Iron Capital Insights

  • Iron Capital Insights
  • August 29, 2016
  • Chuck Osborne

Highway Robbery

Last week as I was conducting a lunch-and-learn session for employees of one of our institutional clients, the subject of regulation came up and I pointed out the dangers of over-regulating an economy. No sooner did I get back to the office and what do you know: Mylan hands us a perfect example of the dangers of living in an over-regulated society.

I’m sure most of you have heard the story by now. Mylan is the pharmaceutical company that currently makes the EpiPen®. The cost of the EpiPen has gone from $100 in 2007 to $600 today, which is what one would call highway robbery.  But how does this happen?

As we have written before, facts must be placed in full context. So the first thing one should ask is, what has changed in the healthcare industry since 2007? That answer should be obvious. The healthcare industry has seen huge change in the form of a massive increase in regulation. How does that impact how a company, like Mylan, operates?

Let’s start with the company’s chief executive officer. Heather Breech is the CEO responsible for this enormous price increase. Breech is the daughter of Joe Manchin, a Democratic U.S. Senator from West Virginia and the state’s former governor. Breech has been at Mylan since 1992 and worked her way up through the ranks. One might think that the CEO of a pharmaceutical company would come from a department like finance, sales, or research and development. Someone from finance would understand how the budgets worked and which departments were contributing financially, while someone from sales would understand the customer’s needs and how to grow the business. Someone from research and development would understand the product and what goes into the development of new products.

Breech came up a different path: she was the director of government relations. I’m not making this up. (This is why I never read fiction, truth is more amusing…who would ever make that up?) The daughter of a U.S. Senator becomes the most valuable employee at her company because she was good at government relations.

This brings us to how an EpiPen now costs $600.00. First, the company has a monopoly. Epipen is just about the only product of its kind, and as recently reported in the Wall Street Journal, the former head of government relations has done a good job keeping it that way. Even though the EpiPen has been around since the 1970’s, the FDA has been helpful to Mylan by thus far stonewalling any generic competition. For that matter, one might ask why a technology this old is not sold over the counter as it is in other countries? That is how the government relations department gets one of its own in the corner office.

Regulation is very helpful in limiting competition. It also helps in other ways; in this case it prevents what economists call price discovery. The price for EpiPens did not go up all at once. Most of the cost has been paid by insurance companies. In 2007 when the EpiPen cost $100, most consumers probably paid just their co-pay, back then you were talking about $10 or $15. Mylan got away with raising the price because most consumers didn’t see it; he insurance company paid it (of course that money comes from premiums so we all pay it – but that is another newsletter). It was not until co-pays and deductibles have risen so much that consumers became aware that an epipen cost $600.00. Hence the sudden, and justifiable, outrage.

For a market to function properly there must be competition and there must be price discovery. In other words, consumers must have a choice and they must be aware of those choices. This is why these stories never happen to companies like Apple. If one does not wish to buy an iPhone, then he can buy a Samsung. It is easy to discover the cost and determine what is best.

The EpiPen costs $3 to manufacture. Imagine if Mylan had to compete in a truly free market. The EpiPen could cost $10 to $20 over the counter and the company would still have a huge profit margin. And, here is the real kicker: if Ms. Breech had actually taken those MBA courses that she once lied about on her resume (again, can’t make it up), she might understand that the company could make even more money by expanding its market. If it cost only $10 over the counter, every parent in America would own several of them. My children thankfully do not suffer from severe allergies, but several of their friends do, and if children have never been stung by a bee or had a peanut butter sandwich, how do parents know? We would all make it part of our first aid kits. Every restaurant in America would have a supply on hand. Schools would not need to rely on Ms. Breech’s donations; the school nurse would order them right along with the Band-Aids and Tylenol. Mylan would still do great and Ms. Breech very likely could still pay herself $18 million. But, that would be work and the company would have to compete with a lot of other firms. They would have to really execute.

This is a classic case of what happens when a society becomes over-regulated. That will not be how the story will be told, however. This message and explanation, while accurate, isn’t tweetable. “Greedy capitalist” is tweetable. That is the sad thing. The likely reaction will be for even more regulation, and could lead to price-fixing. Price-fixing leads to shortages, and this isn’t gas in the 1970’s. Shortages won’t mean pushing your car to the gas station to wait in line. Shortages in this case mean someone will die, and it likely will be a child.

The solution is not more of what caused the problem. Allergy sufferers need choices, not more red tape. Regulation needs to encourage competition not eliminate it, and regulators need to be held accountable. Corporate government relations departments shouldn’t even need to exist, but the fact that this is now a pathway to become CEO should speak volumes. We have gone a long way from our capitalist roots, and we need to start heading back.

Warm Regards,

Chuck Osborne, CFA
Managing Director