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Revenue generated from drug production by U.S. pharmaceutical companies has grown substantially because of price increases. Drug pricing is largely unregulated, which means drug companies can often raise prices beyond inflation rates. This allows companies to increase their revenues continually, even if demand for one or more drugs is not high. Global prescription drugs are predicted to reach $1.13 trillion in 2025 by some estimates.
Key Takeaways
- Prescription drug prices are relatively unregulated in the United States.
- Drug companies can raise their prices beyond inflation rates despite demand.
- Most of a drug company’s revenue comes from steadily increasing prices of drugs that have been on the market.
- A drug’s uniqueness, efficacy, and competition factor into its pricing.
- Companies also consider the R&D costs required to bring a drug to market.
Exorbitant Drug Costs
There’s a great emphasis from the news media on sky-high prices imposed on the new drugs released by pharmaceutical companies, and for good reason. The cost for a new drug was $300,000 in 2023. That figure rose to a median price of $370,000 in 2024 despite criticism to lower drug costs.
But, the majority of a pharmaceutical company’s revenue comes from a pattern of steadily increasing prices of drugs that have been on the market for some time. And the number of drugs that companies have in their pipelines will also affect each drug’s price. Prices for drugs already on the market jumped by 15.2% between 2022 and 2023, which is about $590 per drug.
The Inflation Reduction Act of 2022, signed into law on August 16, 2022, included provisions to help lower the costs and negotiate the price of prescription drugs for people with Medicare. This will start with 10 high-cost drugs in 2026 and expand to 20 high-cost drugs by 2029. Companies that refuse to negotiate with Medicare face a 95% tax penalty on that drug.
Important
For Medicare beneficiaries, the Inflation Reduction Act also caps out-of-pocket costs at $2,000 starting in 2025 and caps monthly costs for insulin at $35. Many of the drug price caps would not apply to those with private insurance.
How Drugs Are Priced
Because of drug companies’ pricing power and their ability to increase prices without regulation, the worry about sluggish demand is far down on the list of concerns in relation to pricing. Pharmaceutical companies concern themselves with a variety of factors when pricing drugs.
- Uniqueness: The uniqueness of the drug must be considered—that is, how many other drugs are already available that treat the same condition. If the market is heavily saturated with drugs to treat a certain condition, new drugs for the same condition will likely be priced lower.
- Efficacy: Drug companies must consider whether new drugs have the potential (or have proven through clinical trials) to change the current practice of medicine used to treat the conditions that the drugs target. The companies must also consider whether their drugs can prevent the need for certain medical treatments or the necessity for surgeries or other procedures.
- Competition: Competition is another factor that affects pricing. Drug companies must consider the popularity and success of the drug’s competition, and they must determine if new drugs have added benefits over competing drugs. Additional benefits lead to higher prices.
Fast Fact
Johnson & Johnson was the largest pharma company by revenue in 2024, which earned $88.82 in sales that year.
Drugs that can cut down on expensive surgeries, hospital trips, and doctor visits are often priced higher because of the savings they offer customers on the back end. Drug companies also issue higher prices to drugs that can extend or even save lives.
Ultimately, the main objective of pharmaceutical companies when pricing drugs is to generate the most revenue. This often means facing competition, which serves to drive prices lower. However, drug companies have balanced pricing drugs too low with the ability to enact price increases at steady intervals.
Issue of Pricing
Pricing a drug incorrectly is a mistake that drug companies strive to avoid. Pricing a drug too low or too high has a great impact on its potential for success. For example, if a drug is priced too high, payers may be unwilling to reimburse for it or physicians may be disinclined to prescribe it.
They may believe the drug is not worth the high cost if it is likely that it will offer too little benefit to warrant the cost. On the other hand, if a drug is priced too low, physicians may conclude that it offers a discounted form of therapy, less effective than a more expensive drug that already exists.
The research and development (R&D) involved with each drug is another monumentally important issue related to its price. The amount of time, effort, and money that a pharmaceutical company invests in the R&D for each drug must be weighed when the drug is priced. This often leads to higher prices to ensure that the revenue generated will exceed the expenditures behind the drug’s development.
Why Do Pharmaceutical Companies Raise Their Prices?
Pharmaceutical companies raise their prices to earn more revenue. Pharma companies often state that price increases are necessary to fund their continuing research of new drug discoveries. In addition, as some patented drugs face no competition, pharma companies can raise prices without customers having suitable alternatives.
Who Controls the Price of Medicine?
Pharmaceutical companies that create drugs and other medicines control the prices. While they are involved in the regulation of the industry, the U.S. government is not involved in setting prices. However, insurance companies and the pharmacies that sell the products are responsible for the total end 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 require the same costs or testing as the original. They don’t need to discover a solution—they can use the previously engineered technology that a brand-name company discovered or created once the patent expires.
The Bottom Line
Drug companies set prices when they sell their products. Without competing drugs (or any still under patent), they can set whatever price they want because there aren’t any alternatives. In many cases, a drug’s uniqueness, efficacy, competition, and R&D costs are factored into how they are priced. Under the Inflation Reduction Act of 2022, drug companies and Medicate have to negotiate the price of some of the high-cost drugs that are been on the market for some time.
Correction—April 26, 2023: This article has been amended to state that the Inflation Reduction Act of 2022 includes provisions to help lower the costs of prescription drugs for people with Medicare (not Medicaid).
