Call it the rebate wall: the financial barrier that branded pharmaceutical manufacturers have erected around their formulary positions, built from the accumulation of list-price-based rebate payments that make displacing an incumbent drug financially unattractive even when a therapeutically superior or lower-cost alternative is available. It is one of the more counterintuitive features of American drug pricing — a system in which discounts serve as a barrier to competition rather than a spur to it.
The Formulary Access Game
The mechanics of formulary access in the commercial market run through PBM formulary committees, which evaluate drugs for placement on preferred, non-preferred, or excluded tiers. In theory, these decisions are made on clinical grounds — efficacy, safety, comparative effectiveness. In practice, they are made on a combined clinical-financial basis where rebate levels are a material input into the formulary recommendation. A branded drug that offers a thirty-five percent rebate off list price has a significant advantage over a biosimilar competitor that offers twenty percent, even if the biosimilar’s net price is lower, because the absolute dollar value of the rebate on the higher-priced originator may exceed the absolute dollar value of the biosimilar discount. The formulary committee is optimizing the rebate revenue the plan receives, not the net cost of drug acquisition.
This dynamic is particularly consequential in therapeutic categories where multiple branded agents have established formulary positions and are competing primarily on rebate size rather than clinical differentiation. Anti-TNF biologics, GLP-1 agonists, SGLT-2 inhibitors, and several oncology categories exhibit exactly this structure. The competition among manufacturers in these categories has produced escalating list prices — because rebates are priced as a percentage of list — and escalating rebate commitments, while the net prices paid by plans have in some cases declined modestly. The game theory is stable: no manufacturer can unilaterally reduce its list price without sacrificing the absolute dollar value of its rebate commitments, which risks formulary demotion.
The Biosimilar Problem
The rebate wall’s most visible casualty has been the biosimilar market. American biosimilar penetration has consistently lagged European markets by wide margins, and while regulatory barriers and litigation strategies contribute to this gap, the formulary economics are a principal driver. A biosimilar entering a market against a well-rebated originator faces a structural disadvantage: it cannot match the originator’s rebate level without pricing its list price at a comparable level (defeating the purpose of biosimilar competition), and it cannot offer a meaningfully lower net price if the plan is optimizing for rebate revenue rather than net acquisition cost. Several major biosimilars, including adalimumab biosimilars competing against Humira, have navigated this by offering higher list prices with comparable rebate structures — a perverse outcome that the rebate system makes rational.
The Inflation Reduction Act’s drug negotiation provisions apply primarily to Medicare, where the rebate architecture operates differently — manufacturers pay Medicaid best price-derived rebates rather than commercial-style PBM rebates. In the commercial market, the rebate wall remains largely intact. Some employers have moved to reference-based pricing or international reference pricing for specialty drugs, which sidesteps the rebate system entirely by anchoring payment to an external benchmark. But these strategies remain at the margin of the commercial market and have produced their own complications, including patient access disputes and provider billing conflicts.
The Net Price Illusion
The rebate system’s defenders frequently point to net price trends as evidence that the system is working: net prices for branded drugs have, in recent years, risen more slowly than list prices and in some categories declined slightly. The argument proves less than it appears to. Net price moderation, achieved through escalating rebates on escalating list prices, does not reduce the cost burden on patients whose cost-sharing is indexed to list rather than net price. It does not address the cross-subsidization embedded in the system’s structure, where low-income patients in high-deductible plans effectively subsidize rebate revenue that flows to plan sponsors and PBMs. And it does not resolve the biosimilar penetration problem, which is a foregone opportunity for more durable and structurally sound cost reduction.
The rebate wall is, in the end, a pricing equilibrium sustained by collective action dynamics that individual participants cannot unilaterally escape. The manufacturer that reduces its list price risks losing the formulary position that justifies its rebate commitments. The PBM that moves away from list-price-based rebates risks losing the revenue stream that subsidizes its other service lines. The plan sponsor that demands net pricing may face higher gross drug costs if manufacturers have not correspondingly reduced list prices. What looks like a conspiracy is actually a Nash equilibrium — stable not because anyone designed it that way but because deviating from it is individually costly even when collective deviation would produce better outcomes.
