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Wednesday, October 2, 2019

Systematic Demystification of Drug Price Mystique and the Needed Creative Destruction

In the United States better than 90% of the population does not know the real price of drugs they use. It is not their fault. It is the system they have to live by. Purpose of the exercise is to ask the question “are the patients are paying too much for the convenience of the current mutually subsidized healthcare system?” In the current system everyone pays their monthly insurance premium and when they purchase of their prescription drugs they pay certain amount as copay for each drug. Folks, who do not have healthcare insurance, can pay an exorbitant amount for their medicines. What transpires between the drug manufacturer and the patient is explored in this blog. There is no financial interest/conflict with any educational/commercial or regulatory body.

Not much effort, at least I have not seen it, is made/published to decipher the price movement from API manufacturer to the patient. It is considered by many an arduous exercise. An attempt to unravel the drug price mystery is made. It may not be totally accurate but most who understand costing, profits, manufacturing and economics will understand the process. They would appreciate who are the players in the pricing jungle and how their behavior impacts drug prices for the patients. 

Drugs are priced such that each player, manufacturer and supplier, make their respectable profit to stay in business. This is global phenomenon for every sale. Following entities participate in the drug manufacture and distribution. 

·       API (Active Pharmaceutical Ingredient) Manufacturer 
·       Drug Formulator
·       Pharmacy Benefit Manager
·       Insurance company 
·       Pharmacy

Schematically Figure 1 illustrates elements of price and margin flow for API manufacturer and formulator. Formulated drugs are acquired by PBMs and supply chain and distributed to patients. Even with a good understanding of the distribution process drug pricing to the patients is still a mystery. 

Price mystery can be un-layered to a point. Every company that is involved in drug distribution sees the cash cow and every intention to make drugs affordable gets thrown out the window. Every effort is made through political pressure and otherwise that the current cash cow is not disturbed. 

Prices of API manufacturer and their formulations are not difficult to calculate and decipher as they are like pricing are like pricing of any saleable product. Each has three elements: raw materials are reacted or blended in right proportions, package and conversion cost and profit (1).

Unraveling of drug pricing begins with API and formulator costs and profits. It is not very difficult to calculate the factory costs and after margin addition, one can calculate APIs and their formulations selling price prices within +/- 10%. Chemical engineers, chemists and cost accounting professionals who are well versed with manufacturing processes are familiar with the process (1, 2). 
Figure 1: API Manufacturer to Patient Product Flow Distribution

What happens to the drug price between the formulator and the patient is known to few and rarely discussed. They are the content of the BLACK BOX. 

Many most likely wonder how the drugs are priced. Based on what one reads, it seems that patients in the United States are being taken for a ride by the PBMs. This seems very possible and math along with pricing at API and Formulation levels confirm it. The best way to recognize the existence of the BLACK BOX is through calculations and comparing the price differentials.

Drug pricing for Metformin hydrochloride, Ciprofloxacin, levothyroxine and atorvastatin are used as an illustration example in Table 1. API (active pharmaceutical ingredient) are average prices (2). Costs of excipients, formulation and packaging costs and profits are based on certain known assumption for other manufactured products. Resulting formulated drug costs could be with in 15-25% of actual costs. API costs include API manufacturer’s profits. Instead of accuracy, pricing concept is illustrated. Idea is to demonstrate how the drug prices progress from PBMs and the supply chain to the patient. 

API and formulation costs are not based on the most optimized processes. This is due to these being produced at too many plants and they don’t have the most optimized processes due to lack of economies of scale (3). Opportunities to lower the costs do exist. 

Metformin HCl
API cost $/kg (2)
Inert excipients $/kg (@40%API cost)
Conversion cost, $/kg(@40%API cost)
Profit (@ 40% above)
Total. $/kg
Average Dose
500 mg
500 mg
0.112 microgram
20 mg
Formulator Sale price per tablet, $
Patient purchase price, $/tablet    
With insurance
Without insurance
Table 1: Formulator Drug Selling Price $/kg and Patient Purchase Price

Table 2 illustrates the percent price markup of the four drugs between the manufacturer selling price to patients. One can see that the supply chain and that includes PBMs and other distributors are profiting heavily (4) in the current drug distribution process. This is the “THE BLACK BOX” of Figure 1 which is seldom discussed and least understood by most. 

% Mark-up from Formulator Selling Price
Walmart %
Rite-Aid %
With insurance
Rite-Aid %
Without insurance
Table 2: Percent Price Differential between Formulator and Patient

Patients need different dose drugs. Sale prices for metformin illustrated in Table 1 e.g. are same from 100 to 1000 milligram tablet. This might seem to be an oddity but since the PBM/seller sale prices are so high, they can use game of averages and easily absorb variable dose sale prices. With averages, PBMs even can give away drugs for free through their mail order system. All said and done drug priced in Table 1 are such that they deliver their expected profits. 

Patients in addition to paying the price differential also pay per month premium to enroll in a drug insurance program whether s/he uses any drug or not. This premium is also profit assurance for PBMs and insurance companies. Monthly insurance premiums cover any profit shortfall. 

PBMs are there to assure supply of the necessary drugs at the best prices. However, based on Table 2 price markups (@1,300 to 66,000 % for the four drugs) between manufacturer and the patients, distributors of drugs have enslaved US population in a fa├žade of being their friend. Markups (@1,300 to 66,000 % for the four drugs) in Table 2 suggest that patients are not seeing the savings they should get if they could get drugs directly from the formulators. It seems that the intermediaries are keeping these markups to enhance their own profits (5,6)Some of the PBMs even formulate the products the sell in the United States adding further to their profits. 

In the US’s current mutually subsidized system drug companies and PBMs have created a system which does not allow patients to have quality drugs at competitive prices. The juggernaut, through legal lobbying (legal corruption) system, is so strong that constituents cannot and will not see any drug price relief unless the current mutually subsidized healthcare system is dismantled. Possibility of any reform is dismal. 

Creation of Drug Formulary, in my mind, is an artificially created system that prevents patient’s choice and competition between the drug suppliers. Drugs approved by USFDA should be available to US patients. Doctors should prescribe brand or generic drug that are best for the patient. Patient should decide whether they want brand or generic and pay the necessary copay for drug of their choice. If only drugs of greatest value to the insurance company are listed on the drug formulary, then USFDA should not be approving every drug. 

The current mutually subsidized system prevents competition and promotes listing and dispensing of drug that offer the highest rebates to the PBMs and intermediaries. Lack of competition in pharma companies prevents adoption of best manufacturing technologies and practices which lower selling prices. Simply said “BLACK BOX” participants are more interested in their profits. Patients are just the media for their profits. 

It should be noted that three PBMs (7) adorn the top TEN Fortune 500 company list and their revenues are higher than the largest pharma manufacturers (8). It seems that occupants of the “Black Box” are capitalizing on patients desire to get well and extend their life. 

If drug are to be made affordable, alternate “creative destructionists” to the current distribution system have to be created, tested and adopted. Two companies (9) have started such exploration in specialty needs. They could expand beyond special needs if successful in their current venture. An alternate plan called GEN Plan outlined in “Improving Drug Affordability for the United States Populous through Alternate Business Models” could be considered (10)

Civica Rx (11) after its sustained success with injectables could adopt GEN Plan (10) or its elements to serve generic drug needs of the US population. Amazon, Berkshire Hathaway and JPMorgan plan (12) consortium although geared to their employees, if successful, could be also be expanded to the general populous for generic drugs. 

Open drug sale competition, better manufacturing technologies and improved regulations can also be used to lower drug prices (1, 13)The current markups (illustrated in Table 2) can be significantly lower, thereby lowering drug prices. 

Vested interests will exercise every possible influence to prevent any change to the current cash cow model. Creative destructionists will be plenty of naysayers and all of the legal hurdles will have to be overcome, conformed and some may have to be changed to dismantle the current barriers and juggernauts. 

Girish Malhotra, PE
EPCOT International 

1.     Malhotra, Girish: Chemical Process Simplification, John Wiley & Sons., 2011 
2.     API Prices https://www.pharmacompass.com September 20, 2019 
3.     Malhotra, Girish: Impact of Regulations, Manufacturing and Pharmaceutical Supply Chain (PBMs) on Drug Shortages and Affordability Part 2, Profitability through Simplicity, April 3, 2019 
4.     Ollove, Michael, Drug-Price Debate Targets Pharmacy Benefit Managers, www.pewtrusts.org, February 12, 2019, Accesses August 10, 2019
5.     Langreth, Robert, etal: The Secret Drug Pricing System Middlemen Use to Rake in Millions, Bloomberg, September 11, 2018, Accessed March 22, 2019 
6.     Schladen, Marty: US military community beset by pharmacy-middleman headaches, The Columbus Dispatch, September 29, 2019 Accessed October 1, 2019
7.     The Top 10, Fortune 500, Accessed October 1, 2019
8.     Pharmacy Benefit Managers, Wikipedia, Accessed October 1, 2019
9.     HIMSRo, Accessed October 2, 2019
10.  Malhotra, Girish: Improving Drug Affordability for the United States Populous through Alternate Business Models, Profitability through Simplicity, May 4, 2018
11.  Civica Rx, https://civicarx.org
12.  Malhotra, Girish: Could Amazon (A), Berkshire Hathaway (B) and J.P. Morgan Chase (M) be the Anti-Ballistic Missile (ABM) needed to Control/Curb Rising Healthcare Costs?, Profitability through Simplicity, February 9, 2018 
13.  Malhotra, Girish: Profitability through Simplicity, Accessed October 2, 2019 

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