In recent months, several governments, including the UK, EU and US have introduced new pricing regulations on the pharmaceutical industry. These measures come after record levels of post-pandemic demand for medication have left many countries’ public healthcare expenditures surging with drug bills, amidst already high inflation. However, as drug manufacturers also face spiralling costs in their operations, a renewed clash between governments and the industry is emerging over drug prices.
Just last month, for instance, two US pharmaceutical giants, AbbVie, and Eli Lily, pulled-
out of a voluntary pricing agreement with the UK’s NHS. Under the pricing scheme, the growth rate of the NHS’s spending on medication is capped at 2% each year. Any excess amounts spent by the health service would then be reimbursed back by the drug manufacturers. In the industry, these are known as “clawback costs”. Nevertheless, after collectively encountering more than £3bn ($4bn) in clawback costs this year, from just £600 million in 2021, many manufacturers, including the two above-mentioned, pulled out of the agreement. With these costs representing a staggering 26.5% of the country’s total industry revenue, these events serve as warning signs of the growing threat current UK pricing regulations pose on the commercial viability of their operations.
The situation, however, extends beyond the UK. The German giant, Bayer AG, is diverting the
majority of its pharmaceutical arm away from Europe, following healthcare spending cuts and
further pricing restrictions imposed by France and Germany, respectively. In the US, traditionally seen as the most lucrative market, the recently introduced Inflation Reduction Act
has similarly stunned the domestic industry. Through the US government’s additional power
on negotiation and price caps for some prescriptions, the new legislation is likely to significantly affect earnings for Big Pharma groups, from their most profitable market.
According to data from EY, the global biopharma industry held a record $1.4tn worth of
‘firepower’ in 2022, which combines the total market capitalisation, cash and equivalent assets and existing debt of companies. Nonetheless, the reason for the industry’s strong opposition and vulnerability to price regulations may be attributed to its research-intensive nature.
In order to develop new drug medications, pharmaceutical companies invest heavily in
research and development, involving lengthy and expensive clinical trials. These investments
are, therefore, highly susceptible to wide-ranging external risks, such as supply chain
disruptions or geo-political tensions. The main impact that pricing regulation may have on the
industry is two-fold, the first being the limitation of financial resources available for investment,
due to reduced profitability. This is primarily due to the hypothetical unlimited liability that
clawback costs may represent. Secondly, price controls also impair the future returns of
investments in a new medication, irrespective of research costs. While pricing limitations
already reduce profitability they also prevent prices from reflecting the true costs and value of the new product, regardless of the success in the market.
A 2022 analysis by Deloitte points out that the costs to develop a new asset in the life sciences sector, from discovery to launch, reached almost $2,3bn, increasing by $298 million from 2021. These findings also point to the continuous evolution of the pharmaceutical industry. More specifically, the industry is shifting from the use of drugs for the treatment of chronic illnesses to that of medication to treat severe medical conditions, rare illnesses, and infectious diseases. Current trends in the industry include a rush by drugmakers to develop new treatments to cure obesity or even cancer. The evolution in demand, however, implies the need for further clinical research and therefore additional investments with risks, given the
increasing complexity of the products involved. This trend would naturally translate into higher prices, further adding on to the difficulty of finding a durable price agreement.
The implications of the current situation in the short term could include worsening drug
shortages as manufacturers divert their operations to more profitable markets. This issue
would particularly be acute for Europe, currently in the midst of a cold and flu medicine
shortage. However, in the longer term, the discouragement of investments in the life
sciences would result in enormous opportunity costs through the economic benefits that could be achieved from further progress in the field. COVID-19 vaccines, themselves, illustrate a good example of the potential economic value of the industry.
While discussions between governments and pharmaceutical companies still remain on-
ongoing, at least in the UK and the US, any enduring disaccord over drug prices risks having
significant repercussions on both the global industry and healthcare.