What's behind skyrocketing drug prices

Can the outrageous actions of one individual taint an entire industry?

By demonstrating total disregard for the patients that drug companies serve, pharmaceutical bad boy Martin Shkreli, former CEO of Turing Pharmaceuticals, is trying his hardest to destroy the reputation of the industry. Shkreli became America's most detested businessman when he jacked up prices on an AIDS drug 5,500 percent, from $13.50 a pill to $750. Meanwhile, a generic version of the drug is available for $1.00.

Shkreli proudly defended the price-gouging, unapologetically claiming his obligation was to serve investors. His extreme indifference to the patients whose lives are upended by his massive price hikes allowed the media to cast him as a "greed is good" Wall Street villain. His cavalier attitude may turn the full force of public opinion against the pharmaceutical industry, which is otherwise doing great work in treating and curing life-threatening diseases like cancer. Shkreli's timing is ironic since it comes just as a new generation of breakthrough drugs is working its way through the arduous pharmaceutical trial process.

Shkreli got his 15 minutes in the spotlight last Thursday, but perhaps not the way he wanted. His photo in his gray hoodie was on the front page of every newspaper as he was led away by FBI agents. He was arrested for creating a quasi-Ponzi scheme by using money from Retrophin, a prior pharmaceutical company he started, to pay off losses in his hedge funds.

Meanwhile, Valeant, a legitimate company with a different business model, drew scrutiny for its own pricing by increasing prices 200 percent to 500 percent. As Cleveland Clinic CEO Toby Cosgrove said on CNBC last month, "We worked hard to reduce costs across the system by $10 million, and all our efforts got offset by price increases from Valeant totaling $11 million."

Two years ago Gilead caused an uproar when it announced its new Hepatitis C drug, Solvaldi, would cost $84,000 for a 12-week treatment, which put it out of reach of many patients. To its credit, Gilead spent billions to develop two breakthrough drugs, Solvaldi and a second Hepatitis C drug, Harvoni; together, they generated $14 billion in revenues in the first nine months of 2015.

The latest round of drug-price increases have stirred up a public furor. As a result, the U.S. Senate Committee on Aging held hearings on these enormous increases on Dec. 9, during which senators from both parties denounced the unconscionable price increases on decades-old drugs.

The pharmaceutical industry's rationale that it needs high prices to afford the research has been turned on its head by Valeant's business model of spending less than 3 percent on research & development (R&D) and paying less than 3 percent in taxes. Under CEO Mike Pearson's leadership, Valeant attracted many investors and increased its stock-market value to more than $90 billion by last August. Since then, serious operating problems and questions about its business practices have contributed to a 60 percent share- price decline.

Pearson, a former management consultant, says 3 percent is sufficient because Valeant R&D is much more efficient than the big pharmaceutical companies. As a longtime medical technology executive, I find this assertion preposterous, because no pharmaceutical company can create breakthrough drugs for just 3 percent of revenues. The most productive pharmaceutical companies such as Merck, Eli Lilly, and Roche, spend 17 percent to 24 percent on R&D. They have deep internal expertise and take on scientific risk, rather than just acquiring small drugs and marketing them.

As egregious as these price increases may be, they are just the tip of the iceberg. A much deeper problem threatens the financial viability of the Affordable Care Act (ACA), known as Obamacare. When President Obama's former chief of staff Rahm Emanuel was putting together ACA back in 2009, he negotiated deals with leading pharmaceutical companies. For their support of ACA and $70 billion in payments to the federal government, the pharmaceutical industry obtained legal guarantees that the government could not negotiate drug prices. Now the chickens are coming home to roost for the government and private health plans as pharma makers regularly increase prices 6 percent to 10 percent — and many go far higher.

The pharmaceutical industry faces twin threats, just as the new generation of promising life-saving drugs is in final development. First, the entire industry is at risk of being vilified for not caring about patients. Second, the industry's research-driven business model is under pressure from short-term investors arguing to abandon research in favor of simply acquiring drugs from start-ups. The pitfalls of price gouging are now being exposed, as are the consequences of simply buying drugs from others.

It's time for the leaders of the pharmaceutical industry to speak out forcefully against these practices, and reaffirm their primary commitment to patients and research. That's what Merck CEO Ken Frazier did at a recent Fortune conference, declaring, "Turing is not the market. This is a hedge-fund guy masquerading as a pharma exec." Frazier is following the mission established by founder George Merck, who declared, "Medicine is for the people. It is not for the profits."

All pharmaceutical companies should adopt that motto before the U.S. government, in response to public outrage, contravenes ACA to set strict price controls. Time is running short, and public patience is wearing thin.