Of Models and Morals: Value-Based Pricing as a Case

I have always been interested in our broad frameworks for thinking about social/economic problems, how those frameworks shape the choices we see as reasonable, and how they remain stable or, eventually, change.

As a graduate student, I found the history of the corporation compelling in this regard. This was the kind of story told by my dissertation adviser, Neil Fligstein, in The Transformation of Corporate Control. Over the course of a century, a succession of “conceptions of control” dominated the large corporation: new ideas about what its purpose was and how that should be achieved. This culminated with the financial conception of control, in which shareholder value was widely accepted to be the firm’s purpose, and people with finance backgrounds the most appropriate leadership—with downstream consequences for business and society.

I have always been interested in our broad frameworks for thinking about social/economic problems, how those frameworks shape the choices we see as reasonable, and how they remain stable or, eventually, change.

In my own work, I initially thought of this in terms of institutional logics: I wrote about the rise of a market logic in academic science, in which people came to understand scientific research as worthwhile because of its potential to produce technological innovation that, in turn, would drive economic growth. The argument of Creating the Market University was that policymakers adopted this framework and made policy decisions (about patent rights, about research funding) within it. This, in turn, promoted the expansion of practices within academic science that were grounded in such a logic (patenting and licensing, academic entrepreneurship, university-industry collaboration).

Thinking Like an Economist is really written within this same broad framework. I’ve moved away from the language of institutional logics to talk about a “style of reasoning”—but at its base, it’s another book about how a new way of thinking (economic reasoning) took over a new space (policy domains), with downstream effects on what choices (policies) seemed reasonable—and thus with political consequences.

The books and articles that most appeal to me are often looking at a similar class of problems: I am thinking, for example, of Gabi Abend’s The Moral Background, which explores the competition in the first half of the twentieth century between a “standards of practice” conception of business ethics, with a focus on “scientific worldview, moral relativism, and emphasis on individuals’ actions and decisions,” and a “Christian merchant” conception, with a “Christian worldview, moral objectivism, and conception of a person’s life as a unity.”

Or Rakesh Khurana’s From Higher Aims to Hired Hands, which similarly explores how business schools came, in the 1950s, to replace a conception of business as a profession with a one centered on shareholder value—again, with intellectual, moral, and practical consequences.

Or, more recently and at a finer grain, Barbara Kiviat’s work on the moral assumptions embedded in insurance pricing. A range of predictive variables—such as race, gender, zip code or credit score—can theoretically be used to set insurance prices; as a society, we have agreed—unevenly—that some of these are legitimate to use and others illegitimate.

Kiviat talks about competing models of what constitutes morally appropriate insurance pricing—one grounded in actuarial fairness, or the idea that it is fair to consider factors that predict likelihood of using insurance; and another she characterizes as “solidaristic,” in which the point of insurance is to distribute costs across a population. These competing models have long been in tension, but this tension has been amplified with our growing capacity to individualize risk prediction.

Changing Models for Pricing Drugs

The crazy world of pharmaceutical pricing appears to be at least partially driven by a similar shift in how the relevant parties think about what prices “should” be—from “cost-plus pricing” to “value-based pricing.” At one level, we’d expect that in a market-driven economy, private producers would charge what the market would bear—but that people would only be willing, or able, to pay so much.

Because it is mostly third parties who are doing the paying, however, the willingness and ability to pay goes much higher than it could for the typical individual—because the cost is spread over many people. At the same time, very high prices are still a problem—especially for uninsured people, but also societally, if we are spending lots of resources on drugs that don’t necessarily have much benefit.

This unleashing of very high prices is dependent on drug companies deciding not to set prices based on the cost of production (including innovation) plus a profit margin. Instead, they are setting prices based on some measure of “value” that is grounded in the additional life/quality of life a drug provides to patients.

Since we typically value our lives quite highly, and are willing to go to great lengths to extend them, this is an approach that is appealing to pharmaceutical companies because it can justify very high prices. In situations where competition is minimal, and deep-pocketed third-parties (government or insurance companies) are paying, this is good for the bottom line.

At the same time, government regulators tend to like value-based pricing because it ties prices to the actual outcomes produced by drugs. At present, new cancer drugs (for example) are all priced at very high levels, even though many only briefly extend the life of very ill people, while a few may be truly transformative for people with some types of disease.

The fact that both pharma and government, which have quite different interests, see this as a beneficial shift—even as there’s no sign that prices are actually being reined in—suggests to me that there is interesting stuff going on here. Value-based pricing is a lot like cost-benefit analysis (discussed at length in Thinking Like an Economist) in that it is a way to produce numbers that is systematic, consistent, and justifiable, but that is also reliant on a lot of assumptions and value choices that are not necessarily evident in the end product.

As such, I assume value-based pricing is similarly shaped by the most powerful actors who have an interest in the numbers it actually produces. In the next few posts, I’m planning to explore it—to learn more about its mechanics, where it came from, and what it means for how drug prices are set in the context of the U.S. medical system—and to try to work out its implications for that system more generally.

One response to “Of Models and Morals: Value-Based Pricing as a Case”

  1. […] But if it is basically correct, it looks like a fruitful place to think about some of my themes of persistent interest, while writing through the […]

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