taking into account the clinical value of the drug to a customer; the degree to which it improves quality of life for the user. After environmental scanning and market analysis, the operations manager will attempt to set a price which consumers (in this case insurance companies) will pay willingly while also maximizing profit. This has the potential to create an ethical dilemma for operations managers, as drugs with the highest clinical value or life saving potential will be purchased by an end consumer at nearly any cost, which encourages that cost to be set very high. Although insurance companies aid patients to a degree, patients with high-deductibles or no insurance at all can end up paying the full bloated list cost for their drugs or not being able to afford the drugs at all. This is an unfortunate travesty wherein the cure for a disease might exist but be completely inaccessible to the afflicted, or put them in dire financial straits purchasing it. Here too we see the relevance of operations management in the pharmaceuticals industry; We are unable to direct negative press and public outrage to the parties responsible for making certain medications unaffordable because the supply chain is completely inscrutable. It will be interesting to follow the issues of health insurance and drug pricing in the future to see if these practices change. Thank you for sharing!
-Matt Thomas
In my business ethics class last semester, we went over the case on the Epipen and how the price suddenly skyrocketed. There was seemingly no reason for the rise in price. What we later came to understand in the article was that Epipen was the only product of its kind on the market. The company prioritized wealth over the well being of its customers and paid the price for it. Different brands like the Epipen began to arrive in the market, steering customers away from Epipen. They most likely had to run through decision theory to figure out if they could maintain the high prices and still make a profit. I imagine they broke it down with alternatives being different prices and putting percentages on how likely the high and low numbers for profits would be and ran the analysis. The price today remains around 300 dollars per Epipen, so it seems Mylan is ok with alienating some of their customer base and making their remaining base pay absurd prices for something that could save their life.
Thanks for your insight, Erin.
The pharmaceutical industry is obviously one with deep-rooted ties to value. Your article talks about the supply chain as it relates to drug pricing for consumers. We start with the prices that consumers pay or insurers reimburse and work our way back to list prices and manufacturers: consumers are paying too much for drugs, so consumers blame companies higher and higher up the chain. What if we flipped the chain and looked at the process from the bottom up?
The Newsweek article you attached offered some valuable information. Mentioned in the article is research conducted by the Tufts Center for the Study of Drug Development that estimated the cost of developing a new drug as $2.6 billion. Were that drug helpful for even 100,000 people, it would still require a price tag of $26,000. This is obviously a much simpler situation than many biotech firms face, but for all of the development that goes into drugs that never make it to the market it could be said that drugs really are just incredibly expensive. Break even analysis for each drug would be inaccurate due to the high cost of those drugs that never sell.
Further, you talk about value to consumers of each drug and its relation to the drug’s price. There exists an interesting moral hazard for biotech firms in the lack of government intervention in pricing. These firms are businesses, and many are public firms that have shareholders to consider. However, those same firms are responsible for the production of potentially life-saving and life-elongating drugs, so how can they ever decide on the value vs. profit story in their drugs’ prices?
This question may not be one of supply chain so much as it is ethical. Operations managers have a tough job in deciding their firm’s priority, and our study of decision-making would prove key for future managers.
Thanks again.
Erin, your choice to compare the fascinating world of healthcare to operations management and the concepts we have been learning in class is a fantastic one. They go hand and hand. As you said, healthcare in the United States is pretty messy, and it has been for a while. There is a lot wrong with our system, but one of the biggest problems right now is how much our country spends on healthcare compared to other developed nations around the globe. Take a look at this graph showing how much more the US spends (https://data.oecd.org/healthres/health-spending.htm). Since we spend so much, you’d probably think the US should have the best healthcare system in the world, right? Wrong. Most of our spending is directed toward the top 5%, leaving millions without any form of healthcare. The American healthcare system is based upon corporate competition rather than overall welfare, and as a result, healthcare is treated as a business that requires the typical operational considerations that any regular business deals with. This significantly drives up our healthcare bill.
In addition to conducting break-even analysis and considering the value-in-use for a certain product or service as you mentioned, those involved in the medical field also need to strongly consider decision theory and risk management. For example, consider the drug Rofecoxib (Vioxx). This drug was prescribed to millions of users with arthritis to help subdue the pain. At the same time, Vioxx significantly increased the risks of heart attack and stroke (https://www.marketwatch.com/story/the-ten-worst-drug-recalls-in-the-history-of-the-fda-2010-12-10). Despite evidence that pointed to the increase of these side effects, Merck, the brand, decided to release it anyway. In the context of decision theory, they must have assigned a percentage to whether or not they’d get caught, and they must have predicted their potential financial gain from releasing the drug. Even though there was a strong risk, the increase in revenue they expected to bring in was enough to influence their decision. Because healthcare in the US is a business, decisions like this one are highly swayed by money instead of actual health and safety.
Erin,
You make great points about the operations side of medicine that very few people understand. I also enjoyed your background experience on the issue. I believe it is a very good thing that the public is becoming more aware of the pharmaceutical industry, however the reasoning behind this is not always pleasant, as you referenced with the rise of the price of an EpiPen. Another key factor that has brought drug prices to the front of a lot of news in the past few years has been the actions from Martin Shkreli. Not only did he negatively impact many people that had to buy “Daraprim”, which he raised the price from $13.50 a tablet to $750 a tablet, he also created a loss of trust with the pharmaceutical industry as a whole. Now, some people are quick to not only blame the PBMs that you referenced in your post, but also the pharmaceutical companies.
Now there is the issue of understanding the uniqueness of the decision-making process in pricing a drug, as well as regaining trust in pharmaceutical companies as a whole. No matter how the price of a drug is determined, the actions by Shkreli and his company have put other companies in a very difficult situation. The public is immediately on edge at the slightest price change and are quick to call out (rightfully or not) the companies responsible for this change. Thanks for sharing, I enjoyed it!
Erin,
This is a well thought out and relevant application of the lessons we learned in class. The drug industry is particularly interesting because the value of a particular drug can vary drastically between the firm’s view and the consumer’s view. Often times firms may state that a drug product can have benefits that consumers don’t agree with. Additionally, products can have unforeseen benefits that can alter the value in the eyes of the consumer. Take Bayer aspiring for example. Bayer was initially introduced to the market as a pain killer similar to Advil or Motrin. Upon further testing, it was discovered that Bayer aspirin was an effective remedy for various heart complications. In this case there was a positive shift in perception of value but occasionally there can be a negative shift which causes the firm’s value to differ from the price consumers are willing to pay.