Tuesday, September 22, 2015

Daraprim: Price increase or Leveraged Financial System

Going a bit off topic for this site today, but it is generally business-finance related, so still relevant to this blog, generally speaking. 

Yesterday, on every social media site, I saw one dominant story.  Specifically this one: 

Always interested in the reasons behind business decisions, I watched a video of the CEO.  Generally, I had a bit different reaction.  To get started, here's the video:




CEO COMMENTS

Rather than just react from the hip regarding the terms "Hedge Fund Manager" and 5,500% price increase and AIDS (or a name that starts with four consecutive consonants) I thought I would look a little more into the CEO's argument.  Here's what it breaks down to:

  1. The drug is a low-demand, rare disease drug, historically under-priced.  It was price far below its peers (other rare-disease drugs) and was effectively not profitable, largely due licensing and other back-end non-production costs.  Key comment: It was only $1,000 to save your life, which is a lot more valuable than that.  
  2. We are changing the service model.  Here he's making some claims that they will provide a higher level service, and better serve the needs of the customer.  Uses term "dedicated patient services."  Also more R&D to help patients have access to a better drug. (read: blah blah blah, I have a business plan, but we want to make this profitable now to access that)
  3. We also offer pro-bono services of the drug.  This is key. Here he argues that the drug will be offered for free to patients who can't afford to pay.  Also mentions co-pay assistance programs for people who can't afford to pay insurance co-pays, and "even if we're having a disagreement with the insurer, we'll send them drug for free until that ..."

MY THOUGHTS

I'll just address the CEO's points one by one.
  1. It's completely fathomable that the drug was under-priced to the point of being unprofitable.  Especially if it was owned by large pharmaceutical companies where it was an ignored net-neutral accounting line. It's also completely reasonable to want to test price increases (or decreases) to a profit maximizing standard. I actually do this quite regularly, the simplified assumption being that you're balancing price sensitivity and profit and finding a profit maximizing equilibrium.  But in normal circumstances slow, incremental pricing changes are more telling for a model, and also safer from a revenue perspective.  This is a giant pricing change, why?  
  2. This sounds like CEO BS.  So there's this scene in Halt and Catch Fire where John Bosworth just got out of prison and Cameron re-hires him, and basically says "I don't know just do CEO stuff."  CEO stuff is what this sounds like.  He's trying to talk about his plan for the business, and he may have every intention of R&D and future "dedicated patient services" but at this point, this company is probably just selling the same old product: daraprim.
  3. The pro-bono services are telling.  What's most telling is "working with patients" through insurance problems, copay assistance.   Effectively, they are communicating that this price increase is designed AROUND an insurance system (and rich people, but mostly the insurance system). Once something becomes part of an easy finance-able system (like insurance, financing, think mattresses over past 20 years, easy mortgages 2002-2007) you increase the customers ability to pay and thus you change the functional demand curve/price sensitivity of customers.  Under this view, my final point here: The CEO's rhetoric tells us that he is leveraging higher pricing against the financial-insurance system, and effectively betting on the ability to extract large mid-term profits from it.  The insurance system, as it exists,  enables this type of cost increase by giving *ordinary* people *extraordinary* ability to pay for effectively one-time services.  A fairly classic perverse incentives/moral hazard problem.


Side note.  At what point did the term "Hedge Fund Manger" become derogatory?  Like this person was trusted with millions (potentially billions) in assets from high net-worth individuals and that somehow is an indictment of character?  Are we getting "Hedge Funds" confused with "Trust Funds?"  Certainly it would be negative if it were a Ponzi scheme or other financial scam, but at this point we're only dealing with a pricing change.

12 comments:

  1. "At what point did the term "Hedge Fund Manger" become derogatory?" C'mon, man, you know this. 2008.

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    1. True, that's the time period. I'm still not sure they all deserve that reputation. Though after reading the cases pending against this guy today.

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  2. 1) Generics of Daraprim are available elsewhere for a fraction of the new price, so what exactly is the justification for raising its price to $750?

    2) Martin claims that the high cost is to make profit to fund future R&D. In that case, can we be assured that every cent of those profits will go towards funding new drug development? If not, and seeing as he did absolutely nothing to contribute to the development of Daraprim, it seems highly immoral for him to be profiting by creating a monopoly on a generic drug.

    3) Here's a question - if pharmaceuticals decided to raise the cost of existing generics and justified it on the basis that it's needed to fund future R&D, how would you feel about that? That's essentially Martin's argument right now.

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    1. 1. There is no justification, as I pointed out, a smaller price shock would be reasonable, this is much higher than that.
      2. Because he's giving some pills away from free, and the true harm goes against insurers and has a diffuse impact on consumers he probably doesn't have moral issue with it. Doesn't mean it isn't a jackass thing to do though. Also, I don't think there's much hope that his firm becomes a big R&D lab, or any profit goes in that direction. I think this whole "doing it so we can do R&D" is complete CEO BS.

      3. Right. It's a bad argument. I don't buy it. I once again think he's doing this to leverage insurance structures. Also, it seems that Shkreli would be smart enough to know that future R&D isn't priced-in to current products. Not in this kind of overt way at least.

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  3. Listening to him made me sick. His attitude could only be described as arrogant and if the above is true relating to back-end costs, then he should explain it. He basically said, pay me more and trust me that I will invest it in future drugs. I wish I could get my existing customers to subsidize my product development by charging them higher prices.

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    1. I deal with business people quite a bit, so I'm fairly used to the attitude that made you sick, but it's still a little jolting. I will say that the biggest thing he needs for his companies going forward is a good PR department.

      It's likely the back-end costs are higher, but not as high as he is stating. A doubling of price may be reasonable, this would not.

      I hope I made it clear in my post that the "invest in future" drugs is likely just CEO BS, what he's using as an ex post facto justification for higher margin.

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  4. Pretty sure he was fired as a hedge fund manager for financial misconduct. And you think he's suddenly decided to stop being a greedy asshole?

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    1. This is interesting, do you have a link to this?

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    2. He may be, but my larger point is that the types of financial incentives setup in this situation enable people like Shkreli to act in this manner.

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    3. And a link to his background http://www.cnbc.com/2015/09/22/controversial-drug-ceo-was-accused-of-serious-harassment.html BTW, I think it was another drug company he was fired from, not necessarily a hedge fund.

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  5. If his goal is to take Daraprim out of the market, he might achieve that! But only Daraprim, and because people won't buy it, specially if there are cheaper alternatives. I highly doubt that he will achieve his goal because people (both normal people and insurance companies) ACTUALLY bought his overpriced drug so he could make profit and create his miraculous alternative. Perhaps this wasn't the best way to go.

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    1. Possibly not. Looks like he is going to re-price the drug now after consumer out-cry. I'll be interested to know what that new price is.

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