Calculating the profit-maximizing point

Price realization is a key driver of pharmaceutical company profitability. All else being equal, a price increase goes right to the bottom line. In an era of relatively dry new product pipelines and patent expirations, price increases are the biggest lever for growth. So how do companies determine how much to raise prices? There are a few considerations:

• How much is everyone else raising prices? It doesn't look good to be way ahead of the pack, but no one wants to leave money on the table by raising prices too little.
• How differentiated is the specific drug? Drugs with fewer competitors or that really work well can command high and fast-rising prices.
• How much substitution is expected? If prices are too high, the drug will be removed from managed care formularies or devoted to a less attractive tier.

The imminent Medicare Drug benefit is a new factor. It doesn't necessarily change the overall logic but the customer and political stakes are larger than before. One example is a newly released report from the Government Accounting Office, which documents that brand name drug prices are increasing about three times as fast as prices of generic drugs for drugs that are commonly used by Medicare beneficiaries. The report may lead to more pressure to use generic drugs in the Part D benefit and possibly cause drug makers to hold the line on price increases.