There seems to be a lot of confusion over how drug prices are determined

I help determine drug pricing for major pharma companies as part of my job, so I'll share some of my thoughts.

As people have noted in the comments, cost of R&D isn't really what influences what determines the price. It really comes down to what the market will bear, and that is determined by payers. In the U.S., the payers include insurance companies and pharmaceutical benefit managers. Ex-US, it is often government organizations (I primarily work with the EU, Australia, Canada, Japan).

So how do companies determine what the market will bear? In the U.S., research is conducted with said payers. Consultants directly discuss with payers how they perceive a certain disease category, how they manage current treatments, and how they would manage a new drug at various prices. Would they pay for a drug, force it to be used as a second-line therapy, allow it to be a first-line therapy, etc.? The drug's therapeutic value relative to other treatments and its cost are the major considerations here.

Some notes on this part: for one, there is something very different between a drug's list price (which is what you usually see reported) and a drug's net price. Payers and manufacturers negotiate confidential discounts for products. In some cases it can be very dramatic: it is estimated, for example, that Abbvie reduced the price of it's Hep C drug by 20-30% off a $83,000 list price (which would mirror the cost in countries like France and Germany) in order to get exclusive access at Express Scripts (that is, ESI would no longer pay for competitor Gilead's Hep C drug and only allow patients to use Abbvie's).

The other is that budget impact ends up being a big component of this. While $83,000, and even the discounted prices of $50-60,000 for these Hep C drugs may seem very high (the $1,000 a pill figure), these drugs are able to cure hepatitis C and can prevent expensive liver operations that can cost $200,000+ to payers. However, the cost is still high and it is exacerbated by the fact that there are a lot of people with Hep C. Similar reactions resulted from the launch of new hypercholesterolemia drugs because, while quite effective and "only" $14,600 a year, so many patients have HCL and it is chronic. Drugs for cardiology, oncology, immunology, diabetes, and Hep C have received the brunt of attention from payers in recent years due to the mix of effective but costly drugs and large patient populations.

On the flip side, a drug like Alexion's is for such a rare disease that the resulting budget impact is relatively minor, and competition in the space is virtually non-existent. As such, payers are willing to bear what seem like very high costs.

The brunt of price setting is with payers. Research is also conducted with physicians and patients to see how prescribing patterns vary on how much a patient needs to pay in copay or how much trouble a physician needs to go through to prescribe a drug (more expensive usually=more trouble). Pricing models are then developed to look for optimal pricing strategies.

Now, in the context of Alexion's orphan drug, cost is still something to think about as far as investment goes. It is not much cheaper to develop a drug for an orphan disease with hundreds or thousands of patients as it is to develop a drug that can treat millions (although it could be argued it is "lower hanging fruit" to do so), and so the only reason a company would pursue making such a drug would be if there was an opportunity to generate sufficient revenue with high prices, since the volume is so limited.

It tends to be simpler in many ex-US countries: they negotiate directly with government organizations. They develop a dossier featuring the drug's clinical efficacy/safety, healtheconomic information, and sometimes additional data like cost-effectiveness or budget impact. In broad strokes, other countries tend to have mechanisms to limit drug prices (tendering, reference pricing, requiring certain cost-effectiveness metrics, etc.) and make tougher decisions in terms of coverage/non-coverage.

Hope that helped!

The WSJ covers price setting in this piece too