Profiting from Blasting Drug Company Profits

By Michael Fumento


Copyright 1996 Michael Fumento

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"My sense is that some of these big drug companies are saying that the heat’s off now. They’re saying that Congress didn’t pass a health care bill last session; they’ve got a lot of new allies in the Congress, and they can get away with more than they could have before."

The speaker was Democratic Representative Ron Wyden, a longtime critic of pharmaceutical companies. The occasion was the release of a Families USA report, "Worthless Promises: Drug Companies Keep Boosting Prices."

Families USA is among those lobbying groups which are still licking their wounds from Congress’s refusal to enact President Clinton’s national health care plan. The promises it claims were broken were those made in 1993 of 17 companies, which represent about two-thirds of the pharmaceutical industry. The companies promised to hold prices overall to rates at or below that of the consumer price index.

Profiteering drug companies make convenient villains, precisely because they provide such valuable products. Demonizing them can help provide a basis for expanding government health regulation. But here, as is so often the case, the allegations don’t match reality.

Sen. Ron Wyden, demagogue-Oregon

Families USA’s main charge was that "From 1993 to 1994, the prices of the top 20 drugs [in terms of how much is spent on them] went up 4.3 percent, on average, while the inflation rate was 2.7 percent."

One problem with the comparison is that drug price hikes almost always come in January. When Families said "from 1993 to 1994," it really meant, as indicated by a tiny note on its chart, January 1, 1994 compared to January 1, 1993.

The drug companies made their promise in 1993, meaning the price hikes mentioned in the Families report had already been implemented at the time the promise was made. By cutting off their calculations when they did — 14 months ago — Families USA threw down the checkered flag before the drug companies had a chance to start their engines.

But leave that aside and let’s look at the basic question. Have drug companies’ hikes recently been out of line with the consumer price index?

Unfortunately, the "top 20" methodology can’t tell us. Top 20 is fine for rating sports teams or video rentals, but in this context it just doesn’t mean much. For example, for all we know the top ten drugs account for 100 times more sales than the next ten. It’s a rating system that’s not so much unfair to the pharmaceutical industry as it is unfair to anybody simply trying to figure out what’s going on.

What is grossly unfair to the drug companies is Families USA’s use of what are called "average wholesale prices," or AWP.

With most products, such as food, wholesale prices are the prices the store pays. The store then marks them up and sells it to consumers at retail.

But it doesn’t work that way with drugs. Indeed, the joke in the pharmaceutical industry is that AWP stands for "ain’t what’s paid." AWP prices "are a fiction" says Dr. Joel Hay, head of the Department of Pharmaceutical Economics at the University of Southern California, Los Angeles. "HMOs pay less, Medicaid pays less, drug store chains pay less, hospital chains pay less, large managed care providers pay less. And the discount can be enormous. Sometimes it’s greater than 50 percent off list price."

The second part of the problem with using the average wholesale prices, according to Ernst Berndt, professor at Sloan School of Management at MIT, is the growing role played by generic drugs in the drug shopper’s budget.

He notes industry studies showing that generic prices are falling at a rate of five to ten percent per year. "For example," he says, "a product like Tagamet [an ulcer medication] became generic in mid-May and is being produced by many major manufacturers and now sells at half the price it used to. My understanding is Families conveniently excluded this."

It did. Indeed, five of Families USA’s "top 20" drugs are now available generically. But the group just assumed that sad little old folks like the ones its report tells about are going to be so loyal to brand names that they ignore the generics. The report put little marks next to the drugs indicating that they were available generically, but omitted this from its calculations.

Neglecting the generic aspect is all the more misleading in that, as Hay points out, when a company loses its patent and its drug can now be produced generically by other companies (or by that company’s own subsidiary), it often actually jacks the price up, knowing that it cannot possibly now compete on price basis. Henceforth it will make all its money on the basis of brand loyalty.

Make no mistake; pharmaceutical companies do okay for themselves. You don’t see too many folks from Pfizer or Eli Lilly standing by freeway ramps holding signs saying "will mortar and pestle for food." And we all know the feeling of getting a prescription that made us gag when we saw the price. But as a June 1994 Congressional Budget Office report put it, "Economists have found that, properly measured, pharmaceutical company profits are only slightly above the average for companies in all industries."

How can this be, when patent laws give companies exclusive, if temporary, rights to market their drugs? Says Hay, "I guarantee you it’s a highly competitive market, and the HMOs, the chain stores, and other buyers are making enormous efforts to get the companies to increase the discounts."

These are the people in competition for your dollar. Think twice before turning their job over to various schemes proffered by "we’re-on-you-side" lobbyists and politicians.


Read Michael Fumento’s additional work on economics.