Thoughtleader: Thomas Nagle, Monitor Group

Over the past 20 years, drug companies went from having carte blanche to set drug prices to operating in an ever more tightly controlled environment. Instead of doctors calling the shots, government and private payers are becoming increasingly vocal about which drugs they will and will not cover. Frustrated patients, in turn, are getting anxious about their out-of-pocket costs and access to the medicines they need.

Tom Nagle

This is the volatile environment that pharma is operating in—and smart companies need to wake up to the new reality, says Tom Nagle, founder of consulting firm Strategic Pricing Group (now a member of Monitor Group) and co-author of The Strategy and Tactics of Pricing. Nagle believes the US goverment will soon follow Europe's lead in taking a greater hand in price negotiations, and pharma will need to be able to communicate the value that products offer. Here he discusses how pharma can meet that challenge.

How have pricing issues changed since you published the first edition of your book?

Until the 1990s in Europe and until only recently in America, the pharmaceutical industry lived in a world of its own. It did not operate in a normal market; it was a market where the person making the purchasing decision was neither the person consuming the product nor the person paying for it. It was a crazy world.

It also wasn't a normal market that was driven by value. And that's what's changed. It has definitely changed in Europe, and it's changing in America. Good pricing was all about setting an optimal price level given what customers were willing to pay. And that willingness to pay was almost unrelated to the drug. It was very much related to things like how frequently companies could detail prescribers.

Those days are rapidly going away because now we're in a situation where you have payers very systematically making these buying decisions. There are only a few products prescribed by a few specialists where decisions are made independently. Instead, buying decisions are driven by a comprehensive understanding of value that goes beyond just the value for a particular patient to the impact of that drug on large numbers of people.

Government cost-containment measures have generated more than $25 billion over three years in the top-five EU countries

What changed?

Ten years ago, companies were in a situation where better anti-infectives were curing patients who otherwise might have died, new gastrointestinals were reducing the number of ulcer operations, and the first statins were preventing countless heart attacks. The value of these drugs was so great that worrying about what companies were paid just wasn't that important. People were more concerned about the benefits they were getting.

But we're now at the point where we're making more incremental improvements and looking at smaller and smaller patient populations. And these drugs cost immensely more than those early statins and those gastrointestinals and those anti-infectives.

So we're in a situation where companies have to justify value, and that creates a normal market for the pharmaceutical industry. You know, I hear people all the time saying, "We're going into this crazy world." Well, no, you're not going into a crazy world. You were in a crazy world. You're going into a normal world. Good pricing used to be about setting the optimal price, given what people were willing to pay. Now pricing has become a lot more complicated because good pricing is about getting paid for the value you create.

Europe is fascinating to watch. Could what's happening there—reference pricing in Germany, for example—happen in the United States?

Absolutely, if you're looking at all the drugs covered under Medicare Part D. It's happening right now with devices and with almost everything covered under Part D that's not a pharmaceutical product. So it could be your blood test strips for diabetes. It could be a wheelchair. It could be a bed for somebody who's at home being cared for. What the government has done is basically put everything into reference categories—just like they've done with drugs in Germany and Spain.

The first bids happened this year. Then they'll take the average price of the winning bid and say, "That's the price that we're going to reimburse at."

Now, somebody can choose to get a more expensive device, but they're going to have to pay for it out-of-pocket. As the baby boomers roll into retirement and the cost of Medicare Part D skyrockets, I can certainly imagine them doing something similar with drugs, where there's only one drug in each category and if you want any other drug, you pay the difference.

What do you think about the controversy over Avastin's pricing, specifically the decision to charge twice as much for lung and breast cancer indications?

In this market, price has to be justified by economic value. And the economics of a drug for one indication is not necessarily consistent with the economics for another indication. And if you realize that from the get-go, there are a number of things you can do. You might kill one of the indications because it's not going to be economically viable. Or, you might lower the cost per unit, either modifying the drug itself—which would be very costly—or the way we package it—which could be less costly.

Let's consider Avastin, which was first launched for colon and rectal cancer. Genentech came up with a price that was pushing the limit but still justified from a value perspective, and that price was about $35,000 for the course of treatment. Everyone swallowed hard, but they accepted it.

A few years later, Avastin got approved for lung and breast cancer. Researchers had tested it using dosages that are twice as high for breast and lung cancer—the typical amount for those indications—and now a course of treatment costs $70,000. But the benefits are no greater than they are for colon and rectal cancer. It's going to add the same three months to your life, but you're getting charged twice as much.

Now from a value perspective, you can't tell that story. You can't explain why a month of life is worth twice as much when you have lung cancer than when you have colon cancer. But if Genentech had thought about this in advance, there are a couple of things it could have done.

For starters, it could have packaged a larger dose for lung and breast cancer and charged only 10 percent more. Unfortunately, in clinical trials, you're not only testing your drug's active ingredients, but you're also testing everything—right down to the packaging. So if you wait until the last minute to think about pricing, it's too late. If you decide you want to change the way you've packaged the drug, you've got to go back and do more tests. However, when you have pricing and reimbursement people involved early on—as you're designing your Phase III trials—they're able to make sure all the pieces fit together in a commercially logical way. And, amazingly, very few companies are doing that systematically.

What's striking is that you don't bring up the argument about recouping the cost of R&D, which was almost a mantra of the industry for the last several years.

It's a bad economic argument. No prices, not for drugs nor airplanes nor anything else, are set to recover the cost of R&D. That's a stupid argument. The fact that an R&D effort cost a lot of money is absolutely no justification whatsoever for a high price for the product. On the other hand, having high prices and high contribution from drugs is, in fact, a very good argument for driving R&D. But it's the high prices that drive the R&D, not the R&D that drives the high prices.

How should pharma companies prepare for this "normal market?"

The first thing you've got to do is make sure you're creating value. And it starts with value-driven R&D—and the honest-to-God truth is it's commercially driven R&D.

The other aspect of value-based R&D, other than just thinking in commercial terms, is also thinking in terms of a disease franchise strategy. A lot of pharma companies decide what they're going to be in based on what comes out of the lab. You miss a huge number of synergies in terms of capturing the value in your product portfolio.

Pharma companies need to have disease franchise strategies that drive where they invest their R&D budgets, which compounds they choose to in-license, and which companies they acquire. When a drug comes out of their R&D pipeline that doesn't fit in one of those franchises, they should sell it.

The second thing that you need to focus on in this more value-based world is competitive strategy. Merck took this route when it lowered the price of Zocor to compete with generic simvastatin. Pharma is getting nailed by generics, even before patents expire, and a handful of companies are starting to think about their competitive strategy.

Everybody knows that the first generic is always the most profitable. Pharma can take advantage of that. For instance, a pharma company can allow the launch of a generic version about six months before the end of a patent—either through a generic subsidiary or a standard licensing agreement. That generic is going to get a huge advantage, but the pharma company can also benefit from the ability to collect royalty payments.

Do you think a pathway for biogeneric approvals will accelerate the number of these agreements?

Yes. When it's so difficult to make a product, biologics companies will still be able to make an enormous amount of money. The best thing in the world for them to do would be to say, "We think there should be competition, but we're going to charge every one of those competitors a license fee for the access to our technology and how to make the product."

Are those kinds of discussions actually happening today?

In biologics, I don't know. They are certainly happening in Big Pharma. Big Pharma is thinking about how they'll capture a portion of the generic value or what strategies they can take to just discourage people from wanting to come in with a generic in the first place.

How will R&D change in response to pricing pressures?

When companies are rolling out new products, they've got to be able to communicate their value. Historically, they've communicated only the differentiation. Communicating the differentiation is different than communicating the value.

For example, take Sanofi-Aventis's obesity drug Acomplia. Everybody knows that obesity is costing the healthcare system a fortune. Sanofi-Aventis is emphasizing that this drug is going to save a lot of money on healthcare expenditures in the long-term. But payers want to know how much money and where. And the problem is they don't want to start paying for a drug until they have outcomes data.

Because clinicians design Phase III trials, all they pick up is clinical data. They don't expand the trials to collect data that would help their case commercially. Sanofi-Aventis might have worked with trial participants' health insurers to track how much the cost of heathcare went down for patients taking Acomplia compared with patients taking a placebo. They'd be able to say: People who took Acomplia had this many fewer heart attacks or used this many fewer cholesterol-lowering drugs, etc. And now you're able to tell an economic story.

How far off are we from being able to do this?

It's being done. But it's done four years after a drug is launched, based on the data of people taking it. Then a company realizes, "Wow, this drug's really phenomenally valuable." And at that point, they can't go back and say, "OK, now we know we're really valuable. We want to be paid 20 percent more." And the payers say, "Right."

It's so easy in the United States to underestimate the importance of value-driven R&D because companies haven't had to deal with it as much. But you're seeing it in Europe, as well as the importance of access negotiation, which needs to be part of the pricing strategy.

As soon as a new drug is approved in Europe, companies begin negotiations on whether or not they're going to be reimbursed. The five big European countries have managed to cut their projected budgets by 11 percent just by negotiating.

Government officials will talk about evidence-based medicine and introducing cost-effective drugs. They want that, but they also want just lower prices. And they're going to use all kinds of very aggressive techniques to get those lower prices. And if pharma doesn't understand how to negotiate with them, they risk payers taking advantage of them.

Tom Nagle founded the Strategic Pricing Group in 1987, the year he published the first edition of The Strategy and Tactics of Pricing (Prentice Hall Business Publishing). He previously worked as a professor of marketing and strategy at the University of Chicago and at Boston University. Nagle is a graduate of Penn State University; he received his PhD from UCLA. He is now a partner in the Cambridge, MA office of Monitor Group.