SALMAN KHAN: I'm here with Professor Laurence Baker from Stanford Medical School, and I'm hoping he can at least start to get me to understand something that I've always wondered about and worried about a little bit. Let's say that I'm some drug company. So let me write this down. So I'm some pharma company, pharma company A right over here, and let's say that I invest 10 years and $100 million in some drug. I get it through all of the clinical trials, and it gets approved by the FDA. And let's say, just for sake of simplicity, it cures disease x. Now once I get to that point, I'm feeling pretty good about myself as a pharma company. What happens next? I'm assuming that I'm going to have to go to the insurance companies and maybe Medicaid and Medicare and figure out how much they're going to pay for it, but how does that conversation even happen? PROFESSOR LAURENCE BAKER: Yeah. So you're going to have a conversation with a bunch of different folks. In the US, we have lots of different private insurance plans. We've got government plans. And you're actually going to have conversations with Europe and with some of the other systems around the world, because each system is going to make its own decision. SALMAN KHAN: And they have a different way of doing it. PROFESSOR LAURENCE BAKER: They may some have similarities in the way that they probably want to talk to you about. SALMAN KHAN: Does there tend to be a lead system? Does it tend to be either the Europeans, or does it tend to be the private insurers in the US? Or do you just start all of those conversations at once because there's so much money on the table? PROFESSOR LAURENCE BAKER: So there will be some strategy your business is going to come to because it's very hard to have all of these conversations exactly simultaneously. So you'll talk to the US. You'll talk to Europe. And there are some cases in which people have viewed the regulatory processes in Europe as a little easier for some things, so they may want to start in Europe. But in other cases, if you're looking at a drug that maybe some of the national systems in Europe are less likely to want to pay for, you might want to start with the US, where there's a little more flexibility. SALMAN KHAN: But the general rule of thumb is all the money is in Europe and the US mainly right now. PROFESSOR LAURENCE BAKER: A lot of it. The Asian systems, some of them are pretty sophisticated and using a lot of the advanced drugs, too, but I think the majority of the money is in the US and Europe, North America. SALMAN KHAN: And between Europe and the US, I guess I've always imagined North America was maybe where the bulk of the money was. But is that the case? PROFESSOR LAURENCE BAKER: The US, well, our health care system spends more than everybody in the world, and it's true for drugs, too. We spend more on drugs here than most other places. SALMAN KHAN: OK. So definitely if I'm here, pharma company A, I want to make sure I get this right in the US. PROFESSOR LAURENCE BAKER: Yeah. Eventually you probably care a lot about the US. SALMAN KHAN: Part of my investment that I made is based on some understanding that, if I got all the way through, that I would get some type of return within the US. Will I necessarily immediately go to Medicare because they're one of the largest players, or will I go to, like we talked about, Blue Cross Blue Shield or Kaiser or some of these other players? PROFESSOR LAURENCE BAKER: So Medicare is actually an interesting one for drug prices because, historically, Medicare has not been a big coverer and still isn't of a lot of the drugs that you hear about. So Medicare does not pay by itself for outpatient drugs, drugs that you might take at home. SALMAN KHAN: Really? I always assumed that-- they don't. PROFESSOR LAURENCE BAKER: So Medicare, in its main pieces-- Medicare, we call Part A, Part B, Part C-- so Part A and Part B, let's start there. They tend not to cover, or they don't cover, outpatient drugs. If you get a drug in the hospital while you're hospitalized, Medicare will pay for those. And so if you've got a drug that's going to be primarily used in that setting, you're going to talk to Medicare about it, and that's going to be an important piece of the conversation. But if you're talking about an outpatient drug, you're talking to many [INAUDIBLE]. SALMAN KHAN: Now, when we're saying outpatient, inpatient is you're in the hospital. You're sick. You need, I don't know, morphine right now. That's inpatient drug. PROFESSOR LAURENCE BAKER: Yeah. SALMAN KHAN: Outpatient is, hey, you're going back home. Take this three times a day. PROFESSOR LAURENCE BAKER: Yeah. Somebody sends you to the pharmacy to pick up the prescription, and you take it home with you. That's going to be an outpatient kind of drug. So Medicare doesn't cover that in its main Part A and Part B. There's Medicare Part D, which is a drug plan in Medicare, and that will cover a lot of the outpatient drugs. And so there you'd have conversations with them. But most of the Medicare Part D plans are essentially private companies that Medicare contracts with. So you're not really talking to the government at that point. You're talking to these private plans that have contracted with Medicare to provide Part D care. SALMAN KHAN: So once again going back to the crux of the question of how are these drugs going to get paid for, how are we going to determine the price at which these drugs get paid for, it goes straight back to the private plans again because they're going to contract. Part D is going to say, oh, you're Medicare Part D. We're going to go to go to Aetna. We're going to go to some other plan or whoever it might be. I don't know who it might be. PROFESSOR LAURENCE BAKER: Whoever is offering those Part D plans. SALMAN KHAN: Whoever is offering those Part D plans-- and so it will ride off of whatever that private party has already negotiated with the pharma company. PROFESSOR LAURENCE BAKER: It would be related, probably, to that. SALMAN KHAN: OK. So let's say that we have some type of insurance. I'm running out of letters now. Let's call this insurance company Y right over here. And I go have a conversation with insurance company Y, and I'm like, hey, this is a big deal. Disease x, you know it's been killing people. I want$1 million per pill. PROFESSOR LAURENCE BAKER: Yeah, and so those have been really interesting conversations in the US. So there's some bargaining back and forth between the insurance company and the drugmaker. The drugmaker is going to have spent a lot of money. You've got $100 million up there. SALMAN KHAN: Yes. I deserve to make at least$10 billion off-- I'm only kidding. PROFESSOR LAURENCE BAKER: So there's a certain amount, to a certain extent [INAUDIBLE]. SALMAN KHAN: It's called anchoring in a negotiation. PROFESSOR LAURENCE BAKER: Right. You start with what you think you can get. SALMAN KHAN: Yes. Absolutely, yeah. [? PROFESSOR LAURENCE BAKER: Push ?] that number to get everybody's mind around, yeah. So in reality, it costs well over $100 million to take a drug through the trials, to do the development work. So they're going to be sitting there with a number, at least internally, saying, we want to get our$800 million, our $1.5 billion back from this. And so we're going to try and price it accordingly. SALMAN KHAN: Because it's not just the cost of that one drug-- so what is the cost? Do you know that off the top of your head, the average drug? PROFESSOR LAURENCE BAKER: It's hundreds of millions. So there's the development costs that go in that the pharma companies aren't typically willing to talk a lot about. And then there's the cost of getting through the trials and the FDA approvals, which people say$500 million and up. They'll say higher numbers sometimes. SALMAN KHAN: For one given drug? PROFESSOR LAURENCE BAKER: Yeah. SALMAN KHAN: $500 million. So it can be as high as$500 million. PROFESSOR LAURENCE BAKER: It can be higher. SALMAN KHAN: Can be greater than $500 million. And so that doesn't even take into the probability-weighted risk, that there's a 10% chance that it fails or a 10% chance that it works. So it's really, if you're spending$100 million per drug and only 1 out of 10 of those drugs are going to get to the end zone-- PROFESSOR LAURENCE BAKER: Yeah. You'll see along the way. You won't spend a whole wad and then find out. You'll find out in steps. So you'll have to spend something to get there. SALMAN KHAN: I see. You'll stop. So even though on one drug, it might be $100 million or$500 million, they might have spent another $300 million or$400 million on drugs that didn't go anywhere. PROFESSOR LAURENCE BAKER: Plus their own development costs in the background. SALMAN KHAN: Plus their own development costs. So if you try to fully load the cost, it's a large number. PROFESSOR LAURENCE BAKER: It's large, yeah. Right. Exactly. They're running an operation where they've got to put in a lot of money in up front. When they get a success, they have to get enough out of that one success to pay for the operation, to keep things going for the next development round. So they're looking at those kinds of numbers, and they're trying to figure out in this negotiation what they can sell this for. And that's a back and forth discussion. The insurance companies have some ability to say what they're willing to pay, but a lot of these drugs, if they're doing the curing a disease that people care about, the pharma companies have a lot of ability to come and say, this is what we need to get for this and set that price and be able to get it for a while. SALMAN KHAN: So obviously, the pharma company is coming here with all of this investment. They definitely want it to get covered. But the insurance company, their incentive is they don't want to look like, all of the sudden, this company that doesn't provide the cure for disease x. Do insurance companies ever walk away and say, well, that's just too much. I understand you invested all of this money, but we just can't do that. That's just crazy. PROFESSOR LAURENCE BAKER: So it's a little bit of a mixed bag. The US doesn't have a lot of cases where insurance companies have really put their foot down and said, no, they're not going to do anything. They're not going to have anything to do with some new drug that comes out. And some of that's due to the existence of lots of different companies. So if five of the companies say no but the next guy in line says yes, then the dynamic of that in a competitive market is often that everybody else will eventually come around and say, OK, we're going to [INAUDIBLE]. SALMAN KHAN: Someone is going to do something. They might not pay for it outright. The whole reason why we're having this conversation is because there are some drugs that seem reasonably priced to me, but there are some that are like $30,000 a pill or something. I made up that number. PROFESSOR LAURENCE BAKER: Yeah. So the cases, the really expensive ones, are drugs that are unique-- tend to be unique, at least to some extent-- cure disease that gets some high profile, so people are worried that they're going to die if they don't get this drug. And of course, they're still on patent. That's another feature of all this, where you get the high price for a certain period of time until your patents run out. SALMAN KHAN: And then the generic-- PROFESSOR LAURENCE BAKER: And then generic comes in and the price-- SALMAN KHAN: Can make them for the cost of the pill, which is-- PROFESSOR LAURENCE BAKER: It drops dramatically. SALMAN KHAN: Pennies or dollars. PROFESSOR LAURENCE BAKER: So how you get these things set in a competitive market is an interesting question. One of things that gets the brand name drugs to be a little cheaper is competition within the class. So if there is two or three drug manufacturers who have something that will basically do the same thing, that will tend to take the edge off the$30,000 a pill kind of situation and get you down to more reasonable prices. It won't get you all the way to generic pricing, but [INAUDIBLE]. SALMAN KHAN: It just seems to me-- you just mentioned that very few insurance companies have ever walked away from this. If you ever have a negotiation-- buying a used car-- where one of the two parties is not walking away, then it doesn't seem like there's actually a hard, serious negotiation. Am I getting that wrong? PROFESSOR LAURENCE BAKER: Yeah, I don't know all the ins and outs of all these negotiations. There's lots that goes on in these things. But I think that one of the things that people would say about the US is that when a drug manufacturer comes up with fairly unique, on-patent drug that does some tangible good, that they more or less can set the price that they want to get for it. And they're going to make some calculation, because they could set a high enough price that everybody would say forget it. So they're going to try and figure out something. But they're trying to get as much as they can, and they get some leeway for at least a period of time to name that price. SALMAN KHAN: So they'll get leeway, and I guess there's some range of reasonableness where it's like, OK. Yes, you've done something amazing for humanity. You're going to get a 35% return on your investment, but that shouldn't be a 300% return on your investment. PROFESSOR LAURENCE BAKER: Yeah. I don't know at what point the US would ever walk or the private insurers will ever walk from this. I haven't seen it really happen, and I think drug companies are pretty sophisticated about trying to figure out what price they think they can make work and get that as high as they can get that. SALMAN KHAN: So I guess I'm still unclear to see who's making out here really well. PROFESSOR LAURENCE BAKER: This has been a really interesting debate. Pharma companies put huge amounts of money into these drugs. And once in a while, they do some really useful things, and they get high premiums. There are other people who argue that some of the things that they're getting high premiums for aren't really valuable enough or somehow we've been told we need a drug that, if we had it to our own devices, we would never have come up with the fact that we need it. And so what's the real value at the end of the day? And I think that's one of the debates we're going to have in this country for a little while. The industry has been coming up with new things, and they're going to keep trying to do that. We want to, from a social standpoint, from a policy standpoint, try to make sure that things we're doing are really valuable to society and not copies of other drugs or not inventing a disease that didn't need a solution and then solving the problem. And sometimes we worry that maybe we're getting some of that. And I think that's the challenge for the US health insurance system, for the regulatory processes to try to guide the innovation and guide the purchasing of these things to really create the most value for society. It's been a challenge. It's going to be a challenge. We have the challenge, because we have tremendous opportunity with new drugs created. SALMAN KHAN: So your gut sense is there probably are some drugs out there that they're doing really well, well above and beyond the investment cost, but it's hard to say. It's really on a case by case basis. PROFESSOR LAURENCE BAKER: Yeah, I don't think you'd want to make a generic statement about all the drugs that have been discovered. Some of the things that we've put out there in the last couple of decades are really important drugs that are going to do a lot of good. And I think there are debates about some other ones where maybe somebody's been able to be clever about marketing and sell it, and we're less sure that it's [INAUDIBLE]. SALMAN KHAN: And that, actually, marketing-- I don't want to make this conversation too long-- but some people bring up that the drug companies, they say, look, there's a lot of investment right over here on this. And so they have to get some reasonable return on it, and that seems to make sense, especially when you probability weight it and all of that. But they spend a significant amount of marketing as well, on actual marketing. You watch the nightly news, most of the ads, you're going to see a drug company. They do the physician dinners, and they do all of their things like that. That seems to undermine that argument that all of the money is going for R&D. PROFESSOR LAURENCE BAKER: Right. If you just totalled up the dollars, I'm not sure what the numbers would come out like, and honestly, the pharma companies aren't really excited about telling everybody all of the details of their businesses for good reason. So absolutely, there's a huge amount of marketing [INAUDIBLE]. SALMAN KHAN: You spend a ton of money on the marketing. And then you get the consumer here to put the pressure on the insurance companies and the doctors to say, hey, you better cover that, or I'm asking for that. PROFESSOR LAURENCE BAKER: Yeah. There was a time within my memory where we weren't allowed to do direct to consumer marketing, where the laws prohibited that. And the change came around, and now we're allowed to do it. And it's really changed the way that drugs are marketed. SALMAN KHAN: And I have found that weird because, if these are drugs that are meant to be by prescription, which means that it should be a doctor's judgment on whether or not you should get the drugs, why is it being advertised on the nightly news to a general audience? PROFESSOR LAURENCE BAKER: Right-- a general audience who doesn't understand all the ins and outs of the drug and whose doctor may or may not want to take the time to explain it all to them. SALMAN KHAN: Exactly. But then they'll go to the doctor and say, please give me this drug. And then the doctor, it's easier for them to say, well, sure. Why not? PROFESSOR LAURENCE BAKER: Yeah. No, I think a lot of doctors would express a certain amount of frustration about that. Their patients come in. It's hard to have the conversation in a short period of time, so it's easier just to give them the drug. SALMAN KHAN: Fascinating.