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Value-Based Drug Pricing: Watch Out for Side Effects


When I hear discussions of value-based pricing of drugs, I am reminded of one of my most satisfying professional memories: treating patients with pneumococcal pneumonia.

Its cause is a bacterium called pneumococcus (technically, streptococcus pneumoniae). Under the microscope pneumococcus is an almost cute little bug, occurring mostly in pairs that stare back at you like ferrets’ eyes.

There is nothing cute, though, about what it does to patients. They come in burning with fever, coughing, and breathless. Especially when the bacterium jumps from the lungs to the bloodstream and even the brain, the infection can be rapidly fatal.

So why the fond memories? Because we have an almost magically powerful treatment for this devastating illness: simple, unadorned penicillin. It can bring nearly moribund patients back to life in hours or days. And it’s dirt cheap.

Which leads me to ask: what would penicillin cost under value-based pricing, a system in which drug makers set prices based on the benefits of their products to consumers and the larger society, rather than drugs’ costs of production? Penicillin has saved millions of lives since its first use in 1942, and it still works for many patients despite growing bacterial resistance to the drug. (Fortunately, many fewer patients get infections with pneumococcus now because we have a good vaccine for it.) Surely, under value-based pricing, penicillin would sell for thousands or tens of thousands of dollars a dose.

Medicine depends on many cheap generic drugs like penicillin to treat conditions as diverse as acne, gout, hypertension, heart disease, and cancer. Pricing these drugs according to their value would make them unaffordable to uninsured and underinsured patients and dramatically increase the aggregate costs of pharmaceuticals.

There is a compelling superficial logic to value-based pricing. Why shouldn’t manufacturers charge the full value of the products they produce? Why shouldn’t consumers have to pay it? That logic begins to fray, however, when you think about how other markets work in our capitalist system.

What would airline tickets cost if they captured the value of the trips travelers make: the memorable family vacations, the visits to grandchildren, and even the business trips where important deals are cut. How much would a car cost if it enables the family breadwinner to get to her job? What about the toothbrush that preserves your teeth?

In fact, economists will tell you that functioning markets don’t price products according to value. At least in theory, they price products according to the marginal cost of producing them. All the value that companies don’t capture is one of the wonders of free markets. Consumers harvest it as something called “consumer surplus.” Suppliers make a reasonable but not excessive profit, and society is vastly better off.

So as we discuss value-based pricing, we need to be careful about when and how we apply this very seductive paradigm. One place where it may make sense is when competitive markets don’t exist. In pharmaceuticals, this occurs most commonly when government grants monopolies to drug companies through patents and rights of exclusivity. In those circumstances, firms face no limit on what they can charge, resulting in prices that can be shockingly, almost scandalously, high, and may even exceed the value that the drugs produce. In this case, taking value into account may provide some guidance on price.

And, of course, knowing the comparative value of drugs can be very useful to clinicians and health systems when choosing which medications to prescribe or to put on their formularies.

But, if we go in the direction of setting prices according to value, we should be clear that we are not mimicking the functioning of the competitive markets that we so celebrate in capitalist economies. We are creating a very different, socially constructed yardstick that is appropriate primarily in the absence of effective markets, and that could result in profits that vastly exceed anything that companies would make under normal market conditions. Since those prices would be a social construct, society will have a right to ask whether they are justified by their consequences for companies, consumers, and society at large.

Publication Details



David Blumenthal, Former President, The Commonwealth Fund

[email protected]


D. Blumenthal, "Value-Based Drug Pricing: Watch Out for Side Effects," To the Point, The Commonwealth Fund, July 21, 2016.