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Differential Pricing of Pharmaceuticals: Theory, Evidence and Emerging Issues

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Abstract

Differential pricing—manufacturers varying prices for on-patent pharmaceuticals across markets—can, in theory, lead to increased patient access and improved research and development (R&D) incentives compared with charging a uniform price across markets. Theoretical models of price discrimination and Ramsey pricing support differentials based inversely on price elasticities, which are plausibly related to average per capita income. However, these models do not address absolute price levels and dynamic efficiency. Value-based differential pricing theory incorporates insurance coverage and addresses static and dynamic efficiency. Limited empirical evidence indicates a weak positive relationship between prices and gross domestic product (GDP) per capita. External referencing and parallel trade undermine differential pricing. We discuss previously neglected factors that undermine differential pricing in practice. High price growth relative to GDP in the USA leads to widening differentials between the USA and other countries. Concerns over the effects of confidential rebating challenges acceptance of this approach to implementing price differentials. The growth of branded generics in low- and middle-income countries leads to complex markets with product and price differentiation.

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Notes

  1. Retail prices may also differ due to distribution markups and taxes, but these are not discussed here.

  2. For example, see Outterson [6] and sources therein.

  3. In theory, dynamic efficiency requires that producers capture the full expected marginal social surplus created by innovation. This conclusion ignores potential practical issues, for example, that full producer surplus capture may induce excessive, ‘racing’ R&D to capture monopoly rents or, if R&D is lumpy, a significant share of surplus may suffice to induce appropriate investment. The underlying theory also assumes that consumers/decision makers on average accurately perceive the benefits and risks of drugs.

  4. Differential pricing theory focuses on on-patent products sold by a monopolist with pricing power. Models of markets with generics typically assume that prices are constrained by competition, assuming that the generics are required by regulation to be bioequivalent to the originator, hence quality is known. Such equivalence is not required of branded generics in many LMICs, hence quality uncertainty undermines price competition (see Sect. 4.3).

  5. This welfare measure is a simple aggregate of equally weighted consumer utilities.

  6. Overall price elasticity combines an unobserved pure (income-compensated) price elasticity and an income effect due to the price change. This income effect is expected to be positive. For detail, see Danzon et al. [3].

  7. R&D investment to establish safety, efficacy and manufacturing standards for new drugs entails joint costs and creates a knowledge base that can benefit consumers globally.

  8. WTP in poor countries could include payment by citizens and donors.

  9. Consistent with the patent system and other policies, the aim here is second-best efficiency, recognizing that implementing first-best efficiency would entail taxes and subsidies that themselves entail administrative costs and are therefore not generally considered practical.

  10. Parallel trade is also called ‘commercial drug importation’ in the USA.

  11. Manufacturers may limit supply to each country to the quantity needed by that country, without such restriction constituting a boycott.

  12. Medicaid is an exception, where states must operate within annual budgets.

  13. https://data.bls.gov/pdq/SurveyOutputServlet. Retrieved 29 August 2017.

  14. The Bureau of Labor Statistics PPI treats generics as new forms of originator compounds, hence the price of the compound drops significantly following the entry of cheap generics. Generic prices generally decline post-launch [37, 38].

  15. See, for example, Sagonowsky [39]

  16. Sweden is an outlier in 2016 compared with previous years.

  17. For example, if a patient has a stop loss of $US3000, a co-insurance rate of 25% becomes irrelevant once the drug price exceeds $US12,000, because any price increment is borne by the payer. Both Medicare Part D for seniors and the Affordable Care Act for non-seniors have stop-loss limits on patient cost sharing that are designed for financial protection but thereby make patients price insensitive.

  18. The PMPRB uses consistent data sources and methodologies. It provides the best available source for cross-national price comparisons over time.

  19. Foreign–Canadian price ratios for 2016 show minor differences between Figs. 1 and 2, plausibly due to different data sources.

  20. PBMs are intermediaries/agents contracted by health plans, self-insured employers and other plan sponsors to manage drug coverage. Some very large health plans manage their own PBMs [42].

  21. PBMs’ utilization management tools include very restricted formularies, with only one or two preferred drugs per class; a large spread in patient copayments for preferred versus non-preferred drugs; step edits; and prior authorization for non-preferred drugs.

  22. The theory that price transparency facilitates collusion by competitor firms was developed by Stigler [40]. Consistent with this, the Congressional Budget Office estimated higher costs for Medicare Part D if PDPs are required to publish drug-specific rebates [41].

  23. For example, two dominant, incumbent drugs in a class could create barriers to entry of competitors if they make their rebates contingent on being one of only two preferred drugs in the class for a formulary. If a PBM were to add a new drug on the preferred tier, either in addition to or in place of an incumbent, because the new drug offered a lower list and net price, the PBM could lose significant rebate revenue from incumbents, especially if the uptake of the new drug is slow due to prescriber/consumer brand loyalty to the incumbent drugs.

  24. For example, Graf [44] examined the rebate contracts used by German Sickness Funds, which are now authorized to contract with manufacturers on behalf of their enrolees using exclusive or non-exclusive contracts. In several Asian countries, drug dispensing by providers has encouraged rebating by manufacturers to providers. Recent policies in South Korea, Japan and China seek to discourage provider dispensing and manufacturer rebating as potentially harmful to efficient drug prescribing.

  25. A study of insurer/provider contracting in the USA found that large insurers and small provider groups obtained relatively low prices [47], as predicted if differential pricing primarily reflects relative bargaining power. Further research is needed to evaluate the efficiency implications, if any, in such contexts.

  26. In theory, MNCs could outsource manufacturing to contract manufacturers, but the MNC would still incur the cost of capacity construction. Agency issues may also be best handled if the LMIC manufacturer also markets the product under its own name and handles distribution, regulatory and marketing, as is currently the norm, rather than contracting with the originator firm to produce its product under license.

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Authors and Affiliations

  1. Celia Moh Professor Emeritus, Health Care Management Department, The Wharton School, University of Pennsylvania, 3641 Locust Walk, Philadelphia, PA, 19104, USA

    Patricia M. Danzon

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Correspondence to Patricia M. Danzon.

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Patricia M. Danzon and the Celia Moh Foundation have no conflicts of interest that are directly relevant to the content of this article.

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Danzon, P.M. Differential Pricing of Pharmaceuticals: Theory, Evidence and Emerging Issues. PharmacoEconomics 36, 1395–1405 (2018). https://doi.org/10.1007/s40273-018-0696-4

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