Living Economics

The Orphan Chase
Orphan drugs are profitable because of third-party health insurance and favorable regulatory oversight.

"Successes have many parents, failures are orphans." So goes the popular saying. But in the pharmaceutical industry, orphan drugs have many eager parents.

Orphan drugs are drugs for rare diseases that afflict fewer than 200,000 Americans. For an industry that has traditionally thrived on blockbuster drugs for top killer diseases such heart failures and breast cancer, the success of narrowly targeted orphan drugs is a curious phenomenon. They are called orphan drugs because most big drug companies are not interested in such small markets.

But the orphan drug market has doubled in the U.S. over the past years. Their sales are expected to jump from $28 billion worldwide in 2003 to about $44 billion in 2008 (Plain Dealer). While still a fraction of the $300 billion pharmaceutical industry, their profit margin is substantial because of their protected pricing power and their high FDA approval rate.

For example, Genzyme Corp of Massachusetts charges an average of $300,000 per patient per year for its biweekly treatment of a genetic disorder called Gaucher disease, which can lead to bone fractures, anemia and fatigue (Baltimore Sun).

While other blockbuster drugs might also cost a lot, but the success rate of orphan drugs is much higher because of their favored treatment from the 1983 Orphan Drug Act. The Act provides a tax credit on R&D, fast-track regulatory review, exclusive marketing rights for 7 years and other perks to encourage companies to develop drugs for conditions that afflict fewer than 200,000 Americans (Plain Dealer). As a result, the cost of developing orphan drugs is about 1/100 of other drugs and orphan drugs are more than twice as likely to make to market in a fraction of the typical 12 - 15 years needed for other drugs.

The success of orphan drugs is a perfect illustration of how price discrimination by a monopoly can guarantee profit even when the market for an orphan drug could be as small as 6,000 people (WSJ 11/15/2005). In fact, there are only two price levels. Namely, the maximum level of what the market can bear and the charity level where the orphan drug companies fund the co-payment of the indigent. Since these co-payments are a fraction of the maximum price ultimately payable to the drug companies by the health insurers, the drug companies are happy to donate money to charitable organizations that fund co-payments for the poor (WSJ 12/1/2005). Without the big pockets of the health insurers who have not found an ethically defensible way to deny payments for expensive drugs, such extreme price discrimination may not have been possible.

Although the protected market status of orphan drugs last for only 7 years, there is no relief from generic versions in sight (see No Monopoly, No Competition). Most of the orphan drugs are biotech products for which no federal process exists for approving generic equivalents (WSJ 11/15/2005).

References:
  • Baltimore Sun. 8/28/2005. "Orphan drugs moving ahead."
  • Plain Dealer. 10/11/2005. "The rise and rise of 'orphan drugs.'"
  • WSJ. 12/1/2005. "Through charities, drug makers help people - and themselves."
  • WSJ. 11/15/2005. "How drugs for rare diseases became lifeline for companies."
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