The Pharmaceutical Price Gouging Dilemma

Drugs play a critical role in our daily lives – they can be used to reduce pain, regulate bodily processes, and even mitigate metastasizing of cancer. Since pharmaceutical drugs are essential to the health of American citizens, the public reacts sensitively when a price of a lifesaving drug goes up. When the price of a lifesaving drug goes up by a marginal amount, consumers will usually swallow the additional cost. But when the price goes up significantly, many might push for reform rather than passively accept the change. An instance of this happened recently when the price of a drug increased by more than 5000 percent within the span of 24 hours.

In September, price gouging in the pharmaceutical industry was brought to public attention when Martin Shkreli, the CEO of Turing Pharmaceuticals, raised the per-pill price of his newly-acquired product, Daraprim, from $13.50 to $750 overnight. Daraprim had been on the market for 62 years and was a very widely used drug for curing toxoplasmosis, a common parasitic infection.

This exorbitant price increase is known as price gouging, a market phenomenon and concern that involves firms jacking up the prices of their product by rates that are considered unfair. Price gouging is considered unfair when the new high prices make them financially inaccessible to masses. And yet, price gouging is not regulated in the pharmaceutical industry.

This price hike caused a huge public and social media backlash, with people denouncing Shkreli as a “thief”, “brat’’, or “criminal”. Shkreli, however, claimed to the Los Angeles that he wasn’t going to put “this money in [his] pocket and use it to pay [himself] a dividend,” but rather invest it in research aimed at eliminating toxoplasmosis. Many medical professionals, though, have doubted his rationale as it’s widely accepted that Daraprim is effective already with little to no side effects according to Dr. Carlos del Rio of Emory University. Eventually, Shkreli’s damaging actions, drew the attention of powerful figures and organizations. Democratic presidential candidate Hillary Clinton promised to personally look into reforming the drug market. The Infectious Diseases Society of America and the HIV Medicine Association claimed that this price gouging was unjustifiable, and the encapsulating Pharmaceutical Research and Manufacturers of America disavowed Shkreli as a member.

Shkreli’s price gouging is particularly revealing of the dilemma that price gouging in the pharmaceutical markets presents and how difficult it is to find a resolution to this dilemma. This dilemma and resulting difficulty can be underscored through three key ideas:

One, the ubiquity of price gouging makes preventative measures difficult.

Most major pharmaceutical and biotechnology groups have attempted to paint Shkreli’s decision as an anomaly. In truth, though, price hiking is commonplace among pharmaceutical companies. Drugs that are more life saving and far more consequential than Daraprim have had their prices increased gradually over time to avoid media backlash.

According to Alliance Bernstein, a global asset management firm, the Canadian drug company Valeant increased the prices of their two heart-related drugs, Cuprimine and Isuprel by more than 2000 percent over the past two years. Similarly, Wolters Kluwer’s PriceRx database, a database of drug prices information, reflects that the prices of the Pfizer’s drugs have gone up by 115.9 percent since 2013. And the well known Gilead Sciences, the research based biotechnology company, charges $84,000 per treatment for its widely sought out hepatitis C drug treatment, according to the Centers for Medicare and Medicaid Services.

These examples show that price hikes are not a rare phenomenon in the pharmaceutical market. It is a practice that is more pervasive than what is evident, and therefore these examples only detail a small aspect of the price gouging and unfair market practices that pharmaceutical companies employ. So while encompassing groups such as PhRMA attempt to portray Shkreli’s actions as uncommon, in reality, Shkreli is actually emblematic of a widespread practice, and an even larger issue in the industry.

Two, the pharmaceutical market structure facilitates price gouging.

The pharmaceutical market is imperfect with evidence of monopolistic competition in specific drug categories. Drug manufacturers produce differentiated products and can have complete market share within a therapeutic segment rather easily due to the variety of diseases encompassed under the pharmaceutical umbrella. Consequently, many drugs are not substitutes of one another, and many do not have substitutes at all. Because of this, firms can remain immune to the price changes of other drugs, essentially eliminating producer competition altogether.

What needs to be considered in conjunction with a firm’s external price immunity is the inelastic demand for certain drugs. Some people need certain drugs to live and function. These drugs are absolute necessities for these people, and in many cases, because of the market structure, these drugs have no substitutes. Thus, the pharmaceutical companies that produce these drugs can jack up the price of their drugs because they have a consumer base that has a strongly inelastic demand for these drugs, guaranteeing that sales will not wane over time.

Three, price gouging is hard to resolve from the producer side as potential solutions are hard to implement.

One way to potentially resolve this situation is to introduce competition. While this seems theoretically simple, as any firm could offer a cheaper substitute to Daraprim and push Turing out of the market, it’s not exactly feasible in practice. Drug producers looking to create substitutes might be turned off while looking at the profitability in markets that are small and dictated by a single, established firm. In addition, the patent process takes too long for firms to join in on the market. Patents for new drugs to compete with monopolistic ones like Daraprim would take an average of a little under 3 years to be approved, and because the market that the drug would compete in would probably have changed within that time, entrepreneurs are not willing to make that investment. Therefore, Shkreli’s production of Daraprim is a monopoly in its market that is created by not only market forces, but also protocols and regulations.

One possible way to combat high prices in the pharmaceutical market is by demanding transparency in pharmaceutical firms and government regulation. But government regulation in itself can be tricky to implement in that it can be too in favor of the consumer. Imposing policy that lowers drug prices may in the short run make drugs more affordable to the consumer, but it can also dramatically stifle the revenue of the pertinent pharmaceutical firms. This can lead to the loss of innovation and incentives for improvement of drugs in the long run.

Ultimately, society must decide if life-saving drugs should be more affordable for those who desperately need. However, this will have to be considered with the trade-off of creating an efficiency loss and drastically cutting the revenues of pharmaceutical companies that will put that revenue to use in research and development in the pipeline for new drugs.