OBJECTIVES: To develop a lifetime model of Type-2 diabetes mellitus and its sequelae, to compare the costs and benefits of pioglitazone plus metformin (PIO+MET) versus sulphonylurea plus metformin (SU+MET) oral combination therapies in patients with insufficient glycaemic control despite maximal tolerated dose of metformin monotherapy. METHODS: A decision-analytic model employing a Markov process was constructed using TreeAge DATA. The model incorporated efficacy evidence from a key clinical trial comparing the glycaemic control of PIO+MET versus SU+MET, as measured by initial improvements in HbA1c and the rate of disease progression in terms of HbA1c (the coefficient of failure). Treatment pathways reflecting best practice in Scotland, including third-line insulin therapy, were modelled, with published (UKPDS) cost data of diabetes management and co-morbidity treatment. RESULTS: Patients treated with PIO+MET achieved better HbA1c control and improved serum lipid profiles, which translated into fewer diabetic complications, better quality of life and improved overall survival. Additional drug costs of PIO+MET over SU+MET were partly offset by lower costs to treat and manage diabetes complications, and delayed third-line insulin therapy. PIO+MET patients incurred mean additional costs of £1,217 per patient and gained 0.05 additional quality-adjusted life years (QALY's) per patient compared to SU+MET patients. The estimated incremental cost per QALY gained of PIO+MET compared to SU+MET was £25,599. If a QALY is valued at £30,000, PIO+MET is associated with a net health benefit of £209 per patient (95% confidence interval: –£6,679 to £8,076). CONCLUSIONS: The relationship between HbA1c and the incidence of complications in Type-2 diabetes is well established. Evidence from a large head-to-head trial indicates superior glycaemic (HbA1c) control accompanied by significantly improved serum lipid profiles in patients treated with PIO+MET. Given that PIO+MET provides a positive net health benefit, therefore PIO+MET is a cost-effective intervention relative to current treatment in Type-2 diabetes.