The pricing system for drugs in the United States is broken, said David Brennan, executive vice president of the North American division of AstraZeneca, the drug maker with headquarters in the U.K. and Sweden. Trouble is, no one, including the drug companies themselves, has any clear idea how to fix it.

Brennan, who was also appointed to AstraZeneca’s board last week, made these remarks at a Wharton healthcare conference in February. Not surprisingly, he doesn’t advocate a radical overhaul: Such a move could hurt the productivity of an industry that has contributed substantially to advances in human health and longevity during the last three decades, he said. What’s needed is realistic cooperation among all the players — drug makers, insurers, consumers, doctors, hospitals and employers.

“We need to take a calm view,” Brennan said. “The hysteria of some of our industry’s critics is misplaced. And some of the louder whining in our industry is also mistaken.”

But dispassion can’t be an excuse for inaction, he cautioned. All the parties have to find a way to address spiraling healthcare costs and patient access, while preserving financial incentives for innovation and quality care. “Unless we can arrive at an integrated view of how to finance our system that will benefit the largest number of patients possible, the extraordinary collective achievement that is our U.S. healthcare system won’t be sustained.”

Few would argue with Brennan that the drug industry, in particular, has been facing troubles. In September, Merck & Co. withdrew its blockbuster painkiller Vioxx from the market amid accusations that the company had been long aware of the drug’s potential to cause heart attacks and strokes. As a result, other drugs in the same class as Vioxx — Cox-2 inhibitors — such as Pfizer’s Celebrex endured similar federal inquiries. In February, Vioxx and other Cox-2 inhibitors were given the green light from a U.S. Food and Drug Administration advisory panel, which recommended restrictions on direct-to-consumer marketing for the drugs and suggested that they come with a “black-box” warning label about potential deadly side effects. Also in February, another best-selling drug came under scrutiny when Canada announced it was suspending sales of Adderall — a treatment for hyperactivity and attention-deficit disorder made by U.K.-based Shire Pharmaceuticals — citing reports that connect the drug with 20 sudden deaths worldwide.

AstraZeneca hasn’t been spared in this round of bad publicity, either. Last year, the company’s cholesterol-lowering drug, Crestor, which earned $908 million in sales in 2004, faced an FDA petition for withdrawal from the market because of reported serious side effects including muscle and kidney damage. On March 14, the FDA denied the petition, stating that Crestor posed no unusual risks beyond the other drugs in its class. Despite that victory, the company still has other problems to contend with: In December, it withdrew its European application for approval of the cancer drug Iressa after tests called into question its effectiveness. And in October, the FDA withheld approval for Exanta, a blood thinner, because of concerns about side effects.

Despite the recent setbacks, AstraZeneca has done well financially. In 2004, the company earned $3.1 billion, or $1.82 per diluted share, on sales of $21.4 billion, compared with $2.3 billion, or $1.32 a share, on sales of $18.8 billion the year before. What’s more, the company’s stock has outperformed the average drug maker. Over the five years that ended on February 22, it rose 21% compared with a drop of 15% for the Dow Jones Pharmaceutical Index.

Where Are the New Blockbusters?

Beyond recent headlines, all of the big drug makers face a fundamental challenge, Brennan said. They’re not producing as many blockbuster drugs, and given the cost of drug development, they need to continue to do that to thrive. “In 2003, U.S. pharmaceutical companies spent more than $33 billion on research, but we have not had as much to show for it,” he noted. “From a high of 53 new drug approvals in 1996, our number of approvals has dropped into the low 20s in recent years.”

A variety of factors have pushed down approvals. Drug makers long ago grabbed the “low-hanging fruit, if there ever were any,” Brennan said. The scientific problems that they confront today are knottier than ever, and the process of getting drugs approved more expensive. In addition, investors are less willing to reward companies for producing new drugs for diseases for which effective treatments exist. Combine these factors, and “big pharmaceutical companies need a drug to be able to deliver annual sales of at least $500 million” to justify bringing it to market, he said.

Partly because of the dearth of new drugs, some analysts have predicted an industry consolidation. In theory, mergers would allow companies to operate more efficiently by eliminating redundancies and combining research staffs. Brennan scoffed at the predictions: “There isn’t an iota of evidence that increasing size has improved the one statistic in our industry that really counts — the number of new drugs successfully brought to the market.”

Brennan argued that this number is as important to the consumer as it is to the companies that make the new drugs. Medications, after all, remain one of the most cost-effective ways to treat disease. “There is no single statistic that defines better what has been achieved over the past 30 years than that, for 2004, cancer surpassed heart disease as the leading cause of death in the U.S. for Americans under the age of 85,” he pointed out. “This is due primarily to the fact that a generation of medicines for cardiovascular disease has had profound impact.”

How does one square advances such as that with the tough scrutiny that drug makers have received lately? Brennan blamed the fact that consumers tend to face their highest out-of-pocket healthcare bills for medicines. Plus, drug pricing can seem upside down. “Who pays the highest price for drugs in the United States?” he asked. “The poorest people. If you walk in and pay cash at a pharmacy, you’re going to pay the highest price.”

Brennan said he appreciated consumers’ frustration. AstraZeneca, after all, is also a buyer of healthcare for its tens of thousands of employees. In that role, it has banded together with about 160 other big employers in an initiative called the Leapfrog Group. Leapfrog members survey hospitals on their practices and pay bonuses to those that satisfy a variety of quality-of-care standards. “We’re also working with a parallel program for physicians called Bridges to Excellence,” he noted. “It has identified parameters for quality care for diabetes and cardiovascular disease and provides bonuses to physicians who meet the benchmarks.”

Other employers are taking steps that could have an equally big impact. For example, some companies have implemented financial incentives such as higher co-pays to make their employees more prudent in their purchases.

It’s too soon to tell whether these incentives will work. Some early evidence suggests that they’ve had unexpected — and unwelcome — results. “A study by the Rand Corporation found that, when co-pays doubled, the use of prescription drugs fell by 17 to 23% for patents with diabetes, asthma and gastric-acid disease,” Brennan pointed out. “At the same time, visits to emergency rooms rose 17% for people with those conditions, and hospitalizations rose by 10%.”

Faced with these sorts of findings, Pitney Bowes, the mail- and document-management company, decided in 2002 to lower its co-pays for diabetes and asthma drugs, Brennan said. “Within two years, the number of expensive hospital stays had fallen significantly.”

Going forward, the economic model of the healthcare industry in general and drug makers in particular will change, Brennan said. Costs partly will drive the change, but so will further advances in technology.

Already, drug companies are questioning whether they can afford their legions of sales representatives. “Pressure on the sales model has been increasing for a while,” he said. “But it’s like nuclear disarmament: Nobody wants to step back first.” Personal selling won’t disappear, but the days of having “six or seven people working the same zip code” will. Brennan speculated that the industry would return to how it was when he began his career in sales 25 years ago — when a single rep typically worked a territory.

Drug companies’ messages to consumers will change, too, as advances in genomics allow earlier detection and treatment of disease. “We’ll be able to look at you and say, ‘You have got a problem, and the cost of the fix should be $250,000 over your lifetime, but it will get you to where you want to be, which is without a heart attack when you are 50,'” Brennan said. “It’s going to create a different value proposition in the industry.

“I believe we are at the dawn of another extraordinary era in healthcare,” he added. “But we can get there only by ensuring that the costs and benefits of the system are allocated as fairly as possible, and that risks and rewards are aligned to unleash the entrepreneurial spirit of the best science we can muster.”