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How Pharmaceutical Companies Price Their Drugs

Revenues generated from the production of drugs by US pharmaceutical companies, both at home and abroad, are increasing dramatically, in part because of repeated price increases.

Pharmaceutical company prices are relatively unregulated and they can often raise drug prices beyond inflation rate. This allows pharmaceutical companies to continually increase their revenue, even if the demand for one or more drugs is not high. By 2024, global prescription drug sales are expected to reach $1.18 trillion by some estimates.

Key points to remember

  • The price of prescription drugs is relatively unregulated in the United States
  • Pharmaceutical companies can raise the price of their drugs beyond inflation rates, regardless of demand.
  • The majority of a pharmaceutical company’s revenue comes from the ever-increasing prices of drugs that have been brought to market.
  • When pricing their drugs, pharmaceutical companies consider the uniqueness and effectiveness of a drug as well as competition from other companies.
  • Companies also consider the research and development (R&D) costs required to bring a drug to market.

Exorbitant drug costs

The news media in the United States put a lot of emphasis on the pharmaceutical companies that published new drugs with exorbitant prices. Emphasis was also placed on drugs previously marketed under new ownership whose prices rose sharply. Pharmaceutical companies do this, of course, to generate revenue.

However, the majority of a company’s revenue comes from a trend of steadily increasing prices for drugs that have been on the market for some time. The number of drugs that pharmaceutical companies have in their pipelines will also affect the price of each medicine.

The Inflation Reduction Act of 2022, enacted August 16, 2022, includes provisions to reduce prescription drug costs. It allows Medicaid to negotiate the price of prescription drugs for the first time, starting with 10 expensive drugs in 2026 and increasing to 20 expensive drugs by 2029. Companies that refuse to negotiate with Medicare face a 95% tax penalty on this drug.

For Medicare beneficiaries, the Inflation Reduction Act also caps drug costs at $2,000 beginning in 2025 and caps monthly insulin costs at $35. Many of the drug price caps would not apply to those with private insurance.

How are drugs priced

Because of the pharmaceutical companies pricing power and their ability to raise prices without regulation, worry about weak demand is low on the list of pricing concerns. Pharmaceutical companies are concerned with various factors when pricing drugs.

Uniqueness of the drug

The uniqueness of the drug must be taken into account. In other words, how many other drugs are already available to treat the same condition. If the the market is heavily saturated with drugs to treat a certain condition, new drugs for the same condition are likely to be cheaper.


Competition is another factor that affects prices. Pharmaceutical companies must consider the popularity and success of the drug’s competition, and they must determine whether new drugs have additional advantages over competing drugs. Additional benefits lead to higher prices.

Drug efficacy

Pharmaceutical companies need to consider whether new drugs have the potential (or have been proven by clinical tests) to alter the current practice of medicine used to treat drug-targeted conditions. Companies must also consider whether their drugs can prevent the need for certain medical treatments or the need for surgeries or other procedures.

The world’s largest pharmaceutical company in 2022 is Johnson & Johnson, which had annual revenue of $93.8 billion in 2021.

Medications that can reduce costly surgeries, hospital trips, and doctor visits are often more expensive because of the savings they ultimately offer customers. Pharmaceutical companies also offer higher prices for drugs that can prolong or even save lives.

Ultimately, the primary goal of pharmaceutical companies when pricing drugs is to generate the most revenue. This often means dealing with competition, which serves to drive down prices. However, pharmaceutical companies have balanced drug prices that are too low with the ability to enact price increases at regular intervals.

Pricing issue

Incorrect pricing of a drug is a mistake that pharmaceutical companies are trying to avoid. The price of a drug that is too low or too high has a significant impact on its potential for success. If, for example, the price of a drug is too high, payers may be reluctant to reimburse it or physicians may be reluctant to prescribe it.

They may believe the drug is not worth the high cost if it is likely to provide too little benefit to justify the cost. On the other hand, if the price of a drug is too low, doctors may conclude that it offers a cheaper form of therapy that is less effective than a more expensive drug that already exists.

The Research and development (R&D) surrounding each drug is another issue of monumental importance when it comes to pricing. The amount of time, effort, and money that a pharmaceutical company invests in R&D for each drug must be weighed when pricing the drug. This often leads to higher prices to ensure that the revenue generated will exceed the expenses behind the development of the drug.

Why are pharmaceutical companies raising their prices?

Pharmaceutical companies raise their prices to earn more revenue. Pharmaceutical companies often state that price increases are necessary to fund their ongoing research into new drug discovery. Moreover, since some patented drugs face no competition, pharmaceutical companies can raise their prices without customers having suitable alternatives.

Who controls drug prices?

Pharmaceutical companies that create drugs and other drugs control prices. The US government is not involved in price setting. However, the insurance companies and pharmacies that sell the products are responsible for the total final amount that a customer will pay.

Why do generic drugs cost less than brand name drugs?

Generic drugs cost less than brand name drugs because they don’t spend the same amount on research and development or clinical trials as the company that created the original (brand name) drug. Generic drugs do not need to discover a solution, they are able to use previously designed technology that a brand name company has discovered/created after the patent expires.

The essential

Pharmaceutical companies set their own prices when selling the products they have created. Without any competition for a newly created or still-on-patent drug, pharmaceutical companies can set any price, knowing that there is no alternative. Under the Inflation Reduction Act, drug companies would have to negotiate with Medicare the prices of certain expensive drugs that have been on the market for a number of years.

When considering the price of a drug, pharmaceutical companies consider the uniqueness of the drug, the competition, the effectiveness of the drug, as well as research and development costs.

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