The pros and cons of indication-specific pricing

Most products–especially commodities–are sold with a single price.  You can buy an iPhone for largely the same price throughout the country.   In the case of pharmaceuticals, however, there may be a case that prices should vary depending on their use.  For instance, there may be a treatment which provides large benefits to patients with disease A and modest benefits to patients with disease B. A paper by Cole, Towse, Lorgelly, and Sullivan (2018) outlines three ways that drug prices could vary by indication to reflect differential value:

a single drug authorised under different brand names with different prices; distinct “discounts” applied to different indications, and a single weighted average price.

Types of differential pricing schemes

Examples of how one could allow a drug’s price to vary by use include:

  • Differential payment by approved indication (for example Trastuzumab for HER2+ breast cancer and gastric cancer)
  • Differential payment by line of therapy or sequencing of use (for example Trastuzumab in early and late stage breast cancer)
  • Differential payment by use as a single or combination therapy (for example product used on its own vs in combination with a competitor product)
  • Conditional payment based on cumulative treatment volume (for example a cap on payment above a certain total volume)
  • Conditional payment based on treatment completion (for example payment is only made if a patient completes their treatment course)
  • Episodic (bundled) payment (for example payment for a six-month period that would include all chemotherapy and administration costs)
  • Outcomes-based payment agreements

General thoughts on price discrimination

More generally, the economics literature on price discrimination finds that indication specific pricing in a static sense will improve profits for producers but may or may not improve overall social welfare.  The former holds because if price discrimination did not improve profits, there is always the option of reverting to the single price.  For price discrimination to improve welfare, we would need price sensitive individuals to buy more goods than the could otherwise without price discrimation.  As the authors state clearly: “Price discrimination increases welfare if and only if it increases the total volume consumed.”

A simple example of indication-specific pricing in action

If life sciences set the price to maximize profits, they may set a high price reflecting the value provided to patients with disease A.  Patients with disease B (or their insurers) will not buy this treatment because the price will exceed the value to patients.  However, if the treatment provides positive value, then it generally would be welfare improving to set a lower price for the treatment for patients with disease B than disease A, so that patients with disease B would get access to the treatment.  This is an argument made by Bach (2014).

This discussion, however, treats the price of the treatment for patients with disease A as fixed.  Chandra and Garthwaite (2017) argue that with indication-specific pricing, the price charged for the treatment among patients with disease A would rise.

Cole et al. make the wise argument that what matters most is not the level of prices, but the level of societal surplus generated by said prices. They argue that there are 3 key factors not addressed by the current literature.

  1. What is the level of uniform price?  If the uniform price would be very low, indication-specific price could increase prices.  If the uniform price would be high, indication-specific pricing would lower prices for some indication and expand access to patients with lower-value indications.
  2. How do prices relate to value?  In countries with health technology assessment (HTA) organizations, one can insure that prices set reflect value.  While there is much debate about how well value is measured by the HTAs, Cole et al. argue that prices cannot exceed value in an HTA system since they would not be reimbursed.
  3. Benefits of competition.  “A system of IBP would, in the dynamic context, create the R&D incentives required for producers to target further indications / sub-populations, thus facilitating more aggressive competition at the indication-level. We argue that, as a result, the value-based indication prices (based on setting price at the maximum WTP) should be seen as the price ‘ceilings’, and that competition can drive prices down below these levels.”

Incorporating dynamic equilibrium

Measuring price and welfare in the short-run is not the only goal for indication-specific pricing.  Part of the goal is to incentivize high-value innovation across diseases.  Thus, incorporating how indication-specific pricing would affect future R&D and drug development is important.

Economic theory suggests that there are two important dynamic effects which impact on R&D and on pricing. Firstly, with a single price, some high value or low value indications may not be developed, even though the incremental value of the drug to patients exceeds R&D and supply costs. Secondly, scientific progress stimulates R&D competition and often leads to several products coming to market in a therapy class. We propose that IBP makes it more likely (i) that competing products get developed and (ii) that competition occurs in any given indication.

Let us extend our simple example from above where a drug company is considering setting a single price or using indication specific pricing.  If the treatment was already indicated for diseae A, life sciences firms may not have an incentive to  conduct clinical trial for the treatment of patients with disease B if they knew the price would fall for all treated patients.   Or they may not produce clinical trials for disease A if they know that the eventual price will be far below the value it creates if potential future uses are limited because of a forced single price.


Cole et al.’s conclusion is succinct and bears repeating:

Economic theory indicates that – in the short term – indication-based pricing can improve overall welfare if it means greater patient access, but payers may (or may not) be worse off. However, the potential longer-term (dynamic) effects of IBP are sometimes neglected – optimised incentives for R&D and potential for increased price competition at the indication-level, driving down prices and delivering better value to the health system.

In short, although there are implementation challenges, indication-specific pricing is worth exploring.


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