Is Rate Of Return Pricing A Useful Approach When Value-Based Pricing Is Not Appropriate?

Article by: Adrian Towse

A new editorial published in the European Journal of Health Economics by Mike Drummond and Adrian Towse argues that, whilst the majority of health economists (including the authors) consider value-based pricing (VBP) to be the method of choice for pricing new drugs, an alternative approach, rate of return (RoR) pricing, could be useful in two situations where VBP may be considered inappropriate.

RoR could be useful in the pricing of treatments for ultra-rare diseases. In this case, treatments such as enzyme-replacement can cost as much as $500,000 per year. Even if they extended life at full health, it is unlikely that they could ever be considered to be cost-effective when judged against conventional standards. If it is decided to reimburse these therapies, VBP is unlikely to be helpful in setting an appropriate price, since the price will be too low, either to encourage manufacturers to launch the products, or, in the long run, to stimulate research into rare conditions.

A second case is in the pricing of ‘cures’, such as gene therapy, for conditions that are currently being treated at great expense. If the new therapy was considered to offer a higher quality of care, such a treatment could command an exceptionally high price if VBP were applied.

Of course, considering value-based prices to be either ‘too high’ or ‘too low’ in these situations is a value judgment. It might be argued that, in the case of rare diseases, therapy should not be made available unless manufacturers were willing to drop their prices dramatically or, alternatively, in the case of cures, that exceptionally high rewards should be given to manufacturers who discover a replacement for highly expensive therapies or which transform life expectancy or quality of life. However, many health care payers would have difficulties with both of these propositions.

Using RoR pricing for pharmaceuticals gives rise to a number of challenges. Firstly, the high failure rates in drug discovery mean that most R&D does not lead to a product. Therefore, the cost of failures has to be factored into the calculation of the rate of return price. Secondly, R&D in pharmaceuticals is a global activity and manufacturing plants supply many countries. Rules for allocating these global costs between countries are inevitably arbitrary. Thirdly, as mentioned above, RoR pricing would not give enough incentives for manufacturers to be cost effective in research, nor to pursue the most important (valuable) disease targets, as the allowed return would be the same whatever area is explored. Finally, capping returns reduces the incentive for competitive entry, and setting the rate too low will discourage R&D investments valued by society.

In the case of ultra orphans, Berdud et al (2018) avoid most of these challenges by proposing an adjustment to a health system’s value-for-money threshold for differences in average cost and different bands of patient population size, rather than obtaining cost information for individual products. This approach gives an incentive for generating more quality-adjusted life years and does not reward an individual company for having higher than average R&D costs. A ‘cure’, however, may well be cost-effective at the value-for-money threshold, so alternative proxy approaches will be required – in this case, to adjust the threshold downwards. These could be based on industry averages for R&D costs, success rates, and rates of return on investment, but include a premium return to reflect the priority society gives to getting cures. However, it would be important to avoid setting the RoR price based on product-specific costs, since this would encourage a cost-plus approach.

Drummond and Towse conclude that there may be a role for RoR pricing in situations where the value-based price is considered to be inappropriate. The RoR price could be higher or lower than the value-based price, depending on the particular situation.

If RoR pricing were to be applied, it would be important to find ways of dealing with the problems of accurately estimating development costs while providing incentives to manufacturers to be as efficient in the R&D process. We suggest exploring proxy methods that do not involve obtaining research and product cost information from individual companies or require attribution of cost to individual markets.

Attention would also need to be given to driving the direction of R&D in health and medicine. If VBP were universally applied, it would not only improve the efficiency of current care but also drive research towards the discovery of high-value treatments in the future. This incentive would be largely absent in a world of RoR pricing. It would be important for society to find other ways of incentivising the types of research it would like to see. This is not easy. Governments funding clinical development directly, taking on the cost of failure, is unlikely to be a sensible use of health system resources. Setting higher rates of allowable returns for priority areas is another approach. Of course, this simply mimics using VBP.



Drummond, M. and Towse, A., 2019. Is Rate Of Return Pricing A Useful Approach When Value-Based Pricing Is Not Appropriate? Eur J Health Econ. DOI.

Related research

Berdud, M., Drummond, M.F., Towse, A., 2018. Establishing a Reasonable Price for an Orphan Drug. OHE Research Paper 18/05. London, Office of Health Economics. RePEc.

Towse, A. and Garau, M., 2018. Appraising Ultra-Orphan Drugs: Is Cost-Per-QALY Appropriate? A Review of the Evidence. OHE Consulting Report. RePEc.

Pearson S., 2019. Early Experience with Health Technology Assessment of Gene Therapies in the United States: Pricing and Paying for Cures. OHE Seminar Briefing 25. RePEc.

Marsden, G. and Towse, A., 2017. Exploring the Assessment and Appraisal of Regenerative Medicines and Cell Therapy Products: Is the NICE Approach Fit for Purpose? OHE Consulting Report. RePEc.

Hampson, G., Towse, A., Pearson, S.D., Dreitlein, W.B. and Henshall, C., 2018. Gene therapy: evidence, value and affordability in the US health care system. Journal of Comparative Effectiveness Research, 7(1), pp.15–28. DOIRePEc.

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