Japan: Balancing Cost and Innovation through Pricing

Global and Japanese pharma companies can create a win-win situation through a new pricing mechanism, writes Nobuko Kobayashi.

Despite its affluence and a large, aging population of 120 million, Japan generally does not make the short list of target markets for initial drug launches by American pharma startups. Rather, many American drug manufacturers elect to launch first in the US or Europe prior to launching innovative medicine in the Japanese market. Among the most compelling reasons for the lag time in Japanese drug launches is the perception of a difficult approval process and, perhaps more importantly, an unfavorable pricing environment for true innovation.

Even when Japan-specific pivotal trials are successful, the pricing system in Japan presents a major hurdle for many American biotechnology companies. In the US market, commercial insurers individually negotiate drug pricing policies with manufacturers according to a relatively flexible array of paradigms, ranging from perceived physician and patient demand to budget impact models to comparative value analyses. It is also customary (and expected) for manufacturers to modestly increase pricing after launch. In contrast, drug prices are highly regulated in Japan. The government sets the initial price according to two primary methodologies: reference pricing and cost calculation methodologies.

Japan is also known for the practice of price deflation. This further suppresses the long-term relative economics of Japanese drug launches. It also creates a barrier for the introduction of truly innovative drugs (such as some disease modifying drugs) which, by definition, may not have direct comparators and therefore lack a price benchmark for reference pricing. The cost method, on the other hand, may not allocate appropriate premiums for truly innovative drugs, particularly relatively inexpensive-to-manufacture small molecule drugs. Given this array of circumstances, many American drug companies choose to release in other markets, US or EU, to make the reference point before tackling the Japanese market.

Surprisingly, the view looks quite different from the Japanese side. Many decision and policy-makers are not as concerned as they should be that the country is being passed over for innovation in the form of groundbreaking drugs with non-Japanese origins. Six years ago, in 2012, Price Maintenance Premium (“PMP”), also known as the Innovation Premium, was introduced to assign premium for the pricing of new drugs. Many non-Japanese pharma players availed themselves of PMP. As of 2012, GSK had the most drugs with PMP application at 51, followed by Pfizer with 43.

The Japanese government asserts that PMP encourages innovation, driving the drug lag (the time elapsed between when a drug becomes available outside Japan and then in Japan) significantly down. In pre-PMP days (2006 to 2009), a mere 18% of domestically approved drugs had drug lag of less than 1 year, whereas from 2015-19 the anticipated equivalent estimate is 71%, according to the Ministry of Health and Labor. 

PMP has been considered a success, albeit with a larger-than-expected drawback. While it eased profitability for new drug introduction, it also drove up pharmaceutical spend as pricier new drugs flooded the market. National medical spend, within which drug constitutes about 20% in Japan and is already north of 42 trillion yen or 380 billion USD, keeps ballooning at the pace of 1 trillion yen or 9 billion USD increase a year without a corresponding major policy revision. In response, PMP underwent a major overhaul in April 2018 to limit the scope of application. As a result, drug pricing is expected to contract by 7.5%.

Why this discrepancy of views from Japan and abroad?  First, there is a misrepresentation of data. When Japan officially measures its drug lag, an indicator used to signal the innovation speed (the shorter the drug lag the better for innovation), it typically includes the drugs that were simultaneously developed both in US and in Japan. These drugs have, over the past decade, been introduced more swiftly in Japan largely because of acceleration of approval process. But if we enlarge the scope to all newly developed drugs, incorporating the ones that were not originally developed for the Japanese market, the drug lag is in fact largely present or getting worse. Based on the data, it appears that Japan is still passed over for initial launches of truly innovative drugs, even if such drugs eventually find their way into global markets.

Why is Japan overlooked for the early launch market even in the presence of PMP? Because PMP is fundamentally built on the historical pricing methodology of reference and cost. PMP is, as the name suggests, a premium put on top. It is a Band-Aid of solution instead of a comprehensive framework regarding how to price innovation in new drugs.

The lack of attractive pricing for American manufacturers is not only an inhibitor of innovation but also a contributor to cost increase in the Japanese medical market. For example, let’s examine a case where a biotech startup or pharmaceutical manufacturer develops a truly innovative, disease-modifying osteoarthritis drug which could eliminate the need for expensive total knee replacement surgery (i.e., $20k to 40k in many markets including the US).  The only available treatments currently are relatively inexpensive NSAIDS and other drugs which only address pain. The problem is, they can have serious side effects and allow progression of the disease - in some cases, even facilitating it.

The new drug, if appropriately priced, would presumably ease the total cost of medical care and improve the quality of life for the patient. In the current Japanese pricing scheme, the regulatory body might not be able to price appropriately as there is no reference price point until the same drug is launched in other markets. And the cost methodology would likely be inadequate to reflect the drug’s R&D costs and value. The manufacturer of such a drug would be ill advised to launch in Japan until well after reference prices can be established in more financially attractive markets. The Japanese patient would thus wait longer to receive innovative care compared to a patient in many Western markets.

How can international pharma companies help Japan unlock its potential? The first step is to continue to oppose the revision of PMP as the old version provided a nice cushion. But if we truly want to give Japan the credit of a large market it deserves, we must revise the fundamental lobbying message which is to introduce a new pricing methodology which takes into account holistic cost avoidance. Cost avoidance that is an incorporation of total patient-level and societal costs of significant delay in getting treatment. In the field of regenerative medicine, Japan has already taken the route to assign a provisionary price to launch, which will later be adjusted by its cost benefit analysis. The sector could implement a test introduction of such a new methodology in the biotech drug arena where innovation is particularly accelerated, and hence where the old pricing scheme cannot render an answer.

It is critical that Japan, with its aging population, cuts healthcare expenditure as well as fosters innovation. The size of the market makes it intrinsically attractive to any global pharma player. Innovation of the pricing scheme could unlock potential that benefits all facets of the market.

Nobuko Kobayashi is a partner in global management consulting firm A.T. Kearney’s Consumer Goods and Retail Practice.