The more valuable the drug, the greater the prize---that creates market incentives to explore underdeveloped areas of medicine.

The outlined VBP approach to reward medical innovation minimizes the failures of the patent system outlined above. First, as long as threshold value λ reflects real willingness/ability to pay for health gains, the VBP approach is superior to monopoly profits under patents because no unrealized social benefits (deadweight loss) are created. Note that even if drug prices are higher than the marginal costs of their production, a deadweight loss may not occur. A deadweight loss does not occur as long as, from societal perspective, marginal costs equal marginal benefit (i.e., costs of a drug including downstream cost effects equal societal WTP). Note that manufacturers may set the price just below the level of the threshold ICER, which could lead to higher prices than without a VBP system. Still, this may not necessarily be an undesirable reaction as it may increase future R&D activities. In any case, a threshold based on the cost of palliative or nursing care, which in Germany, e.g., is no more than €23,000 per life year, does not seem to allow for much upward shifting of prices.

Second, as long as the expected social benefits exceed costs, private research incentives are in line with social incentives. If a drug price is based on the threshold cost-effectiveness ratio reflecting the social value of incremental health benefits, the innovator will be rewarded for the net health benefit actually created over time. Hence, the innovator also has an incentive to conduct trials on new indications for a drug that is already approved.

In addition, as the reward system does not provide for licensing copycat drugs, it prevents welfare losses from free riding and excessive market entry. This is in line with the reasoning of [36], who argued that if an entrant causes incumbent firms to reduce output, entry is more desirable to the entrant than to society. Further, there is no need to subsidise start-up and production costs of generic manufacturers. Litigation costs because of patent infringement lawsuits against generic manufacturers also vanish. Finally, firms currently allocate substantial resources to marketing8 in order to protect their profits. Restricting excessive entry and competition for market share could change the proportion between R&D and marketing expenditures.

To provide sufficient incentives for innovation the terms of any award must be fixed before the informational asymmetry with regard to costs and benefits of research is resolved [57]. The threshold value λ, which is used for monetary valuation of health benefits under VBP, may offer credible and time consistent incentives for medical innovation, particularly if based on the cost of palliative or nursing care. Of course, future WTP for health improvements may change due to government budgetary pressures. However, under current patent system there is also a risk of future modifications of patent law as well as enforcement of discounts by the government.