Drug pricing is the new Big Pharma giant-killer

On its face, the recent contracting deal between Express Scripts and Abbvie in hepatitis C – which gives Abbvie a substantial leg up over its main competitor, Gilead, in exchange for a price discount – violates a holy biopharma commandment: Thou shalt not engage in a price war out of the gate when thou launchest a new drug. Is this a one-off deal that won’t have much impact across the industry? Or, does it mark the “end of days” for biopharma?

The answer is “no” and “no”. This deal doesn’t signal the demise of the drug development industry as we know it – however, it does point toward a giant-killer opportunity for small biotechs that could disrupt Big Pharma’s historically successful business model and competitive edge.

First, some history. Until now, payers haven’t typically negotiated cheaper prices for new drugs immediately upon launch. Instead, pharma companies have mainly used discounts to prop up sales of well-established branded drugs in huge markets that are either genericized or highly competitive.

Why haven’t drug companies previously competed based on price and payer contracting when they first hit the market? Most tangibly, because the stakes simply weren’t high enough. Until now, payers have often placed a new drug lacking a definite head-to-head efficacy benefit on a roughly similar reimbursement tier with its branded competitors. In that scenario, a manufacturer can maintain high prices, accept the low formulary placement (and high patient copay), and compete with direct-to-consumer ad campaigns, copay assistance programs, and similar activities – which is exactly what all the major pharma firms have done.

But now, a key assumption underlying that calculation – that patients will have the choice, even if they have to pay a little more out of pocket – can no longer be taken for granted. In the “old world”, Abbvie’s Viekira Pak would have been significantly disadvantaged compared with Gilead’s Harvoni, because it is more cumbersome (four pills vs. one; twice-daily vs. once). What patient, if they had the option, wouldn’t choose the more convenient drug?

But by negotiting a lower price, Abbvie has ensured that most Express Scripts patients won’t be able to choose its “better” competitor, period – and all of a sudden, it’s back in the game, in an enviable position. Unless Gilead wants to run a long, expensive trial proving that its once-daily drug is actually more clinically effective than the four-pill cocktail (and not simply more convenient), the company must either settle for a smaller piece of the pie (Viekira Pak-ineligbile patients and those who fail Viekira Pak), or offer a comparable discount to regain equal access. Either way, Abbvie is in a much better competitive position than it would have been otherwise, and the deal is “Exhibit A” that discounting at launch is a viable come-from-behind strategy.

A more theoretical case for why pharma companies haven’t previously undercut prices at launch is based on game theory. Because a “race to the bottom” is bad for all companies in the long-term, the thinking goes, no-one will make the first move to drive prices down for newly-launched drugs, for fear of killing their own business and the industry as a whole in the process.

But the game theory argument is flawed, because it assumes that the industry depends absolutely on high prices for its survival. That may be true for Big Pharma companies – but that’s because although they are well-designed to fight today's war, they are highly vulnerable in the evolving environment, particularly to emerging biotechs that are untethered to the historical operating model.

Until now, large drug companies’ sprawling, expensive sales and marketing infrastructures have enabled them to dominate markets and created huge barriers for smaller entrants. But if contracting can be used as a major weapon to lock out competitors, then Big Pharma’s commercial operations aren’t an advantage any more – they’re just an expense line – a massive expense line, with headcount to boot, that keeps the company’s leaders from imagining a different way of doing business.

In contrast, a pre-launch biotech in tight competition with a global pharma company now has two choices. One is "business as usual" – spend huge sums to build and maintain a sales force, market the heck out of its drug, and claw for every sliver of market share. Or, the company could spend a fraction of that cost to hire a top-notch market access team and secure contracts with large payers to lock out competitors. In the second option, even if the biotech gave away some pricing power, it’s likely the combination of unfettered access to patients and reduced sales and marketing spend (which is a low-return investment even in the best of times) would maintain a high operating margin – and create a new model for value-creation in biopharma in the process.

Some may argue this is an over-simplification, as it assumes that doctors and patients will accept reduced access to a higher-priced drug, and accept the cheaper one as medically equivalent. Admittedly, that may not be true in all markets, but there are at least a few cases on the horizon (PCSK9 inhibitors for hypercholesterolemia, perhaps) in which payers may be able to favor one new agent over another without risking backlash from the clinical community.

And once the door is wedged open, is it so far-fetched to think the same principle could be applied more broadly – to new psoriasis drugs spanning various mechanisms of action, for example? Even oncology, long the “third rail” for active management by payers, could see a pricing and contracting battle among anti-PD-1 agents for melanoma, if their clinical profiles appear largely similar.

When Big Pharma companies are solely competing against one another, they may be sufficiently wedded to the conventional business model that “game theory” will kick in to keep them from battling one another on prices of new therapies, except in rare cases. But small biotechs are more likely to follow Abbvie's lead, disrupt the game entirely, and take down their larger, more established competitors. The question is no longer whether we will see pricing and contracting wars among newly-launched drugs, it's when – and which companies will survive.