How Pharmaceutical Companies Price Their Drugs

Revenue generated from drug production in the United States has more than doubled in the past ten years. In 2014 alone, the U.S. brought in more than $250 billion in prescription drugs sold in retail outlets. The major key to this high revenue is repetitive price increases.

Drug companies have an unusual ability to function relatively unregulated and to raise drug prices beyond inflation rates. This allows the drug companies to increase their revenues continually, even if the demand for one or more drugs is not high. The result is a huge outpacing of demand in the U.S. from 2010 to 2015. The growth of prescription drug revenue has averaged 61%, which is three times higher than the increase in prescriptions for those drugs.

There has been a great deal of focus on new drugs that have been released with sky-high prices. There has also been increased focus on previously released drugs under new ownership that have undergone abruptly increased prices. Drug companies do this, of course, to generate revenue. However, the majority of a company’s revenue comes from a pattern of steadily increased prices of drugs that have been on the market for some time. The number of drugs that drug companies have in their pipelines will also affect each drug’s price.

Because of drug companies' pricing power and their ability to increase prices without regulation, the worry about sluggish demand is far down on the list of concerns in relation to pricing. Pharmaceutical companies concern themselves with a variety of factors when pricing drugs. The uniqueness of the drug must be considered; that is, how many other drugs are already available that treat the same condition. If the market is heavily saturated with drugs to treat a certain condition, new drugs for the same condition will likely be priced lower. Competition is another factor that affects pricing. Drug companies must consider the popularity and success of the drug’s competition, and they must determine if new drugs have added benefits over competing drugs. Additional benefits lead to higher prices.

Drug companies must consider whether new drugs have the potential (or have proven through clinical trials) to change the current practice of medicine used to treat the conditions the drugs target. The companies must also consider whether their drugs can prevent the need for certain medical treatments or the necessity for surgeries or other procedures. Drugs that can cut down on expensive surgeries, hospital trips, and doctor visits are often priced higher because of the savings they offer customers on the back end. Drug companies also issue higher prices to drugs that can extend or even save lives.

Ultimately, the main objective for pharmaceutical companies when pricing drugs is to generate the most revenue. This often means facing competition, which serves to drive prices lower. However, drug companies have balanced pricing drugs too low with the ability to enact price increases at steady intervals.

Pricing a drug incorrectly is one of the biggest mistakes a drug company can make. Pricing a drug too low or too high has a great impact on its potential for success. If, for example, a drug is priced too high, payers may be unwilling to reimburse for it or physicians may be disinclined to prescribe it. They may believe the drug is not worth the high cost if it is likely that it will offer too little benefit to warrant the cost. On the other hand, if a drug is priced too low, physicians may conclude that it offers a discounted form of therapy, less effective than a more expensive drug that already exists.

The research and development (R&D) surrounding each drug is another monumentally important issue in regard to pricing. The amount of time, effort and money that is invested in the R&D for each drug must be weighed when the drug is priced. This often leads to higher prices to ensure that the revenue generated will exceed the expenditures behind the drug's development.