A February executive order on pharmaceutical price transparency does nothing to change the incentives that keep costs opaque. But drug companies and other stakeholders would reap the benefits of such disclosures.
In a world where comparison shopping for everyday products can be accomplished with a few clicks, prescription drugs are an outlier, their prices often only becoming clear when we proffer a credit card at the pharmacy pick-up window. Why is there no set price for prescription drugs? The short answer is that none of the key stakeholders—drug manufacturers, pharmacy benefits managers and payers—wants it.
Despite the current administration’s nothingburger of an executive order, signed in February, calling for more transparency, current policy directives are going nowhere. From executive orders mandating price disclosures to data-driven analyses of healthcare spending, many have weighed in on why transparency remains elusive—but none have cracked the nut. It’s due to the unrivaled power of the major players that set those prices: drug manufacturers, pharmacy benefit managers (PBMs) and even—counterintuitively—payers.
As a consultant to healthcare companies, I see the incentives these stakeholders have to keep the system as it is. But it’s also clear to me that part of the issue is simple inertia and that these entities would see benefits were real price transparency to be realized.
The Fight Over Transparency
Prescription drug prices are among the most frequently highlighted concerns in healthcare. Indeed, a recent survey from the Kaiser Family Foundation found that a broad majority of Americans consider drug costs unreasonably high and want the government to intervene. But let’s face it: consumers don’t have the political clout that the other players do.
The current lack of transparency allows manufacturers to maximize revenue by selectively pricing for their customers. Specifically, an artificially inflated rack rate enables manufacturers to offer varying rebates to pharmacy benefit managers (PBMs) and payer clients. It also permits them to charge excessively high prices to uninformed customers while providing coupon programs for those who take the time to research the best drug prices. The coupon programs provide the additional advantage of enabling manufacturers to highlight a solution when regulators and politicians raise concerns about the high cost of drugs.
The concept drug companies are using is known in economic theory as willingness to pay, defined by Harvard Business School as “the maximum price a customer is willing to pay for a product or service.” The blog entry continues, “Willingness to pay can vary significantly from customer to customer. This variance is often caused by differences in the customer population, typically classified as either extrinsic or intrinsic.” Extrinsic differences can be identified by observing the customer, specifically the healthcare payer system, PBM or individual consumer. Intrinsic differences are harder to observe but can be understood through data analysis of prescribing trends, and no one excels at data analysis more than Big Pharma. The current opaque pricing system enables pharmaceutical manufacturers to select the most suitable price for their customers based on each customer’s unique characteristics. While these pricing strategies may not represent the best business model for PBMs and payers, built-in inertia means we remain stuck with the current system.
Although PBMs and payers may not be entirely comfortable with the current pricing regime, it can be difficult for them to advocate for change when drug manufacturers send them a six- or seven-figure rebate check each quarter. Shifting away from the current opaque pricing structure will require significant effort and would mean giving up on rebate revenue, and the cost of switching to a transparent model is just not worth it in the view of PBMs and payers.
Transparency’s Benefits
While many see transparency efforts as a threat to traditional pricing models, there are ways in which greater clarity could benefit pharmaceutical manufacturers. First, open-book pricing helps build trust with patients, healthcare providers and payers, who often view opaque costs skeptically. By openly sharing how research, development and manufacturing costs contribute to a medication’s price, companies can demonstrate the actual value of their innovations and highlight the substantial investments that go into creating lifesaving treatments. Thus, a move toward transparency would go a long way toward changing attitudes toward healthcare’s favorite scapegoat.
Such transparency may also serve as a competitive advantage, especially in an era of mounting regulatory scrutiny. Clear, well-communicated costs can reduce conflict, protect reputations and foster more stable partnerships and reimbursement deals.
In recent years, policymakers have floated various ideas to address this opacity. The recent executive order, for example, sought to require list-price disclosures in TV ads. Although well-intended, such measures have done little to change the system. As one commentator noted, the recent executive order “sells out seniors, goes back on [its] promises to lower drug costs, and hands pharmaceutical companies exactly what they want.”
A potential turning point arrived when the Biden administration allowed Medicare to negotiate directly with drugmakers for certain medicines through the Inflation Reduction Act. Advocates believe this could lower costs for older Americans, though critics in Big Pharma claim it might hamper innovation.
Part of the difficulty lies in devising fair yet effective frameworks. As an analysis by Brookings notes, “Having the federal government lower drug prices directly—whether by negotiating with manufacturers or unilaterally setting prices—would save money for governments, employers, and consumers, but constitute a major policy initiative that turns away from reliance on market forces.” At the same time, taxpayers subsidize a large share of foundational science but see little benefit in lower prices.
Another challenge is the opaque pharmaceutical supply chain. Manufacturers, insurers and PBMs negotiate out of view, creating inflated list prices with only a loose connection to true production costs. Layers of wholesalers, PBMs and insurance agreements lead to sticker shock for patients and confusion for pharmacists trying to pinpoint who sets prices. The American Academy of Actuaries warned in a 2018 report that inflated or unpredictable costs make insurance modeling difficult.
Ultimately, drug companies and intermediaries benefit from maintaining opaque pricing, but more openness could yield tangible benefits for the healthcare system at large. Policymakers must balance the need to curb runaway costs with preserving industry incentives for research and development. Potential strategies include mandating supply-chain disclosures, pegging prices more closely to clinical outcomes and ensuring that the public’s investment in foundational research is acknowledged in final costs.
Given the power of industry lobbying and a patchwork system that conceals true costs at nearly every stage, transformative reform may be slow. Yet mounting public pressure—reflected in poll data, consumer advocacy and legislative pushes—suggests a strong appetite for change. If pursued earnestly and with the buy-in of Big Pharma, payers and PBMs, enhanced transparency could help tame skyrocketing drug costs, offer relief from public pressure and ensure that life-saving medications remain accessible to those who need them most.
