The UK's national health service (NHS) currently pays over £8bn a year on branded prescription drugs, and the OFT is recommending reforms to the system that could slash £500m from that bill.
The current system, the Pharmaceutical Price Regulation Scheme (PPRS) allows pharmaceutical companies to charge up to 21 per cent profit on any medicine they sell to the NHS.
John Fingleton, OFT ceo, said the main problem was that: "prices paid to drug companies do not reflect the value of those drugs to patients."
The OFT argues that the PPRS system should be replaced with a patient-focused value based pricing scheme, which would mean that the price the NHS pays for medicines will reflect the benefits they bring to patients.
"Over time, value-based pricing would give companies stronger incentives to invest in drugs for those medical conditions where there is greatest need. Because the health services in many other countries base their prices on those in the UK, additional benefits would arise internationally," said the OFT.
The OFT market study into the PPRS was launched in September 2005, to assess whether the PPRS provided the most effective way of securing the provision of safe and effective medicines for the NHS at reasonable prices, while promoting a strong and profitable pharmaceutical industry capable of sustained research expenditure to ensure the future availability of new medicines.
The watchdog claims that many alternative products are available in the biggest areas of expenditure, such as cholesterol drugs, stomach acid and high blood pressure that are nearly as effective as treatments that are up to ten times more expensive.
"Focussing prices on the needs of patients rather than on the costs of drug companies would be good for both patients and for business. It would allow more patients better access to more effective treatments, and it would focus drug company innovation and investment on the areas where patients need it the most, creating more valuable drugs in the future," Fingleton continued.
Fingleton expects resistance from the drugs industry "because they make quite a bit of money on one or two drugs which are close substitutes for existing drugs."
Pharmaceutical companies argue that they need to make returns on the research, development and clinical trials expenditure needed to bring new drugs on to the market. Any reduction in the profit margins could well have harsh consequences on the research and development of new drugs.
"The UK gets its life-improving and life-saving medicines at a fair and reasonable price, and the broad assertions that the OFT has made in launching its study are wrong," said Dr Richard Barker, director general of the Association for the British Pharmaceutical Industry (ABPI).
"It is important that any new system does not delay patients' access to new medicines and that it should not lead to major increases in costly bureaucracy and red tape."
"The current system has delivered major benefits to patients, the NHS and the UK as a whole and we expect Government to consider very carefully proposals to make wholesale changes to it so that those advantages are not put at risk."
"There is a stark choice for the Government and the NHS. We either pursue a'more and cheaper' approach to the NHS or we get the fundamentals right," Dr Barker added.
The BioIndustry Association, BIA, has long championed the need to support innovation and the interests of smaller, emerging bioscience companies, which they believe have not been adequately supported by the current pricing system.
"Clearly, the fact that there may be more incentives for innovative companies and reallocation of funds to more innovative medicines is positive, but the manner of implementation and the methodology used for calculating cost effectiveness and value will be critical," said Aisling Burnand, BIA ceo.
"One of our concerns in either case is whether this would place a significant extra burden on smaller companies for additional clinical trial data generation."
GlaxoSmithKline (GSK) released a statement recognising that improvements could be made to the existing PPRS scheme, in particular with its recognition of the expected value new treatments can deliver over existing ones. They also state that it is in the interest of both the Government and industry to produce new medicines of value to patients and remain committed to working with the Government to achieve this.
A spokesperson for GSK said: "it is imperative that any new approach taken is not to the detriment of future scientific investment and understanding. Significant upfront investment and long-term planning is required for the effective development of new medicines, and the UK must seek to preserve the current successful environment in which this takes place."
Fingleton is expected to reveal the findings of the inquiry to the Prime Minister later this week. The UK's Department of Trade Industry (DTI) now has 120 days to consider and respond to the recommendations.