Former Turing CEO Martin Shkreli, who has become the poster child for unfettered ambition and greed in the pharmaceutical space, has struck a nerve with increasingly frustrated Americans about the sometimes astronomically high cost of drugs. And the latest chapter in the Shkreli saga, Thursday's congressional hearing, has only made matters worse.
The investigation into Turing, along with Valeant (VRX), has brought the sector's drug-pricing practices into the public consciouness at perhaps the worst moment possible -- during presidential campaign season. The iShares NASDAQ Biotechnology Index (IBB) and the SPDR S&P Biotech ETF (XBI) have both fallen about 30% since their July 2015 highs, reflecting, in part, uncertainty over pricing and regulation.
Hillary Clinton's September 21st tweet condemning high prescription drug pricing for the sector included a link to a New York Times article on Turing. This tweet, which caused a sell-off in the broad biotech sector, reflects the conflation of industry-reform considerations and the drama surrounding Turing and Valeant.
In the rush to peg Turing and Valeant as representative of the larger biotech sector, investors and commentators have lost sight of the complexities of the industry's incentive structure.
Rep. Elijah Cummings (D-Md.), ranking member of the committee probing drug pricing, pointed out in connection with the Turing and Valeant investigations that price hikes are prevalent throughout the industry, bringing in important, but distinct, industry-wide considerations. "Tactics are not limited to a few 'bad apples,' but are prominent throughout the industry," he said.
The Turing and Valeant distinction
Turing and Valeant have turned the entire biotech and pharma model of research & development investment on its head. Instead of embarking on traditional drug development, involving hundreds of millions of dollars in research and development, Turing and Valeant bought up companies with cheap drugs and significantly raised their prices.
After Turing paid $55 million to acquire the anti-parasitic drug Daraprim -- which is also used to treat HIV -- it raised its price more than fifty-fold to $750 per pill. And Valeant's controversial serial acquisitions were based on a strategy of pushing up prices of the acquired rugs. On May 21, Valeant interim CEO Howard Schiller, who was CFO at the time, wrote in an e-mail that about 80 percent of sales growth in the first quarter came through price increases, according to the congressional memo.
Understanding the biotech debate
At traditional biotech and pharma companies, drug pricing is at least purported to incorporate the cost of developing the drug and to incentivize the companies to innovate and develop new formulations. The cost to develop a new drug and win FDA marketing approval is pegged at about $2. 6 billion, according to a report from the Tufts Center for the Study of Drug Development. While this is may be a hotly debated number, the argument from drug companies is that they need to be incentivized to develop drugs.
The pricing model also reflects a reliance on medical insurance companies, which means that pricing is not based on consumer demand or ability to pay, as Matt Levine points out in his latest Bloomberg View column.
The high prices of drugs that cure Hepatitius C have been especially targeted. Gilead's (GILD) two Hep C drugs, Sovaldi and Harvoni, dominate the market currently (together, they delivered $19 billion to the company in 2015) and the company has become a focus for high drug pricing issues within the mainstream industry. The debate has intensified with competing Hep C offerings at Merck (MRK) and AbbVie (ABBV), along with some push-back from pharmacy benefit managers like Express Scripts (ESRX), and insurance companies restricting access.
Orphan drug companies are perhaps the most instructive sub-group in biotech to understand the pricing incentive structure. An orphan drug is one that treats an incredibly rare disease -- or one that afflicts less than 200,000 people in the U.S. When orphan drugs get approved, the companies that make them are allowed to price these medications at astronomical levels because the people with these rare diseases don't have any other choice. The government provides orphan drug developers with benefits, including tax incentives, subsidized research, enhanced patent protection, and lengthened marketing exclusivity. These companies like Vertex (VRTX), which targets patients with cystic fiborosis, along with names like Alexion (ALXN) and Biomarin (BMRN), are fueled by the higher-priced drugs and other incentives.
The drug pricing system in our country needs reform, but focusing on the Shkrelis of the world misses the point. While the issues at Turing need to be addressed, it's the pricing incentive structures at pharmaceutical companies more broadly that need attention. This comes back to core issue: whether or not 'capitalism at work' should and can be modified in the industry given key moral questions around the value of life and health.