Let's Talk About How Drug Pricing Really Works

Every time there’s a headline about drug prices going up, the reaction is predictable: “Big Pharma is at it again.” I get it. I spent decades inside the pharmaceutical industry, and I would cringe every year when our list prices were announced for the upcoming year. But here’s the thing most people don’t know: the price you see in the news — the manufacturer’s list price — is rarely what insurers pay, and almost never what patients' out of pocket costs are based on. That list price merely the starting point of long, complicated negotiations involving insurance companies, pharmacy benefit managers (PBMs), hospitals, and government programs like Medicare and Medicaid. I know this because for years I personally sat across the table from insurers and PBM's negotiating these contracts while I was at Johnson & Johnson.

Now, let’s start with a basic truth that often gets lost: drug manufacturers rarely sell directly to patients. While this is starting to change, direct-to-consumer sales are still an anomaly. Just like a cereal company doesn’t sell you Cheerios straight from the factory, drug companies sell into a supply chain. Manufacturers pay rebates, discounts and various fees to get their drugs covered by insurance companies — and more importantly, to get them placed favorably on an insurance plan’s drug list (called a formulary). In addition to insurance companies, manufacturers negotiate with other players in the supply chain such as PBMs, hospitals, physicians, government programs, and wholesalers. If a manufacturer wants its drug to be the “preferred” option a doctor can prescribe without jumping through hoops; they often have to offer bigger and bigger rebates as they are in a bidding war with other manufacturers. The discount and fees demanded by these middlemen continue to grow, which is one reason why list prices keep rising and the net price paid by insurers has actually gone down for years.

Here’s the part that frustrates patients the most — and honestly, it frustrated me when I was negotiating these deals too. Patients’ copays and coinsurance are often based on that inflated list price, not the discounted price insurers and PBMs negotiated behind closed doors. So even if a manufacturer gives a 40%, 50%, or 60% discount or rebate, the patient at the pharmacy counter may never see a dime of it. I’ve personally watched situations where insurers paid less year after year for a drug, while patients paid more out of pocket and were told it was because “drug prices are rising.” That’s simply not true across the board. In fact, after discounts and rebates, the net cost of brand-name drugs to the system has been falling for roughly seven years — while premiums and out-of-pocket costs keep climbing.

Another important piece of context: drugs are not the biggest driver of healthcare spending, no matter how often they’re blamed. Retail prescription drugs make up about 9% of total U.S. healthcare spending. Even when you include drugs given in hospitals and doctors’ offices, it’s roughly 17%. The largest contributor of healthcare spending is hospitals, accounting for nearly one-third of the pie. Insurance companies and PBMs sit right behind that, contributing to the massive administrative costs in healthcare that dwarf what other countries spend to run their systems. Yet when premiums go up, drug prices are the easiest to blame. They’re visible. Everyone uses them. And the system has become too complicated for many legislators to know how to enact change, while these middlemen continue to extract hundreds of billions of dollars a year, driving up costs across the system and literally adding very little.

PBMs, in particular, deserve more attention. Most people had never heard of them until a few years ago, but today three companies — CVS Caremark, Express Scripts, and OptumRx — control prescription benefits for roughly 80% of Americans. That kind of market power matters. When I was negotiating, there came a point where saying “no” simply wasn’t realistic. If you lose preferred placement with one of these giants, you can lose access to tens of millions of patients overnight. That imbalance is why manufacturers often cave and raise their list prices to fund the rebate machine — even though they know it doesn’t help patients.

What makes this even worse is the lack of transparency. Contracts between PBMs, insurers, and manufacturers are treated as trade secrets. Until the last few years, PBM's prevented pharmacies from sharing lower cost of options with patients, such as when paying cash would be cheaper than using insurance. (Thankfully, many states have banned this practice with gag clause laws.) However, we are still in a system where the same exact drug can have wildly different prices depending on where you live, which insurance plan you’re on, and even which county you’re in. AND note that this is based on ONE LIST PRICE. A Wall Street Journal investigation found one generic drug with over 2,000 different prices across Medicare Advantage plans. That’s not market efficiency — that’s a pricing patchwork designed to create confusion and extract the most money possible wherever it can.

None of this is to say manufacturers are blameless. List prices matter, and the industry needs to be more transparent about how they’re set. Practices like patent extensions and delayed generic competition need reform. But focusing only on manufacturers ignores the reality of where the money actually goes. In 2024 alone, middlemen — insurers, PBMs, hospitals, and wholesalers — extracted well over $300 billion from drug manufacturers. Johnson & Johnson by itself paid more than $30 billion just to participate in the system. That’s money flowing before a single patient fills a prescription. The system has become so upside down that the middlemen in the drug supply chain now receive more than half of what the country spends on pharmaceuticals. That's right - the companies making the drugs recoup less than 50% of the starting list price of their drugs. 

So when you see headlines about drug price hikes — like the recent news that hundreds of drugs are getting list price increases — remember this: that number is not the finish line. It’s the starting point of a complex, opaque negotiation that most patients never see and never benefit from. If we actually want to lower what people pay at the pharmacy counter, we need transparency, accountability, and real guardrails on the gatekeepers who control access to medicines. I negotiated inside this system for years. The math doesn’t lie — and until we fix how the money flows, patients will keep paying the price and manufacturers will keep raising their prices to play in the game.