Many people view marketing as an inefficient waste of money. Without marketing, however, physicians and patients would not be aware of new products. Marketing is especially important for new pharmaceuticals. While the price of branded pharmaceuticals may be high in some cases, the marginal cost of production (not counting R&D costs) is low; and often the value (in terms of health benefits) is high. Thus, for any treatment where the benefits greatly outweigh the cost, one would want to maximize the number of people who use the product (assuming they have the relevant disease).
Some people may worry, what if the price is much higher then the benefit? From a social welfare perspective, this is not relevant as long as it does not effect demand. If prices are higher, welfare will transfer from consumers to producers, but as long as the treatment benefit outweighs the cost, high prices are simply a transfer from consumers to producers.
Thus, one may want to allow for significant marketing to make sure patients and physicians are aware of the high value treatments they need. A paper by Critchley and Zaric (2019) examines six different pricing regimes:
- First best: In this scenario, a social planner makes all decisions with the aim of maximizing social welfare. The price of the drug is ignored–it is simply a transfer between the payer and manufacturer and does not impact social welfare. The social planner decides the appropriate level of marketing effort. He will only introduce introducing the drug only if social welfare is positive.
- Negotiated pricing. In this situation manufacturers and payers negotiate a price. The price must be less then or equal to the drug’s net monetary benefit since payers won’t pay for treatments where the price exceeds the benefits; the price must be greater than the manufacturing cost since manufacturers won’t make a drug where they lose money. The ultimate equilibrium depends on the relevant parties’ market power. In open pricing, manufacturers may charge any price they wish and payers decide if they will cover the treatment; in controlled pricing, payers may agree to cover the drug only if they receive certain discounts.
- Listing process. In this case, a drug is either placed on a formulary or not.
- Risk sharing. In this case, payers pay some price if the drug works. If the drug does not work for a given patient, however, manufacturers must pay some share of the price back to payers.
How do these different price negotiations stack up?
We find that a listing process may result in suboptimal access to new medicines (access inefficiency). We find that a negotiated pricing policy, a controlled pricing policy, an open pricing policy, a listing process, and a risk‐sharing arrangement all result in a suboptimal volume of patients seeking treatment (marketing inefficiency) and a suboptimal treatment threshold (treatment inefficiency)…we find that value‐ based pricing with risk‐sharing always results in a first‐best level of social welfare
In short, some of the more common negotiated pricing arrangements are suboptimal because they induce less marketing and not enough patients are aware of and receive the treatment.
- Critchley GJ, Zaric GS. The impact of pharmaceutical marketing on market access, treatment coverage, pricing, and social welfare. Health economics. 2019 Aug;28(8):1035-51.