Towards an Efficient Mechanism for Prescription Drug Procurement

This paper applies ideas from mechanism design to the procurement of pre-scription drugs. We present a government-funded market-driven drug procure-ment mechanism that achieves very close to full static efficiency – all members have access to all but at most a single drug – without distorting incentives for innovation. Prescription drugs are an essential component of modern healthcare. In the U.S. drug spending has skyrocketed in recent years – while in 1980 it amounted to $12 billion, less than 5 % of total health care expenditures, in 2004 that number has increased to $188.5 billion, over 10 % of total expenditures.1 The Center for Medicare and Medicaid Services (CMS) currently projects drug spending to rise to $446.2 billion in 2015, approximately 2.2 % of projected U.S. GDP.2 Those statistics suggest that efficiency improvements in the drug procurement process can lead to significant welfare gains. Lessons learned from markets for typical healthcare services such as doctor con-sultations and hospital stays are largely not applicable to markets for prescription drugs. In contrast to healthcare services, prescription drugs are often supplied by patent-protected monopolists and feature marginal costs that are a very small fraction of price. In fact, prescription drugs bear a much stronger resemblance to information goods such as music and software. ∗Stanford GSB, contact: fong kyna at gsb.stanford.edu. Part of this research was conducted during an internship at Yahoo! Research