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Implementing differential pricing for essential medicines via country-specific bilateral negotiated discounts

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It is widely acknowledged that limited access to essential medicines undermines efforts at improving the health and economic well-being of low-income populations. This has spurred on a number of solutions, including differential pricing based on the economics of price discrimination. A desirable feature of differential pricing is its potential ability to reconcile static and dynamic efficiency concerns. There are, however, various shades of differential pricing and this paper aims to evaluate their consistency with economic theory. Starting with the report of the workshop on ‘Differential Pricing and Financing of Essential Drugs’ held by secretariats of the World Trade Organization and WHO in Hosbjor, Norway, in 2001, this paper takes issue with how differential pricing has been defined as a tool for improving access to essential drug benefits.

The paper notes that inadequate attention has been given to policies and institutional arrangements for creating, expressing and maintaining ‘truly’ price-elastic demands in low-income nations and for segmenting markets. In addition, considerations of equity and solidarity have distracted policy advocates from balancing conflicting, yet well intended, views and general rules. The paper argues why differential pricing should be implemented via country-specific bilateral negotiated discounts. It maintains that it is feasible to muster an environment conducive to profitable differential pricing whilst satisfying general rules and concerns about self-reliance, transparency, accountability, equity and solidarity.

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Notes

  1. 1For linear demand curves, the uniform price will be the quantity-weighted average of submarkets’ pricedemand elasticities. If the price-elastic submarket is ‘small’ relative to the ‘large’ price-inelastic submarket, the uniform price will be largely influenced by the consumption levels in the large submarket. Computing uniform prices (as a result of a breakdown in market segmentation) for nonlinear demand curves is rather complicated.[13]

  2. 2An example of a voluntary scheme with a structured discount schedule is the European Commission (EC) Council Regulation 953/2003. The scheme defines differential prices as either ≤25% of the weighted average ex-factory OECD price for medicines in a given formulation and dosage, or cost of production plus a maximum mark-up of 15%. Differentially priced products under the scheme will bear EU logos to prevent diversion (reverse importation).[5,18]

  3. 3This is consistent with empirical evidence considered by the WTO-WHO workshop on pricing of anti-retrovirals within the years 1995–9 (prior to charitable voluntary discounts).[14,15] The dispersion in prices shown by the empirical evidence, however, will reflect supply and market distortions; for instance, preoccupation of drug suppliers with dominant high-income submarkets, price controls and breakdown of market segmentation from parallel trade and external price referencing. Theory also predicts that possible differences in incremental costs of production and supply will be reflected in price differentials. That is, mark-ups over marginal costs can be lower in low-income submarkets, but actual prices are higher because of higher marginal supply costs. Note that differences in supply costs only lead to price variation, not third-degree price discrimination. The latter requires heterogeneity in price demand elasticities.

  4. 4Considering bluffing, gaming and other strategic interactions, and that true price elasticities may be unobservable (third-party payers acting on behalf of consumers) or concealed in order to extract a lower price, estimating ex ante price demand elasticities may be not only difficult but misleading. 5 Given the unobservability of ex ante price-demand elasticity and its revelation ex post, distinctions between second- and third-degree price discrimination may sometimes be blurred. The key difference, however, is whether the seller offers ex ante a menu of purchase options or not.

  5. 5Given the unobservability of ex ante price-demand elasticity and its revelation ex post, distinctions between second- and third-degree price discrimination may sometimes be blurred. The key difference, however, is whether the seller offers ex ante a menu of purchase options or not.

  6. 6That is, cross-price elasticities combined with the national income per capita effects where demand shifters (health needs, marketing [non-price] competition or formulary noncompliance) are constrained. The bargaining process of taking business elsewhere corresponds to equations 3 and 4 in defining the short-run bargaining range, which may be followed by the indeterminate subgame based on sheer negotiating prowess.

  7. 7Consider country submarket A in which political or societal preferences means bioequivalence testing (or collection of observational efficacy and safety data from routine clinical practice, especially for biopharmaceuticals) is needed to encourage substitution. In contrast, all that is needed in country submarket B is loosely ‘essential similarity’, i.e. satisfying standard regulatory tests of efficacy, safety and quality, once sound clinical judgements have established the interchangeability between therapeutic substitutes and generic equivalents. Holding all else constant, submarket B will create and express more price-elastic demand and extract lower medicine prices.

  8. 8The depiction of global drug pricing here doesn’t concern itself with how initial launch prices are set and assumes the price levels support a socially ‘optimal’ rate and mix of innovations. Presumably, pharmaceutical firms will set launch prices using ‘inhouse’ pricing models, ‘rule-of-thumb’ cost-plus or mark-up pricing, guess work and past experiences of negotiations with healthcare purchasers, governments and regulators.

  9. 9Most-favoured-customer or most-favoured-nation rules or ‘best’-price provisions usually stipulate that the steepest price discounts offered to any buyer within a given ‘market’ (however the boundaries of that market are defined) should be made available to other buyers; regardless of whether they are price-sensitive or not. Such rules/ provisions have double-barrel effects: they undermine incentives drug suppliers have to offer discounts and deter buyers from expressing ‘truly’ price-elastic demands by operating an incremental-volume price-discount trade-off.

  10. 10This is based on anecdotal evidence and assumes PBMs in the US pass on discounts to healthcare payers, who in turn pass these discounts on to consumers. In reality, the magnitude of discounts passed on to healthcare payers will reflect profit margins of PBMs. In contrast, the pooled purchasing agencies proposed here will be public entities that will pass price discounts directly on to consumers in low-income nations.

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Acknowledgements

The author would like to thank the Editor and referees for valuable comments that have greatly improved the content and structure of this article. No external funding was used in support of this paper and the author has no conflicts of interests to declare. The opinions expressed are those of the author and do not necessarily reflect the opinions of the author’s affiliated institutions. The article is dedicated to my brother James, and my nephews Gerald and Nathan.

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  1. Office of Health Economics, 12 Whitehall, London, SW1A 2DY, UK

    Ebenezer Kwabena Tetteh

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Correspondence to Ebenezer Kwabena Tetteh.

Appendix

Appendix

Summary of the various forms of price discrimination[1]

Static price discrimination

  1. 1.

    Differential prices for a single product related to differences in demand elasticities

  1. (i)

    First-degree price discrimination. Sellers charge differential prices based on individual demand elasticities such that they capture all consumer surpluses. However, it is an unrealistic business practice because of the transaction costs of identifying individual demands

  2. (ii)

    Third-degree price discrimination. Sellers identify heterogeneity of demand elasticity of a group of buyers (submarkets) in an aggregate market; individual buyer demands are not identified

  1. 2.

    Differential prices for a single product with no prior reference to differences in demand elasticities

  1. (i)

    Second-degree price discrimination. Sellers cannot identify differences in demand elasticity and attempt to do so by offering different purchase options at different prices for buyers to self-select into preferred price schedules. Self-selection reveals buyers’ price sensitivities. All buyers are, however, offered the same pricing terms prior to self-selection. Common examples include quantity discounts (based on bulk volume purchasing) and discount coupons (based on buyers’ ‘value’ of time and hence their willingness to return coupons)

  2. (ii)

    Two-part (nonlinear) tariffs. Buyers pay a fixed charge (to recover fixed/sunk costs) to gain the rights to purchase a product at prices close to marginal costs. It is considered by some to be more efficient than linear pricing

  1. 3.

    Differential prices linked to ‘buying together’ distinct products (also referred to as bundling, portfolio or range effects)

  1. (i)

    ‘Pure’ bundling. Sellers offer a range of products bundled together but the individual products are not sold separately

  2. (ii)

    ‘Mixed’ bundling. Here the individual products bundled together are sold separately

Dynamic price discrimination

  1. 1.

    Inter-temporal price discrimination. Sellers offer different prices in different time periods, especially as insulation against the threat of market share loss to competitors. In general, dynamic price discrimination evolves from sellers’ recognition of time inconsistencies in buyers’ demands and the difficulty of committing to prices charged in one time period in another. It also depends on whether buyers are knowledgeable (forward-looking) or naïve (shortsighted)

  2. 2.

    Behavioural price discrimination. This includes discounts for loyalty, fidelity, reputation or goodwill. Sellers offer, in repeated sales, discounts in time period t2 related to buyers’ contribution to sellers and products’ market shares in t1, especially when sellers recognize buyers have low switching costs and their preferences are independent in different time periods

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Tetteh, E.K. Implementing differential pricing for essential medicines via country-specific bilateral negotiated discounts. Appl Health Econ Health Policy 7, 71–89 (2009). https://doi.org/10.1007/BF03256143

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