Are Drug Pricing Formulas Full
Employment Acts For State
Attorney Generals?
Gerard Anderson PhD
Professor
Johns Hopkins University
Lake Wobegon Syndrome : How Can
Everyone Be Getting A Better Deal?
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U.S. vs. Other Countries
Medicaid vs. Other Payors
Maryland vs. California
Maryland Medicaid vs. Maryland Prisons
Economics 101 – Fixed vs.
Variable Costs
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Fixed Costs
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Variable Costs
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costs that must be incurred regardless of
number of units sold
costs of producing one additional unit
Examples
Fixed - plant and equipment or R & D
 Variable - materials

Fixed Costs Decline As
Number of Units Increase
P
Q
Variable Costs First Decrease
and Then Increase
P
Q
Standard Economic Theory – Price
Determined By Where Variable Cost is
Lowest - Fixed Costs are Irrelevant
P
Firms Produce Where Variable Cost is Lowest
Q
In Reality –Fixed Costs Matter
Pharmaceutical companies could not exist
if everyone only paid only the variable
cost
Most Pharmaceutical Spending
Involves Fixed Costs
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Marketing: 32.8%
Costs of Goods Sold: 25.3%
Profit: 20.6%
R & D: 14%
Taxes: 7.3%
$64,000 Policy Question

Who should pay the fixed costs of
pharmaceutical companies?
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U.S. vs. other counties
Medicaid vs. other payors
Maryland vs. California
Maryland Medicaid vs. Maryland Prisons
Who Is Paying The Fixed Costs?
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U.S. pays twice as much as other countries
Almost 2 to 1 difference in government payors:
 Medicare
 340 B
 Medicaid
 VA
 DoD
Some states pay 3 times what other states pay
Significant variation within state programs
Policy Issue – Spillover Effects

If payor (e.g. Medicaid) gets a lower price then
will other payors have to make up the
difference?
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One economic assumption:
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Pharmaceutical companies will be able to raise prices to
other payors (programs) to cover their fixed costs
Alternative economic assumption:
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Each payor (program) negotiates the best price
independently of what other payors (programs) pay
My Perspective On Spillover Effects
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Each pharmaceutical executive will want
to maximize the revenue from each payor
(program)
Result is that states need an economic not
just a legal rationale for getting low drug
prices
Full Employment for Attorney
Generals
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Without an economic rationale companies
will try to maximize revenue in Medicaid
by “gaming” the system
Unlike Most Goods and Services the
Consumer Is Not King In
Pharmaceutical Pricing
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Physicians must prescribe drugs
Hospitals, nursing homes, HHAs use
formularies
Pharmacies can push drugs that earn
them greater profits
Patients pay small portion of bill out-ofpocket
Medicaid is NOT the Entity Purchasing Prescription
Drugs
Remember the Spread
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Spread is the difference between pharmacy
(hospital, LTC, HHA) purchase price and what
Medicaid believes is the purchase price
In 2002 CBO calculated that pharmacies earned
the following spreads in Medicaid
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23% overall
30% generics
14% brand names
What Are The Economic
Incentives?
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Drug companies want pharmacies to earn the
most money on their drugs so they will prescribe
them
Pharmacies will want to prescribe drugs that
earn them the most money
Both drug companies and pharmacies benefit
when the spread is greater
Medicaid loses when the spread is larger
Trust Me I Am From Pharma
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The source of all the pricing data is the
pharmaceutical companies
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AWP, AMP, ASP, EAC, FUL, MAC, WAC
AMP and Best Price
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Average Manufacturers Price (AMP) is
supposedly what a drug company receives for a
drug in a given quarter from retail pharmacies
Best price is supposedly the lowest price in retail
pharmacies
Medicaid rebates are determined based on
difference
How can any state validate either best or AMP?
Auditing
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CMS investigated pharmaceutical company
reported data on only 4 occasions over a
10 year period according to GAO
Lake Wobegon
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Rebates are difficult to monitor when the
pharmaceutical industry has all the data
Not every state can be getting the best
deal
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Some states pay almost 5 times more for the
same drug
Price Transparency
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Find out the actual prices other payors are
paying for the same drugs
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U.S. vs. Other Countries
Medicaid vs. Other Payors
Maryland vs. California
Maryland Medicaid vs. Maryland Prisons
Comparative Data Allows A
Bully Pulpit
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With comparative price data states can see
where they are getting a good deal and when
they are paying higher prices
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Must be done on a drug by drug basis
States can then focus their negotiations on the
prices of drugs where they pay much higher
prices
Conclusion
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Who is going to pay the fixed costs of the
pharmaceutical industry?
Gaming will occur without an economic
rationale for discounts and rebates
Cannot rely on pharmaceutical companies
for all the data to determine prices
Price transparency will tell states when
they are getting a good deal