Many drugs on the market today are multi-functional, having been approved to target more than one disease. Botox, to take a familiar example, can be used to treat nine medical conditions, in addition to its sanctioned cosmetic applications. For this and countless other drugs, the different kinds of allowed treatments, or “indications,” have varying levels of effectiveness and, as a consequence, offer varying degrees of value for different types of users.

In the United States, consumers have traditionally paid a uniform price for a drug, regardless of the purpose for which it was originally intended. But there’s growing interest in a novel pricing policy, which would allow manufacturers to charge differing amounts for the same drug, depending on the effectiveness of the applications for which it’s prescribed and hence its potential worth to patients. This may sound unfair. Amitabh Chandra, the Malcolm Wiener Professor of Public Policy at the Kennedy School, and his Northwestern University colleague, Craig Garthwaite, analyzed this new approach, “indication-based drug pricing,” in a July 2017 paper, “The Economics of Indication-Based Drug Pricing,” that appeared in the New England Journal of Medicine.

Their study is particularly timely given the recent “advent and proliferation of precision medicine in which biomarkers … identify patients likely to receive greater treatment benefits”—a trend, the authors claim, which will serve to “increase the range and variability in the effectiveness of the same product.”

Indication-based drug pricing borrows in spirit from the widespread practice of “price discrimination,” whereby companies charge different prices for identical drugs in different countries based on the ability and willingness of consumers in these separate locales to pay for the product. The same medication might sell for $20 in India and $2,000 in the United States, due to disparities in relative affluence. “If the drug companies were forced to stick to a uniform price, as many people want, they probably wouldn’t try to sell the drug in India at all— they will pick a uniform price close to $2000,” Chandra explains.

Indication-based pricing is similar except that prices are established on the basis of a drug’s efficacy for specific uses rather than being tied to the income levels of potential customers. Supporters of indication-specific pricing have argued that such a system would reduce prices for low-value treatments, while holding prices steady at the high-value end. Chandra and Garthwaite, however, disagree. “This expectation arises from a belief that manufacturers currently set uniform prices according to the value generated for high-benefit indications and somehow get patients who receive lower value to pay the same price,” they write. “If that were true, it would mean that manufacturers have convinced insurers to consistently pay prices exceeding their products’ value. Unless we think that insurers are epically stupid this cannot happen.”

Simple economics, the authors assert, points to a rather different outcome, which they document in their paper: “Relative to uniform pricing, indication-based pricing results in higher prices for patients who benefit the most, higher utilization by patients who benefit least, higher overall spending, and higher manufacturer profits.”

How people regard the proposed strategy depends on their attitudes towards the drug industry itself, Chandra says. “If your goal is to stick it to ‘Big Pharma,’ it’s absolutely not going to do that. These companies will end up selling more drugs at the end of the day.”

For patients, indication-based pricing is a “mixed bag,” according to Chandra. High-value customers—those who have the most to gain from a particular medication because they have that indication, will likely have to pay more. At the same time, low-value customers would end up paying less, resulting in broader access to the drug for such treatments owing to its increased affordability. Manufacturers will sell more drugs which mean higher profits. “We’re saying that indication pricing is a good idea,” Chandra maintains. “But we’re saying that it comes with a tradeoff—a tradeoff that may not have been appreciated before, which nevertheless needs to be taken into account.”


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Amitabh Chandra Photo

Amitabh Chandra

Ethel Zimmerman Wiener Professor of Public Policy, HKS; Henry and Allison McCance Professor of Business Administration, HBS

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