Drug Price Gouging in Generics

General info on prescription drugs and generic drug price gouging.

Martin Shkreli managed to make himself a household name a few years back. His claim to fame stemmed from the decision by Turing Pharmaceuticals, a company he founded and controlled, to acquire the rights to produce Daraprim. He then raised the price of the drug by 5,000 percent.

This was very bad news for the people who were dependent on the drug. Daraprim is an anti-parasitic drug that is often taken by people with AIDS to keep them from getting opportunistic infections. People with AIDS who are being successfully treated with Daraprim are not going to want to experiment with alternatives.

Daraprim was already a 60-year-old drug at the time Turing acquired it and had long been available as a generic. This meant that other manufacturers could in principle come into the market and compete with Turing’s inflated price.

Shkreli made the bet that no other drug company would take advantage of this opportunity, because even for a generic drug, there are still substantial costs for entry. Since the market for Daraprim was small, a new entrant would be unlikely to recover these costs if Turing pushed the price back down somewhere near its original level. While Daraprim was his biggest “success,” Shkreli was trying this strategy with a number of other drugs before the Justice Department put him out of business with unrelated charges of securities fraud.

Shkreli’s days of price gouging in the generic drug world may be over, but he established a model that other ambitious entrepreneurs are likely to follow. Close to 40 percent of generic drugs have only a single manufacturer. This is partly a result of the failure of anti-trust policy to stem a wave of mergers in the industry. It is also a result of the fact that many drugs simply have very limited markets where it is difficult to support multiple producers.

Most generic producers have not tried to follow the Shkreli model and jack up prices of drugs that people need for their health or even their lives, but some have. The soaring price of insulin is one important example, EpiPen, the asthma injector, is another. Both involve well-known treatments that have long been used, but the limited number of suppliers has allowed for huge price increases in recent years.

This is the context for the public drug-manufacturing corporation being proposed in a bill by Senator Elizabeth Warren and Representative Jan Schakowsky. The idea is that the federal government should create manufacturing capacity (which could be privately licensed) that would allow it to quickly enter a market to compete with the next Martin Shkreli.

If a company tries to jack up its prices by an extraordinary amount, it would find itself soon competing with a government manufacturer that is selling the same drug for the cost of production, plus a normal profit. This is a great strategy, since simply the existence of this capacity should be sufficient to discourage the next Shkreli.

There will be little money in jacking up the price of a drug by 5,000 percent if it quickly results in the disappearance of their market. This should encourage the generic industry to keep its prices in line.

It is important to note a key difference between the generic industry and brand industry. The brand pharmaceutical companies, like Pfizer and Merck, could argue that they need high prices to pay for research. These companies hugely exaggerate their research costs and downplay the extent to which high profits just mean more money for shareholders, but they actually do research.

By contrast, the generic industry is not researching new drugs. They are manufacturing drugs that have been developed by others. In this sense they can be thought of like a company that manufacturers paper plates or shovels. They need a normal profit to stay in business, nothing more.

For this reason, the Warren-Schakowsky proposal is very much the right type of remedy for excessive prices in the generic drug industry. At the same time, we have to recognize that generic drugs are the smaller part of the problem with high drug prices.

Although generics account for almost 90 percent of prescriptions, they account for only a bit more than a quarter of spending on prescription drugs. The story of drugs costing tens or hundreds of thousands of dollars a year is almost entirely a story of brand drugs with high prices as a result of patent monopolies or related protections.

This will require a larger fix, likely along the same lines, with the government paying for research and allowing new drugs to be sold as generics. But the Warren-Schakowsky bill is a huge first step in bringing drug costs down and ensuring that people will not find themselves suddenly at the mercy of the next Martin Shkreli.

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