BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Solving Pharma's Shkreli Problem

This article is more than 8 years old.

This story appears in the February 7, 2016 issue of Forbes. Subscribe

credit: Glen Davis

More than $1 trillion of power in the health care world, as measured by market cap, gathered in December in New York at the Forbes Healthcare Summit. The CEOs of Pfizer and Merck. The billionaire founder of Regeneron. The heads of GlaxoSmithKline and Celgene. But the hottest guest--the one many thought would be a no-show, even though he'd personally messaged that he was "100% coming"--was a 32-year-old in a hoodie.

Even before his arrest on securities fraud charges, Martin Shkreli, a former hedge fund manager, had become the pharma industry's biggest villain. Perhaps the only thing that Hillary Clinton, Bernie Sanders and Donald Trump agree on is that his actions are, in Trump's words, "disgusting." Shkreli was largely unknown outside biotech circles until September, after his company, Turing Pharmaceuticals, purchased Daraprim, a drug to treat rare but deadly toxoplasmosis infections in AIDS and transplant patients, for $55 million and promptly raised its per-pill price from $13.50 to $750 overnight. The Internet quickly named him the "Most Hated Man in America."

He was also the most unrepentant. He did show up, facing the wall of suits in sneakers, jeans and that hoodie: "We have shareholders just like every other company, and our shareholders want us to maximize our profits."

When Kym White, who heads the health care practice at public relations giant Edelman, asked whether he would have done anything differently, he replied, "I probably would have raised the price higher is probably what I would have done." Everyone gasped. Headlines were again generated worldwide.

And why would he do that? "I think health care prices are inelastic," Shkreli said, coldly. "I could have raised it higher and made more profits for our shareholders. Which is my primary duty. Again, no one wants to say it. No one's proud of it. But this is a capitalist society, capitalist system and capitalist rules. My investors expect me to maximize profits. Not to minimize them or go half or go 70% but to go to 100% of the profit curve that we're all taught in M.B.A. class." (For the record, Shkreli doesn't have an M.B.A.)

Martin Shkreli has a knack of saying exactly the thing that will make people angry. But the industry's dirty little secret is that it is full of Martin Shkrelis, albeit less greedy ones with nicer shoes and more polished manners. They usually don't raise prices on old drugs by 5,000%--just 50% or 500%. Over the past three years Merck's price increases have amounted to 29% of its sales growth, Pfizer's 34% and AbbVie's 112%, according to consultancy SSR, which does health care research.

This is pharma's Shkreli problem. Yes, many new drugs must be expensive, or nobody would spend years and billions of dollars to invent them. But should Shkreli--or anyone else--be able to raise the price of a 62-year-old drug 5,000% in one fell swoop? What if he raised the price by just 200%? What if he made sure patients who can't afford the drug get it for free--as he claims he does? Or if he promised to put some of the money into research and development--as he also says he does? Would any of this have made it okay?

We have a new measure for claims about drug prices: the Shkreli test. How would any justification for raising the cost of a drug sound coming out of Martin Shkreli's mouth rather than smoothly parsed in legally vetted sound bites? Some price hikes, like those for innovative drugs, clearly pass. But many others don't.

When I first met Martin Shkreli over a lunch of branzino at a midtown Manhattan restaurant in 2012, he was wearing a suit. And he talked only about inventing new drugs, not buying old ones and jacking up the price.

The son of working-class immigrants, Shkreli was then running a small hedge fund, MSMB Capital, and was becoming small-scale notorious for publicly attacking companies while selling their stock short. Take Afrezza, billionaire Al Mann's attempt at creating an insulin you can breathe in instead of inject. Shkreli shorted the stock of Afrezza-maker MannKind and then filed a petition with the Food & Drug Administration arguing the drug should not be approved. (It eventually was but has not been selling well.)

But he said he wanted to do more than just be a speculator: He wanted to invent drugs, and he'd started a company called Retrophin to do it. Shkreli initially got money to license a muscular dystrophy drug from investors including Fred Hassan, the legendary former chief executive of drug giant Schering-Plough, and Hassan's protégé Brent Saunders. (Both now claim that their relationships ended quickly and Shkreli exaggerated their importance.) "The only person I needed affirmation from was Fred Hassan," Shkreli told me then. He'd also licensed a drug for a rare kidney disease from Ligand Pharmaceuticals.

Then, seemingly out of the blue, Retrophin fired Shkreli in September 2014 and sued him a year later, alleging he had illegally used money, shares and sham consulting agreements from Retrophin to pay off his hedge fund investors and enrich himself. Federal prosecutors and the Securities & Exchange Commission followed up with criminal and civil charges, and more juicy allegations: that in 2010 Shkreli was telling investors that MSMB Capital had $35 million in assets when it had less than $1,000, and that in 2012 he lost $7 million after a short sale of obesity drugmaker Orexigen Therapeutics went wrong. Shkreli claims Retrophin doesn't want to pay him a severance payment and that the feds don't understand his accounting. Or, as he said at the Summit, two weeks before being arrested in a pre-dawn raid and forced to endure a humiliating perp walk in chilly December rain: "Politicians love to beat up on guys that are seen to be public enemies, if you will. That's a great way to get elected."

Soon after being ousted from Retrophin, Shkreli was back in the saddle, raising, he says, $100 million for his new company, Turing Pharmaceuticals.

"[I] made a few phone calls and got $100 million in the bank," he said at the Healthcare Summit. "My investors know what I do with that money. I multiply it for them. That's my job. I did really well, and I'm going to keep doing it. That's part of what capitalist America is all about."

How? He was pushing the envelope on price. It's amazingly easy to raise the price of a drug in the U.S. without seeing volume decline, so long as you make sure that patients can afford the out-of-pocket cost. The insurance companies foot the bill.

None of this was new: Shkreli had learned about price hikes by watching his elders. In 2007 a mechanical engineer and former defense chief executive named Don Bailey took over Questcor Pharmaceuticals and raised the price of a drug used to treat seizures in infants, Acthar Gel, from $50 to $28,000 a vial, and then marketed it for diseases like multiple sclerosis where there was limited evidence it worked. Questcor was sold to Dublin-based Mallinckrodt for $5.6 billion in 2014.

Valeant Pharmaceuticals, based in New Jersey but tax domiciled in Canada, made a habit of raising the prices of drugs. Last February it purchased Nitropress and Isuprel, both heart drugs, and increased their prices by 500% and 200%. The price of Wellbutrin XL, an antidepressant purchased from GlaxoSmithKline, has quadrupled after the FDA warned that generic versions of the drug might not be effective.

In 2005 a banker named Steven Harr pointed out that the only barriers to sky-high prices for cancer drugs were pharma "companies' goodwill and tolerance for adverse publicity" but warned his clients that they risked subjecting the industry to increased regulation and quite possibly price controls. (Harr is now the chief financial officer of Seattle biotech Juno Therapeutics.)

The corollary is that if you're going to raise prices, the last thing you want to do is court publicity. Every other company practicing this strategy tried to avoid the press. This was not Shkreli's move. He called a prominent biotech journalist a "moron" on Twitter. After Hillary Clinton repeatedly tweeted about Shkreli in order to promote her own plans to lower pharmaceutical costs, Shkreli wrote back "LOL." He took to conducting live YouTube streams of himself, playing videogames, cruising online dating sites and answering questions from viewers. In December it came out that he had spent $2 million on the sole copy of an album by the hip-hop group Wu-Tang Clan. He claimed he hasn't listened to it but told the rap website HipHopDX he'd play it for Taylor Swift if she performed oral sex on him. It was more performance art than p.r.

Understandably, respectable pharmaceutical companies want to distance themselves from this circus. "I think it's really important for our industry to make it clear that he is not us," said Kenneth Frazier, the chief executive of Merck. "We are a research-based pharmaceutical industry."

"That guy is not in the same business as we are," echoes Leonard Schleifer, the billionaire founder and chief executive of biotech Regeneron. He blames the fact that insurers don't cover drugs the way they do medical procedures. He says a family member had a $150,000 bypass surgery, which was covered by insurance, and then the insurer balked at paying $6 a pill for Lipitor to prevent another. "People learned to hate the pharmaceutical industry, and politicians took easy potshots," Schleifer says.

Hillary Clinton actually internalized this argument so much that she made it part of her proposal for controlling drug costs, arguing that pharmaceutical companies should face a penalty if they don't spend a certain amount of their revenue on research and development. Aside from being possibly unworkable, this proposal fails because it almost certainly wouldn't have kept Shkreli from raising Daraprim's price--after all, he claims to be spending money on R&D. And do we really want the government mandating how companies invest their capital or deciding whether a drug company's R&D is worthwhile or not?

The current system is almost guaranteed to cause price increases, because it completely lacks the transparency good markets need. Drug companies are forced to focus on expensive drugs for smaller patient populations, because for many common diseases--diabetes, heart disease, depression--there are now highly effective and incredibly cheap generic medications available (80% of drugs dispensed in the U.S. are generic).

Moreover, the customers who pay for drugs are not the patients who consume them but employers and insurance companies--and nobody knows the real price. The negotiating power is in the hands of insurers or pharmacy-benefits managers like Express Scripts (annual sales: $100 billion) and CVS Caremark ($140 billion); they decide which drugs are covered and how much patients pay in copays. Sometimes drug companies give discounts of as much as 60% to these firms in order to get better placement for their medicines. But this also forces companies to take what price increases they can, in order to make up for those discounts.

Although opaque and convoluted, this system is not without its benefits. In 2014 a congressional investigation was launched against Gilead Sciences because it priced a treatment for hepatitis C, Sovaldi, at $84,000 per course. But the drug, and its successor, the one-pill-a-day Harvoni, is incredibly powerful, curing more than 90% of patients. Once a competitor emerged (a drug from AbbVie called Viekira Pak), Gilead began paying 40% of sales in rebates. Now more than 300,000 Americans have been cured of the virus, including former Baywatch actress Pamela Anderson, which will result in fewer liver transplants in the future. As for the initial price, Gilead hardly had a choice: It knew that competition was coming.

The biggest problem is not new expensive drugs but repricing old ones, and not just ones being purchased by Martin Shkreli or Valeant. "You have no new research. You have no innovation. You have nothing but increased drug prices," says Steve Miller, chief medical officer at Express Scripts. According to his company's data, the average cost of a branded drug has increased 127% between 2008 and 2014 (see graph).

All drug companies take price increases in the U.S. on their medicines, often at rates much higher than inflation. Biogen's Avonex, a multiple sclerosis drug introduced in 1996, is about as effective as rivals Copaxone from Teva and Rebif from Merck Serono (not the U.S. Merck). But competition hasn't kept the price down. According to industry analysts, the list price of Avonex has increased from $16,000 a year in 2005 to $70,000 now, making it just as expensive as new, more effective MS drugs. This is not the result you'd expect from a free, transparent market.

How does this happen? In a market with only a few drugs and a few buyers, none of whom are paying out of their own pockets, price competition can work in reverse. Take the case of Novartis' Gleevec, a lifesaving pill that puts a deadly cancer called chronic myelogenous leukemia out of business. It was introduced in 2001 at a cost of $24,000 per patient per year. Then, in 2006, Bristol-Myers Squibb introduced another drug, Sprycel, for patients who had failed on Gleevec. When Novartis introduced its own successor to Gleevec, it was marketed (at first) to the sick patients treated with Sprycel. So it priced the drug to compete with Sprycel and raised the Gleevec price. The result: Gleevec now costs more than $90,000 a year.

Drug company executives defend the price increases. "When you put a drug into the market you've got a relatively small database," said Pfizer Chief Executive Ian Read at the Healthcare Summit. "As you continue to invest in it and when it's in the market, you generate new uses, new indications, and you see its value. You should price drugs to their value. Because that's the way the market works. That's the way you create funds for research."

But the situation seems unsustainable and especially so with cancer drugs. In 2006 Genentech's Avastin was approved for lung cancer at a higher dose than was used in colon cancer, which also meant a higher price. To stem a public outcry, Genentech capped the price at $55,000. Keytruda, the Merck cancer drug that appears to have made ex-President Jimmy Carter's tumors vanish, costs $150,000 per patient per year. Scientists agree that the future is combining drugs like these. How can we afford it if each will cost as much as a Lamborghini?

"I don't know whether it's a one-year, two-year or five-year story, but ultimately it's about affordability as much as innovation," says Andrew Witty, the chief executive of GlaxoSmithKline. "We need to find a balance. I don't know what the answer is. But there needs to be a sensible conversation."

Let's start the conversation on fixing pricing here. 

Here's what won't work: Hillary Clinton's idea of making drug firms pay a tax if they don't spend enough on R&D probably wouldn't lower prices. And her other idea of making seniors who are eligible for both Medicare (health care for seniors) and Medicaid (the program for the poor) take Medicaid would result in savings, but it could also mean giving rich people better health insurance than poor people.

Here are some more interesting ideas:

  • Make the system transparent.
    Right now we don't know the real price of drugs, because all the bargaining happens on the rebate side. Markets work better when everyone can see prices. This would hurt pharma's profits and negotiating power but help its image.
  • Give the FDA the ability to treat a price increase of an off-patent drug as a shortage.
    This would have stopped Martin Shkreli's price hike on Daraprim in its tracks. The drug sells for $20 in the U.K., where Glaxo sells it. In cases of a declared drug shortage, the FDA can allow foreign drugs to be imported. Right now the FDA is not allowed to consider price in deciding whether there is a shortage (or any other situation). It should be allowed to. A related thought: When a dramatic price increase happens, allow the FDA to fast-track any generic that comes along.
  • Pay different amounts for cancer drugs depending on the type of cancer.
    We pay the same price for a dose of a cancer drug whether it is likely to add years to a patient's life or just weeks. That doesn't make sense. Peter Bach at Memorial Sloan Kettering has proposed changing that so you pay different amounts for Avastin in treating colon cancer versus lung cancer, for instance. Express Scripts says it is going to try it out. "This is a necessary step if we're going to start paying for drugs based on how well they work," says Bach.
  • Bring down the hammer for rare-disease drugs.
    One idea floating around Washington: Many new medicines are for rare, or "orphan," diseases. (They're called that because drug companies used to ignore them; not anymore.) Under the 1983 Orphan Drug Act, designed to spur pharma investment in rare disorders, companies are given tax benefits and longer protection from generics if they develop an orphan drug. With big pharma hyper-focused on treating rare diseases anyway, the law should be modified so prices above a certain level take those protections away.
  • Allow Medicare to negotiate drug prices.
    In other words, use the U.S. government's buying power to force prices down. The worry here is this could turn into de facto price controls.
  • Give drug companies skin in the cost-savings game.
    Novartis is launching a new heart failure drug, Entresto, that reduces the risk of patients landing in the hospital by 21%, according to a large trial published in the New England Journal of Medicine. Novartis Chief Executive Joseph Jimenez says he has worked out a deal with insurers where Novartis will get paid extra if patients stay out of the hospital. "It is possible to give some of that value back to the system and to generate enough value for Novartis that my shareholders will say, 'That's a good place to invest,' " Jimenez says.