The Price Is (Not) Right: Discounts, 340B, Access, And IRA

A variety of pharmaceuticals laid on top of a desk next to a calculator, representing our drug pricing outlook. Laid on top are a variety of pills of various colors.
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The TD Cowen Insight

In this unique deep dive report, we attempt to lift the veil on drug pricing in the U.S. and identify companies that are underexposed and overexposed to these risks.

Net drug prices have declined since 2017 owing to higher rebates and discounts. Discounts can be anywhere from <10% to >70% depending on clinical profile, therapeutic area, completion, and formulary access. 340B growth has caused major revenue losses while biosimilars lead to steep and durable pricing/share erosion. Good news is that the Inflation Reduction Act (IRA) is unlikely to cause a major initial impact to biotech profits.

Drug Pricing in the U.S. is Difficult for Investors to Unravel

Drug pricing is governed by an intricate chain of stakeholders. The system is complicated and often difficult to unravel. The process behind drug pricing is shrouded in opacity; hence, most investors overlook many nuances of gross-to-net discounting, payer contracts, and government negotiation mandates for discounts.

Generalist investors may often read about markups on list drug prices. Meanwhile biopharma specialists know the reality is that net drug pricing is actually on a decline, reaching -2.8% y/y in 2021 for 10 major biopharma companies that have chosen to disclose this data annually.

Friction Points Within the U.S. Drug Pricing System

The major points of friction within the system are steep gross to net discounts relating to formulary access (different levels of access based on preferential positioning of drugs on a health plan’s formulary, aka list of covered drugs). These include payer mix by therapeutic area, competitive intensity, and exposure to the 340B program, which is a key federal discount provision allowing safety-net hospitals and their networks to buy drugs at significantly discounted prices. In 2021, for 6 biopharma companies that reported data for their portfolios, the average gross to net discount was 52%.

Formulary Contracts Drive Price and Market Share

From our work, we surmise that while biopharma investors may anticipate the best drug to win out, formulary contracts are often the more important drivers of price and market share than clinical data. This is increasingly a factor as therapeutic areas become more crowded, differentiation less tangible, and competition with big pharma companies with deep portfolios more common. More so, gross-to-net discounts are far steeper, further detracting from profits.

Biosimilar uptake has been robust and provides tailwinds to biosimilar manufacturers. However, price erosion is common, and the branded reference product continues to cede share. Based on our analysis, the reference brand only retains 54% of its sales and 67% of its market share 2 years after biosimilar entry.

The Promise of Innovation and Investment

We are not pessimistic, and all is not lost from the standpoint of innovation and investment in the sector. Rather, we are optimistic and think the ability to innovate remains robust, but the realities of the market dictate that innovation be focused.

Smart companies will increasingly need to explore new avenues offering clinical differentiation to secure favorable formulary positioning, reduced gross/net discounts, and shore up premium pricing for their new brands. In the current environment, a me too/me better brand is unlikely to be as successful and will be faced with competition on net pricing, even though gross-to-net discounts may seem favorable.

The Impact of the Inflation Reduction Act on Biotech

IRA negotiations may have long-term consequences, but biotech is largely insulated from any near-term impact. More so, the good news is that the IRA is not going to lead to a major drag to biotech earnings in FY26/27 from the initial cadre of exposed drugs.

However, that could be a moot point for many of them anyway. Several of the top exposed drugs are expected to face generic, or biosimilar pressure by that point and will become smaller franchises, despite exemption from the negotiations provision.

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