Why Are Generic Drug Prices Shooting Up?

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Generic drugs are copies of branded drugs, which can only be produced after the brand-name drug’s patent has expired. Although they are identical to their branded counterparts (on a variety of measures as described by the FDA) [1], they are priced at significant discounts to the branded price. As generic drug makers go through an abbreviated and less costly process to get an approval from the FDA, prices of generics are relatively lower.  (In other words, branded drug manufacturers pass on the high development costs to consumers.) The scenario was different before the Hatch-Waxman Act, which was enacted in 1984. Before 1984, generic drug makers were obligated to go through the same process as branded drugs to receive an approval from the US FDA, which created steep financial barriers to the development of generic drugs.

The Rise Of Generics

After amendments were made to the law in the favor of generic drug makers, this market saw an influx of new players, which brought generic prices further down. Currently, on average, the cost of a generic drug is 80 to 85 percent lower than the brand name product [2] As prices declined, usage of generics picked up rapidly. The share of generics out of all the prescriptions filled in the US increased from ~18% in 1984 to nearly 80% currently.

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This decade has seen branded drugs worth billions of dollars in sales lose patents. In 2012 alone, the sales value of drugs coming off patent was $33 billion and another $47.5 billion in sales will come under threat of patent expiry this year. As terrifying as this can be to the ears of pharmaceutical companies, it is just what the doctor ordered for the US health care system, as health care expenditure is rising really fast.  ((The Economic Case for Health Care Reform, The White House))  In the ten-year period between 2003 and 2012, generic drugs generated $1.2 trillion in savings to the U.S. health care system [3]

However, generic prices have been moving up for some time now, which is leading to some serious concerns for the pharmacy retail industry in the form of reimbursement rate pressure (Here’s a detailed analysis of this issue).

The Rise Of Generic Prices

According to a report by Elsevier, a drug product and pricing information provider, out of a research sample of 4421 drug groups, 222 drug groups increased in price by 100% or more (between Nov’13 and Nov’14). There are also some extreme cases (17 drug groups) where price increases of more than 1000% were seen. One such product is tetracycline, which is commonly prescribed for bacterial infections. During the same period (between Nov’13 and Nov’14), it’s per tablet price increased from $0.0345 to $2.3632. That is a 67-fold increase in one year! But, why are generic drug prices increasing at such high rates?

Factors That Contributed To The Price Rise

– Industry Consolidation

In 2009, generic drug markets were saturated and projections looked dull. To avoid falling into losses, generic drug makers began to consolidate through mergers and acquisitions to achieve the scale needed to maintain profitability. Typically, when a branded drug loses patent protection, multiple generic manufacturers produce the drug and compete on price. But post-industry consolidation, fewer generic manufacturers are applying to the FDA for permission to produce those drugs. With substantially fewer manufacturers producing a particular generic drug (in some cases only 2 or 3 makers), generic prices have crept up with time. However, there are more influential factors than this.

– Drug Shortages Due to Manufacturing Issues

When one or more of the manufacturers making a particular drug run short of inventory, demand overtakes supply and results in a price rise. Quality and manufacturing issues are a major reason for drug shortages, according to the FDA((FDA Drug Shortages Program FAQs, US FDA)). The FDA monitors every facility that is used for production and should any issue arise, the manufacturing company will be issued a notice accordingly. While getting an approval to re-commence production is very difficult, the drug making company has to go through a rigid approval process to even transfer production to another facility. This results in significant shortages of drugs that are manufactured at both facilities (in case the company manages to transfer production).

Though drug shortages would have a negative impact on patients needing those medications, drug makers might not be ready to make capital investments required for increasing production capacity as costs are significant (and the issue is resolvable, given enough time). Sometimes, a manufacturer might even decide to cease production of a drug simply because they want to reallocate resources to another product, or invest in a more profitable initiatives.

Note: The last remaining drug manufacturer cannot halt production of a specific drug without an approval from the FDA. If a drug is medically necessary, it is highly unlikely that the request will be granted.

– Drug Shortages Due to Stricter Regulation

The FDA has tightened the screws when it comes to to quality control, which has forced manufacturers to invest more in their quality systems. In case of a notice from the FDA regarding a potential quality issue, an incremental investment in improving the facility does the job for the drug maker. However, in extreme cases, it might even lead to the ban of a facility from production. A recent example (in 2014) of this is the FDA’s ban of (all) four Indian plants of Ranbaxy Laboratories (NSE: RANBAXY) from producing or distributing any drug ingredients. Later in 2015, the company lost exclusivity to produce AstraZeneca Plc’s (NYSE: AZN) heartburn drug Nexium due to excessive delays. (Nexium registered annual sales of over $6 billion in 2014 [4])

Conclusion

Consolidations within the pharmaceutical industry, and supply shortages due to various issues have played a major part in generic price inflation. As a result, some retailers have even dropped drugs from their discount generic drug programs. However, one way the industry is responding is by creating a tiered pricing system for generic drugs that would require members to pick up more of the cost. This pricing system is still in its formative stages and might take a while before it helps bring generic prices back down (if at all). Until then, retailers would have to devise their own strategies, including increased spending on acquisitions.

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Notes:
  1. Generic Drugs: Questions and Answers, FDA []
  2. Facts About Generic Drugs, US FDA []
  3. Generic Drug Savings in the United States, GPhA []
  4. Ranbaxy loses generic exclusivity over $6 billion Nexium market, DNA India, January 28, 2015 []