Pharmaceutical Supply Chain: Value-Based Prescription Drug Prices

Why U.S. drug prices are so high
The cost of prescription drugs and medical insurance is on the minds of many Americans.   Many consumers wonder why costs seem to be spiraling out of control as compared to that of other Western industrialized nations.  Although the need for high quality, affordable healthcare and prescription drugs is universal, prescription drug pricing strategies are not transparent or easy to understand and the pharmaceutical supply chain is complex and challenging.

Other countries in the developed world have simplified healthcare systems and consider healthcare and medication to be essentials of life, something that their citizens literally cannot live without on a daily basis.  In Canada, the cost of medication is regulated to ensure that it is affordable for all citizens, no matter their income or personal wealth.  Other countries such as the United Kingdom, France, Germany and Sweden each use different kinds of governmental policies to help control prescription drug spending and pharmaceutical companies.

With simplified healthcare systems in many countries, less organizations are purchasing drugs, enabling purchasers to exert greater buying power when negotiating with pharmaceutical manufacturers.  This is more effective in reducing the cost of prescription drugs.  Other countries effectively limit the number of entities in their pharmaceutical supply chains and healthcare systems (buyers of prescription drugs).  This makes pharmaceutical manufacturers more responsive, sensitive to pricing differences and fluctuations.  In those instances, if a sale is not successfully negotiated, the drug is simply not included on the drug formulary, effectively losing the opportunity to be sold to that part of the consumer base.

Take, for example our neighbor to the North, Canada.  Canada offers comprehensive universal healthcare coverage, reducing the cost of prescription medications significantly when compared to that of American consumers.  The Canadian Health Ministry, Health Canada uses a drug review board to examine the purported claims of prescription drugs and evaluates effectiveness relative to other drugs on the market.  By providing this analysis, Health Canada is better positioned to determine the price for each drug product.

Outside the United States, many countries have established a government agency empowered to negotiate drug prices with pharmaceutical companies.  As part of this effort, the agency investigates and evaluates the effectiveness of new prescription drugs to determine if they provide improved benefits or better outcomes over existing drug products.  Part of the evaluation involves risk analysis and consideration of whether each new drug product is worth bringing into the pharmaceutical market of that country.  One example of this is the healthcare system in the U.K., the National Health Service.  In the U.K., the National Health Service buys all the prescription drugs needed to supply their nation’s consumers, effectively a formulary.


Complexity of U.S. Pharmaceutical Supply Chain and Drug Prices

By comparison, the American healthcare system involves individual medical insurance organizations, hospitals and healthcare plans, all purchasing prescription drugs for their respective consumers.  Pharmaceutical companies negotiate the pricing of their drug products with the healthcare plan providers, PBMs and other groups.  Because prescription drug pricing is not regulated, this results in a wide array of pricing that is not transparent to consumers. PBMs have strong buying power and negotiate discounts and rebates with pharmaceutical manufacturers.  They can refuse to stock a specific drug product if the discount is inadequate, may elect not to include a drug on specific formularies for clients or may list the drug product on a lower tier of benefits.  Positioning a drug product on a lower tier of benefits would make the drug available to patients but would require that more costs were passed along to the patient, making it less likely that the drug would be purchased.

In the United States, even the largest provider of prescription drugs, Medicare cannot legally negotiate the pricing of drugs with pharmaceutical companies.  When considering the number of American patients it serves, Medicare is one of the largest purchasers of prescription drugs in the country.  Being able to negotiate drug pricing with pharmaceutical manufacturers would enable Medicare to reduce drug prices.

Collective bargaining power is used by the United States Department of Veterans Administration to reduce prescription drug pricing for products in nearly all therapeutic classes up to 40% as compared to other entities in the American healthcare system.  The trade-off is that the Veterans Health Administration covers fewer drug products.  Older patients often sign up for Medicare drug plans so that medications not covered by the Veterans Health Administration can be covered by another option.


Why are Prescription Drugs in America So Expensive?

Pharmaceutical manufacturers are usually focused on profitability from the perspective of global profits.  The profits from individual countries are a secondary consideration.


Regulating Drug Prices:  Will Innovation in Life Science be Sacrificed?

Encouraging innovation in the pharmaceutical industry is in the public interest, as well as in the economic interest of the United States.  Pharmaceutical innovation and breakthroughs can occur anywhere, from Western countries to emerging markets.  This year, the FDA reported that it is working on an overhaul to its new drug review process, enabling the launch of new pilots and strategies that will aid in modernizing clinical research and data analysis.  Why is this important? Instituting new incentives, processes and strategies for testing, approving and getting cutting-edge drug therapies to patients can save money and lives.  This may even help reduce drug prices.  Food and Drug Administration Commissioner Scott Gottlieb hopes to reduce the costs associated with clinical research to expedite drug approvals and increase competition to help bring drug prices down.

It is an exciting time to work in the pharmaceutical industry.  Innovation and health advancements seem to abound.  Take for example, two of the most promising new types of drug therapies.  From stem cell therapy clinical trials to genetic testing, life science pharmaceutical companies seem to be making a difference, start to finish, in the quality of human life around the world.  The pharmaceutical industry reported earlier this year, that scientists had neutralized the “most significant gene responsible” for Alzheimer’s disease for the first time.  Life science experts hope that this effort could lead to a new drug that can possibly stop the disease.

What is the future of gene and stem cell therapy?  Highly positive, it would seem.  According to life science industry experts, a “bright and robust” pipeline is anticipated to yield more than 40 approved therapies within the next five years.  Drug development efforts are anticipated to be fueled by promises of an improved regulatory environment designed to accelerate approvals for regenerative medicine therapies.

Tne perspective starts with drug manufacturing.  Producing prescription drugs is expensive.  Not every drug product that starts out in research makes it out of the development stage.  To be profitable, pharmaceutical manufacturers must produce drugs that are successful enough to cover the cost of all their drug products, whether or not they make it out of the research and development stage. The expectations of future profits fuel investments in the pharmaceutical industry.  Having no ceiling on pharma costs increases the likelihood that investments will continue but do nothing to reduce the cost of prescription drugs for American consumers.  In other words, in the pharmaceutical industry, American consumers are paying higher prices for prescription drugs and this helps to subsidize drug research for the rest of the world.  While this is detrimental in terms of cost, it does produce the result of continued innovation, saving untold numbers of lives globally every year.  Lower drug costs or innovation?  This is the dilemma that lawmakers have faced for years.

Yes, the federal government can establish price controls, however this may have somewhat of a chilling effect on the industry.  Pharmaceutical manufacturers may be likely to accept less risk and may become more opposed to supporting as much research and development due to decreased profits.  Without a free market to provide incentives, the research and development efforts of new drugs will not be as aggressive.  Lower profits make investing in pharmaceutical companies less attractive for investors, reducing the probability of research for new, innovative products.  This would mean the patients all over the world would have fewer choices and access would be limited to potentially life-altering therapies.  More therapies lead to better overall patient outcomes.

Canadians benefit from American pharmaceutical manufacturers.  Because Health Canada utilizes price controls, Canada buys prescription drugs from the United States at a reduced cost.  American drug manufacturers sell outside the country but count on paying for development costs via the home market.  In fact, because the U.S. is willing to pay more for prescription drugs, Americans have been bearing the cost of research and development.

The Difference Between Drug Prices and Reimbursement

The pharmaceutical supply chain is neither simple nor straightforward  and drug pricing is not easy to understand.  Unlike in other industries in which consumers are involved, the consumer (patient) is rarely the decision maker as this process is governed by an expert, the physician.  Consumers also do not make direct payments, paying the cost of the drugs directly unless they do not have health insurance or have medical insurance with a high deductible on prescription drugs.  Usually, patients are insured so a co-payment or co-insurance is involved.  Most of the cost of the prescription drugs is usually covered by the insurer.

Here is basically how it all works.  Prescription drugs start off with a list price, established by the drug manufacturer.  Usually this is not the actual price that most, if any consumers pay.  A prescription drug’s list price is only the starting point, the base rate on which discounts and rebates are calculated. 

In the pharmaceutical industry, the term “reimbursement” refers to the specific amount that the insurer pays for the drug product, regardless if this is by Medicare, Medicaid or a private insurer.  The type of drug product will determine who will be paid directly, i.e. in some cases the insurer pays the physician, drug manufacturer or PBM, etc. Pharmacy Benefit Managers commonly referred to as PBMs commonly receive highly discounted pricing. Wholesalers and physicians who purchase prescription drugs also receive discounts and do not pay the list price.  The most common drugs that physicians purchase are those that require administration by infusion.  Usually physicians purchase these drug products through (and from) a PBM or wholesaler who buys the drugs from the pharmaceutical manufacturer.  The drugs are administered to the patient by the physician in the doctor’s office or clinic and this is billed to the insurer, then reimbursed by the insurer.

Factors that Influence Drug Prices by Pharmaceutical Manufacturers

After a pharmaceutical manufacturer has determined research and development costs and decided to manufacture a drug product, the pharma company assesses all costs involved with a clinical trial.  The total expenses involved with research and development and clinical trials is combined and examined to determine if the company can sell the drug and cover these expenses.

After this has been accomplished, the pharmaceutical manufacturer considers the following factors when pricing its prescription drug products:

Clinical Value

  • Does the drug help patients live longer?
  • Will the drug help patients live better?

Competitive Value

  • How does this drug compare to other similar drug products?
  • Does this drug have direct competition?
  • Will payers pay for this drug product?

Market Pricing

  • Can patients afford the co-pay?
  • What is the average co-pay for a patient?
  • What is the pricing for other similar drug products?
  • Will the manufacturer have to provide government-mandated discounts (i.e. 340B clause in Medicaid)?
  • What is the cost of doing business providing discounts to PBMs and wholesalers?
Typically, pharmaceutical manufacturers consider these factors and determine the amount that they can charge for each drug product based upon its clinical value to patients, competitive market value and strategic pricing to meet the needs of the various entities including government programs, PBMs and patients.

With that said, the size of the market (number of patients who would need the drug product) influences the cost of the drug.  Drug products that are needed by fewer patients tend to be more expensive because costs would be spread across a smaller population.  This presents distinct challenges for both pharmaceutical companies and their investors as well as for patients suffering from rare diseases and unusual medical conditions.  Often referred to as “orphan drugs”, economies of scale with respect to spreading the cost of research, development, clinical trials and marketing do not work in favor of these products.   Profitability fuels R&D for other products.

Although consumers are clearly concerned about the cost of prescription drugs, access is also a major concern.  Consumers and physicians have expressed concerns that higher prescription drug pricing may result in insurers deciding not to cover expensive drug products.  Insurers and policy makers have shown increasing resistance to high drug list prices.  The challenge is what to do about it.  Implementing a strategy that reduces prescription drug prices and maintains a reasonable standard of affordability must be balanced with the requirement of enabling continual investment in pharmaceutical research and development, clinical trials and all the costs of bringing drug products to market.

Value-Based Pricing of Prescription Drugs

What if the U.S. were to transition to a new pricing model for prescription drugs?  Instead of associating sales revenue to volume, perhaps the answer is to focus on pricing prescription drugs based on efficacy.  Value-based pricing, in general terms, links the specific price charged for a given drug product to an evaluation of how well it worked.  Changes in recent years in the healthcare industry are starting to show a turn to value-based healthcare programs.  In the healthcare industry, CMS, the Centers for Medicare and Medicaid Services has proposed changing from a fee-for-service model to value-based pricing. 

The value-based healthcare model relies on a team approach to provide needed resources for patient care, focused intently on keeping patients healthier.  Incentives would be provided to the primary care physician, team of healthcare providers and other resources based on the quality and affordability of the healthcare solutions that produce the needed outcome of health for patients.

In the pharmaceutical industry, value-based pricing could mean that insurers and patients could receive rebates from drug manufacturers if drug products failed to work (known as outcome-based pricing).  Another alternative pricing model would be for drug companies to charge different prices for a drug based on the different conditions it is used to treat.

One potential obstacle to value-based pricing is Medicaid’s Best Price Rule.  This ensures that Medicaid programs do not ever pay full list price for any drug product.  The statute includes a requirement that Medicaid will receive rebates that are worth approximately 25% of a drug’s average manufacturer price.  This acts as a guarantee that Medicaid can purchase the drug at the lowest possible price that the manufacturer can afford to sell it.  The problem arises in the outcome-based pricing model.  If manufacturers will be paid less when drug products perform poorly, the manufacturer could see their revenue decimated from Medicaid.  To get around this issue, drug companies and insurers can grant a rebate based upon the performance of the drug across a patient population.


As American consumers get ready to select their 2019 medical insurance and evaluate prescription drug plans, many are concerned about the burgeoning cost of prescription drugs.  Many low income consumers who suffer from chronic health conditions and lack prescription drug insurance may face a choice between food and other essentials or the prescription drugs they need to remain alive and healthy.  Paying for prescription drugs without insurance can be eased with use of prescription drug cards that enable discounts and rebates.

Why is the root cause of why American drug prices are higher than those in other countries?  By comparison, the United States has a more complicated pharmaceutical supply chain and healthcare system, one in which cost is built into multiple levels. These costs are not transparent or easy to identify. The United States is one of the few top economies in the world that does not provide universal health care to its citizens.  In addition to these factors, a huge amount of life science innovation occurs in the United States.

Pharma Companies Try to Keep Drug Prices Under Control by Using Technology for Inventory Management

Pharmaceutical companies face high pressure to keep costs and labor productivity under control as this affects drug prices.  From drug development to clinical trials and production by contract manufacturing companies, drug products need to be tracked, stored and shipped appropriately to meet Food and Drug Administration regulations as well as to ensure quality control and drug supply chain security.  Pharma companies rely on sophisticated warehouse management systems for inventory management and assurance of quality control processes.

Using the proper WMS can ensure that pharma companies maintain proper inventory levels, conserving working capital, labor and time.  Maintaining drug inventory at the optimal level reduces labor cost (handling, stocking, processing and locating drug inventory).  Third party logistics providers (3PL) that offer warehouse and logistics service to pharma companies typically use a specialized 3PL warehouse management system which enables them to bill according to each client’s specific needs and requirements.

Carrying excess drug inventory ties up money.  To be successful pharma companies need to be able to reduce the amount of drug inventory without causing problems in meeting customer demand.  Pharmaceutical companies need to be assured that the WMS technology they use ensures accurate, streamlined operations for inventory management, cycle counting, track and trace, quality control and more.  Of the many challenges facing the pharmaceutical industry, ensuring production quality and drug supply chain security, minimizing the incidence of counterfeit drugs in the supply chain are prominent issues.  These challenges cost millions of dollars every year and can be minimized by using technologies across the pharma supply chain.

American pharma companies innovate, start to finish on life changing solutions such as stem cell therapy and the process of drug development, clinical trials and regulatory compliance is burdensome.  Without regulations, U.S.  pharma companies pass along more of this cost to American consumers.

Getting the cost of prescription drugs down is challenging so as not to discourage future innovation and the development of innovative new life saving therapies.  Lawmakers, policy experts and pharmaceutical industry experts need to collaborate on simplifying the pharmaceutical supply chain to reduce costs and provide transparency for consumers and regulators.

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