Newsroom

Lemonade, Robots and Cancer: The Pros and Cons of Value Pricing

01/22/19

Category:

By:

Tom Robertson, Executive Director, Vizient Research Institute

One weekend last summer, the temperature hit 99 degrees. As I walked down the sidewalk, I could see heat waves rising from the pavement. Two kids stood behind a folding table, on which sat a jug of ice-cold lemonade, the droplets of condensation running down its side. A hand-painted sign said, “Lemonade 25¢.” Handing one of the kids a dollar bill, I drank the lemonade; there are few things better than a very cold drink on a very hot day. The little girl counted out three quarters and offered me my change. I told her to keep it, and suggested that they were not charging enough on such a scorching day. The young lemonade entrepreneurs had not yet learned about value pricing, a revenue optimization strategy that’s having a profound impact on patients with serious medical needs

A 2013 study published in The Oncologist found that one in four cancer patients failed to receive prescribed chemotherapy due to cost, while 20 percent filled only part of a prescription or took less than the prescribed amount due to their inability to pay. A study published by the University of Pennsylvania in 2018 discovered that one-third of Medicare patients failed to fill prescriptions for a life-saving leukemia drug that could provide a virtually normal lifespan with a good quality of life, yet without it are likely to die within five to seven years. The annual cost of the drug is more than $100,000 and Medicare patients (who have no ceiling on prescription copays) are responsible for $8,500 per year.

More than half of elderly Americans have $13,800 or less in liquid assets. Medicare patients with cancer spend an average of 11 percent of their income on treatment, according to an article in JAMA Oncology; patients without supplemental insurance pay 23 percent of their income on cancer treatment. One in 10 elderly patients without supplemental insurance spend 60 percent of their income on cancer expenses.

The devastating economic implications of emerging drugs and biological treatments for complex illnesses will not be solved by universal insurance coverage. Medicare, the leading candidate for a single-payer system, leaves beneficiaries exposed to prohibitive out-of-pocket expenditures for drugs now commonly coming to market with six-figure annual price tags. At the epicenter of the affordability crisis is the concept of “value pricing.”

Value pricing is a marketing strategy designed to maximize revenue by charging as much as the market will bear based on a product’s differentiated advantage over the next best option rather than setting the price based on a markup over costs. The strategy makes perfect sense economically, and rational examples are not hard to find. Consider a robot that reduces the manufacturing costs for a potential customer by $1 million. If the robot costs $50,000 to make, it could be sold at a substantial profit for $75,000. Its value to the customer, however, is much higher. A price of $500,000 still allows the customer to realize a 100 percent return on investment. In the absence of a lower-cost, next-best alternative, the robot will be priced at $500,000.

Following similar logic, consider a new gene therapy that allows a patient with hemophilia to create clotting factor protein and avoid a lifetime of blood transfusions. Using the robot rationale, it may not seem unreasonable to price the new gene therapy just below the cost of a lifetime of blood transfusions. The difference is the customer’s ability to pay. Few of us worry about a Fortune 100 company paying $500,000 for a robot that saves them $1 million. It’s a business decision and if they don’t have the $500,000 they can wait until they do. When patients face tens of thousands of dollars in out-of-pocket expenses for a new drug without which they will die, however, the circumstances change.

A recent report from America’s Health Insurance Plans projects drug spending to grow from $337 billion in 2015 to more than $560 billion by 2020, an increase of nearly 70 percent. The rapid rise is largely driven by new, high-priced specialty drugs – an estimated 225 are expected to hit the market in the next five years, with nearly half costing more than $100,000 per patient, per year. While specialty drugs account for less than 2 percent of all prescriptions, they make up roughly 30 percent of total spending on prescription drugs. Numerous examples have annual price tags in excess of $500,000 per patient, per year.

A spokesman for the pharmaceutical industry defends value pricing by saying, “We price our medicines to reflect the value they bring to patients and society … we also continue to invest in new treatments so we can find ways to make more cancers survivable.” The industry frequently cites research and development as the justification for high prices – implying that new discoveries would disappear if drug prices were lower. An effective drug for the treatment of leukemia that sold in the U.S. for $4,500 per month in 2001 is priced today at $8,500 per month, yet still sells in Germany and France for $4,500 and $3,300, respectively. It’s safe to assume that the company is not losing money at its European prices, and 17 years is arguably long enough to recover research and development costs.

The Pharmaceutical Research and Manufacturers of America deflect criticism of a $154,000 per-year drug price by citing physician services, transportation expenses and the inability to work as significant contributors to a cancer patient’s financial difficulties. In 2017, the 90th percentile household income was $170,432. It’s not clear if the ability to work would enable a cancer patient to afford a $154,000 drug. If patients or even society cannot afford new discoveries, it begs the question as to whether the research and development was prudent.

A 2016 article in the Harvard Business Review (HBR), “A Quick Guide to Value-Based Pricing,” asserts that for value pricing to work, there needs to be a next-best alternative for comparison. The HBR article observes, “For truly new products without peers, value-based pricing won’t work well.” Without a next-best (and higher cost) alternative against which the new product can be compared, a high introductory price would appear arbitrary and could elicit criticism. Value pricing in health care raises policy questions that do not arise in the case of more discretionary consumer purchasing. It’s easy to ask how much more a big screen television shopper will pay for an extra five inches of screen size, but asking how much a desperate mother will pay for an extra two years with her children is far less comfortable.

For patients with life-threatening illness, new drugs or emerging biological treatments are as essential to survival as clean water is to the rest of us. It’s worth asking ourselves whether society would long tolerate a private sector entity holding exclusive access to clean water or charging prices that the vast majority of people could not afford. There’s an economic model for the provision of essential public services that accounts for the high cost of infrastructure that makes traditional market-based competition difficult: regulated monopolies – public utilities. It’s difficult to envision a future for the pharmaceutical industry that doesn’t involve an element of protection for the public good.

Later in the day, when I encountered the lemonade stand on my way back home, I smiled. On the sign, the original price of 25¢ had been crossed off, replaced by a new price of $2. The kids had realized the economic impact of value pricing. It was funny to see in a lemonade stand. Not so in cancer care.

About the author and the Vizient Research Institute™. As executive director of the Vizient Research Institute, Tom Robertson and his team have conducted strategic research on clinical enterprise challenges for 20 years. The groundbreaking work at the Vizient Research Institute drives exceptional member value using a systematic, integrated approach. The investigations quickly uncover practical, tested results that lead to measurable improvement in clinical and economic performance.

Related Materials