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Value-based pricing

In February of 2007, the UK’s Office of Fair Trading (OFT) recommended reform to Britain’s current Pharmaceutical Price Regulation Scheme (PPRS). The PPRS sets maximum and minimum profit levels from the sale of branded drugs to the NHS. The PPRS allows companies freedom to set prices as they please on new substances, but restricts subsequent prince increases. A system of price cuts has also been instituted as well, yet it is likely that firms take these future price cuts into account when making their original pricing decisions.


Are there any other options? Simeon Thornton (Health Econ 2007) argues that a value-based pricing (VBP) scheme would be superior. In VBP, the NHS would pay pharmaceutical companies based on the value of the pharmaceutical to the patient base. One question is how value is determined. Thornton proposes cost effectiveness studies, which in effect means that the government or academics will determine the price.

Pricing will also be allowed to vary by subgroup since people with certain diseases may benefit more from a disease than others. Also, incremental improvement will be encouraged since marginal improvements in treatment will receive higher payments.

This program does seem to be an improvement. It is dynamically efficient since pharmaceutical companies will be paid more for more cost effective treatments. Further, if it turns out patients do not like the medicine and no one takes it, then NHS will not be paying a lot for failed drugs. Also, after generics are available, the price will adjust downward.

In the static environment, the pharmaceutical company will capture all the consumer surplus since price will equal marginal benefit. However, as time passes and generics enter the market, a large consumer surplus will occur.

The major impediment of this reform is the problem of any centralized system: information. How will the NHS determine cost-effectiveness? Will it be impartial? Will the conclusions be manipulable by interested parties? These questions are easy to answer theoretically, but very difficult to predict empirically.