What’s Behind U.S. Drug Companies’ Response to the AIDS Crisis Abroad?

Around the world, there are thought to be about 36 million people infected with HIV, the virus that causes AIDS. Who should shoulder the staggering cost of treating them?

Recently, attention has focused on the American pharmaceutical companies that hold patents for AIDS medications. Bowing to a variety of political forces, financial realities and public relations concerns, several companies have agreed in the past few weeks to offer key drugs to poor countries at prices far below those charged to American AIDS patients.

But rather than end the debate, the moves are likely to spur further examination of America’s system for developing and marketing new drugs. Is a profit-oriented system – one not much different from that used by music promoters or car makers – effective for dealing with a devastating epidemic?

Late in March, Merck said it would sell Brazilians its Stocrin AIDS drug for $920 a year per patient, versus $4,700 charged Americans, while it will sell its Crixivan for $1,029, compared to $6,000 in the U.S. Earlier in March, Merck said it would sell the drugs in poorer “developing countries” for even less — $500 for Stocrin, $600 for Crixivan.

At about the same time, Abbott Laboratories announced it would sell two of its AIDS drugs in Africa at cost, just a fraction of the price charged in developed countries. Also in March, Bristol-Meyers Squibb stated it was dropping efforts to prevent generic drug makers from selling cheap versions of its patented AIDS drugs in Africa. The company also said it would sell Africans two of its other AIDs drugs for “below cost” – $1 a day, compared to $18 charged Americans. Previously, GlaxoSmithKline and some other companies had offered deep price cuts in Africa, which has about 25 million HIV-infected people.

Why have these companies agreed to such discounts? Do the cuts suggest that Americans are being charged too much?

Raymond V. Gilmartin, Merck’s CEO, cited altruistic motives in announcing the cost cuts for developing countries: “Merck is stepping up our own response to the urgent humanitarian need in Africa and other regions of the world,” he said. John L. McGoldrick, executive vice president of Bristol-Myers Squibb, voiced similar sentiments: “This is not about profits and patents. It’s about poverty and a devastating disease. We seek no profits on AIDS drugs in Africa, and we will not let our patents be an obstacle.”

 Thomas J. Donaldson, professor of legal studies at Wharton, says the U.S. pharmaceutical industry does have a humanitarian tradition. “I am confident that their top managers believe they are different from tobacco companies,” he said. Added legal studies professor Thomas W. Dunfee: “There’s a longstanding norm in the United States for companies to engage in a certain range of philanthropic activities.” The most effective and appropriate of these, he said, are those that draw on a company’s core business expertise.

The classic example involves Merck’s decision in the late 1970s to adapt one of its patented animal drugs into a cure for river blindness, a devastating African disease that afflicted huge segments of the population. The company spent hundreds of millions of dollars it knew it could never recoup, since the disease was confined to poor countries.

“It was a heroic initiative, and Merck got a lot of praise for it,” Donaldson said. There were nevertheless some business benefits to the river blindness initiative, he added. “Pharmaceutical companies want to believe they’re in the business of helping people. Their chemists and biologists are motivated by this.” Many of those scientists said they would have left the company had it not pursued its unique opportunity to eradicate river blindness, Donaldson pointed out.

Similarly, discounting AIDS drugs in poor countries is not entirely altruistic. For one thing, these companies are not giving up many sales at higher prices, since these countries are too poor to pay what Americans are charged, anyway. And the companies needed a public relations boost, as it became clearer that their high prices meant millions were denied treatment.

The American companies also faced serious competitive threats. Cipla, a generic drug maker in India, had asked the South African government for permission to sell cheap copies of eight AIDS drugs, including those on which Merck holds patents. A South African law allows the government to give such permission in an emergency. The Brazilian government also was threatening to permit use of generic versions of patent-protected drugs. For Merck and the other companies, cutting costs is better than surrendering the market to generic drug companies – a problem that could spill over to other drugs as well.

As publicly traded companies, drug makers are obligated to seek profits for shareholders. Like any profit-seeking company, they are free to charge the highest prices the market will bear.

But life-saving medications are not like most consumer products. A record company may have a monopoly on a rock star’s music, but if it charges too much, fans can live without the latest CDs. A drug company, however, would seem to be in a good position to exploit AIDS patients’ desperation and charge exorbitant prices. Hence, a drug maker can charge an American AIDS patient $10,000 to $15,000 a year for medications that cost only a few hundred dollars to make.

But manufacturing costs alone don’t reflect the hundreds of millions of dollars that go into discovering, testing and marketing a new drug. Most drugs under study never make it to market. They turn out to be ineffective, burdened by side-effects and/or too expensive to produce. Therefore, a few stunningly successful drugs must pay the research and development costs of all the dead ends.

The system, says Mark V. Pauly, professor of health care systems at Wharton, relies on the relatively wealthy customers to subsidize the research and development costs of both the successful and unsuccessful drugs. And wealthy customers subsidize poorer ones, just as the well-to-do pay more taxes. “The way to get drugs to poor people is to have rich people pay more for them,” says Pauly. “That kind of price discrimination generally is what drug companies want to do, and in this particular case it is probably good for the world to do that.”

Not only are drugs cheaper in poor countries, they are cheaper in many developed ones as well, frequently because of price regulation. But bargain rates come at a cost: Less work on new drugs. “You can make an argument that Americans pay for most of the new drugs that are coming out all over the world,” Donaldson said.

But even within the United States, Pauly pointed out, different people are charged different prices for the same medication. Join an HMO, which can negotiate volume discounts, and you’re likely to pay less than if you pay out of your own pocket. Other industries do this, too. An airline passenger forced to fly on short notice may pay hundreds more than one who reserved an identical seat weeks in advance.

“It’s efficient,” Pauly says. “We have this lump of research and development costs which, for society as a whole, is worth incurring, and which has to be distributed. Well, somebody has to pay it. The economists would say it should be paid by the people who are most willing to pay it.”

In recent years, however, this longstanding price-discrimination system has come under pressure, as more people in developed countries learned they were paying much more than the poor, according to Patricia M. Danzon, a Wharton professor of health care systems and insurance and risk management.

In addition, she said, drug companies may have been reluctant to sell large quantities of AIDS drugs at low prices in poor countries for fear some would flow back to developed countries through a black market, undermining the high prices being charged there.

To critics, any effort to keep prices high seems immoral in the face of the seriousness of the AIDS epidemic. Though public companies have to pursue profits to attract shareholders, it is not hard to make a case that drug companies have a debt to society as well. They benefit from billions of dollars in government-financed research. And government provides patent protection that gives a drug developer up to 25 years of monopoly.

While such public policies are meant to encourage drug development, critics question whether the rewards for drug companies are higher than they need to be. Ideally, society would find the exact point at which the financial incentives are just strong enough to cause needed drugs to be developed, and no stronger. “It is very difficult to know when an incentive is too much – where it generates windfall profits,” said Donaldson.

According to Danzon, it is not possible to gauge the right level of incentive with mathematical precision. It’s obvious, she noted, that if patent protection were shorter, generic drugs would come to market sooner. Once generic drugs enter the market, “prices fall through the floor.”

But, she added, “It would only be worth investing in research and development for disease classes that affect large numbers of patients.” There would be little financial incentive to develop medications for ailments that afflict only small numbers of people, or those that are prevalent mainly in poor parts of the world.

This isn’t to say that the current 25-year protection is exactly right, she said, but any judgment about the system’s effectiveness would have to involve subjective views of whether the world is getting the drugs it needs. If financial incentives are too strong, we get more drugs than we need and prices are too high. Too weak, we get cheaper prices but miss out on some valuable medications.

“We certainly are seeing a lot of small companies [looking for new drugs], and a lot of R&D by established companies,” she said, referring to the effectiveness of the current incentives. “But whether we’ve got too much or too little is hard to tell.” Even when a new drug comes to market, it’s often impossible to gauge its value precisely, she added. Is a new arthritis drug worth the research and development costs if its only new feature is to reduce side effects for a small number of users?

While some critics claim that drug companies are excessively profitable, Danzon says there is no compelling evidence one way or the other. During the Clinton health-care debate of the early ‘90s, a study showed that drug stocks had under-performed the overall market, she said. In the years since, drug stocks have beaten market averages, but even that doesn’t prove that drug prices are unnecessarily high. Investors may be bidding drug stocks up for other reasons, such as a hope that sales will rise if prescription drug coverage is added to Medicare.

Over the past five years, the AMEX Pharmaceutical Index, composed of the 15 largest drug companies, has given investors returns averaging 24.7% a year, far above the 14% of the Standard and Poor’s 500 index, a gauge of the broad market. All of the major AIDS drug manufacturers are in the AMEX index, which has also beaten the S&P 500 over the past 10 years – 15% a year against 12%.

While some critics complain that AIDS research has been too slow, the worldwide demand for the publicly traded pharmaceutical companies’ latest AIDS drugs suggests that the financial incentives have been effective at spurring drug development. Still, some suggest that AIDS is a special case, so serious that drug companies have a moral obligation that should come first.

“AIDS is one of those things that is so catastrophic and overwhelming that you just must put aside the ordinary rules of doing business,” Donaldson said. “We ought not to forget that governments have some responsibility here, too.”

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