Office of Health Economics MSc Module ‘Economics of Health City University The Market for Medicines 13 th December 2002 Jon Sussex

Office of Health Economics Agenda 1.Characteristics of the market for medicines –Demand side –Supply side 2.Regulating the market –Market failure –What and how to regulate: options 3.Exercise - Regulating the UK pharmaceutical industry 4.The Pharmaceutical Price Regulation Scheme and international comparison of medicine prices

Office of Health Economics

Pharmaceutical Sales as % of GDP

Office of Health Economics Types of Medicines OriginalbrandBrandedUnbrandedOTCs* On-patentOff-patentgenerics NHS Private * OTCs = over the counter (i.e. non-prescription) medicines

Office of Health Economics Generics’ Market Shares, 2001 (Retail Market) % of retail market (in value)% of retail market (in volume - Standard units) Original/ Licensed Branded generics Unbranded generics OthersTotal Original/ Licensed Branded generics Unbranded generics OthersTotal France Germany Italy Netherlands Spain Sweden U.K Switzerland Japan Canada USA Source: IMS

Office of Health Economics Demand Side Characteristics ChoosesConsumesPays Normal market Consumer Prescription medicines market PrescriberPatientGovernment / insurer

Office of Health Economics Measures Affecting Prescriber Price Sensitivity Primary Care Trust budgets Practice budgets and prescribing incentive schemes Provision of information (PACT, NICE guidance, pharmaceutical advisers, etc.) Generic prescribing targets

Office of Health Economics Supply Side – Main Characteristics (1) Patents are an incentive for dynamic efficiency – by promising temporary monopoly if successful Patents last 20 years; first 9-11 of which are spent getting the medicine to market, i.e. research & development (R&D) Commercial success in R&D-based companies depends on finding ‘blockbusters’

Office of Health Economics Phase III Development research Discovery and Development of a New Medicine Final patent application Marketing application Attrition rates Cost Post-mktng devel patients Phase IV 5, $800M 0 Chemical development Pharmaceutical development Long-term animal testing Toxicology and pharmacokinetic studies Source: CMR International 1993 Discovery research Investigational new drug application 1990 Phase I Phase II Synthesis Biological testing & pharmacological screening voluns patients 1999 Marketing approval product launch 2001 Regulatory review Regulations Time (years) Phases of drug development Basic research Clinical phases

Office of Health Economics Supply Side – Main Characteristics (2) R&D costs are sunk (global) joint costs R&D costs ≈ 17% of pharmaceutical sales p.a. But ≈ 31% of costs on net present value basis => (even long-run) marginal cost << average cost => Price discrimination (based on Ramsey rule?) if non-linear pricing is impractical  Parallel trade

Office of Health Economics Net Value of the Pharmaceutical Industry – Economic Rent Estimates for 2000: £ million p.a. Producer rents (exports & overseas)500-1,500 Labour rents R&D spillovers to other sectors Total rent700-2,000 Terms of trade effect ? Source: Pharmaceutical Industry Competitiveness Task Force (2001) ‘Value of the Pharmaceutical Industry to the UK Economy’

Office of Health Economics Market Failure Public goods and the free-rider problem (e.g. research) Externalities –E.g. your vaccination reduces my risk of catching an infection –E.g. the caring externality: I’m happy if you’re cared for Incomplete or asymmetric information –Moral hazard (= ‘hidden action’) –Selection problem (= ‘hidden information’) –Principal/agent problems

Office of Health Economics Monopoly Power Economies of scale and/or scope – but NB contestability Natural (local) monopoly Input constraints Patents: dynamic efficiency vs static monopoly

Office of Health Economics Options: Types of Regulation ‘No regulation’ = Competition Act only Profit, i.e. rate of return, control: –Unbanded –Banded Price control: –Baskets of products, as with ‘RPI-X’ control of utilities’ prices –Individual products, e.g. via reference prices, or ‘cost-plus’, or related to therapeutic benefit

Office of Health Economics 1998 Competition Act Came into force March 2000 Based on EU Treaty - Articles 81 & 82 Prohibitions: –Chapter 1 – Agreements preventing, restricting or distorting competition –Chapter 2 – Abuse of a dominant market position Fines up to 10% of turnover; 3 rd parties may sue for damages

Office of Health Economics Banded Rate of Return Regulation Target RoR Outturn RoR > threshold => repay excess Outturn RoR may increase prices %RoR £ capital employed 0 ▲ ▲ ▲ ▲ ▲ ▲

Office of Health Economics RPI-X Regulation of a Basket of ‘n’ Products w 1 p w 2 p w 3 p …….. + w n p 1 n x 100 ≤ ΔRPI - X w 1 p w 2 p w 3 p …….. + w n p 0 n Where: w i = weight for product ‘i’ (e.g. quantity sold in period 0) p t i = price of product ‘i’ in period t = 0,1 ΔRPI = % change in retail price index between period 0 and period 1 X = efficiency factor { {

Office of Health Economics Regulation Criteria Static efficiency: –Productive efficiency –Allocative efficiency Dynamic efficiency Benefit to UK plc – economic rent Regulatory (administrative) burden Equity/other social policy objectives

Office of Health Economics Exercise What, if anything, to regulate? –On- and/or off-patent? –Branded and/or unbranded? –Prescribed and/or over-the-counter? –Sales to NHS only, or all UK sales? If so, how? –Rate of return control, unbanded –Rate of return control, banded –Price control – basket, RPI-X –Price control – individual products, reference prices From 3 perspectives: –General public: patients & taxpayers –Government –Industry

Office of Health Economics Key Questions 1.How price-sensitive are the people making the consumption choices? 2.How much competition is there between one medicine and another, or between medicines and alternative treatments? 3.Do producers have incentives to keep costs down? 4.Will production and consumption choices become increasingly distorted over time? 5.Do producers have incentives to invest in the UK, especially in R&D? 6.Would the regulatory system be costly for the regulator to administer and the companies to comply with?

Office of Health Economics Pharmaceutical Price Regulation Scheme 1999 Have been variants of PPRS since 1960s Department of Health acts as regulator for whole UK Objectives of 1999 PPRS: –Secure the provision of safe and effective medicines for the NHS at reasonable prices –Promote a strong and profitable R&D-based pharmaceutical industry –Encourage efficient and competitive development and supply of medicines Voluntary – but (unspecified) statutory alternative scheme for firms that opt out

Office of Health Economics PPRS 1999 (continued) Covers all branded medicine sales – on-patent & branded generics – to NHS by companies selling > £1m p.a. to NHS (≈80% of total sales to NHS) Return on capital ≥ 29.4% => repay excess to DoH Return on capital ≤ 8.5% => may apply for price increase(s) to take RoC to 13.6% R&D costs allowed up to 20% of sales Promotion costs allowed up to 7% of sales Free pricing at launch but no increases then allowed unless company’ RoC falls to ≤ 8.5%

Office of Health Economics Multilateral, Ex-manufacturer, Price Comparisons at Market Exchange Rates Index UK= at 5-yr av ex rates France Germany Italy Spain UK100 USA Source: Department of Health (2001) PPRS 5 th Report to Parliament

Office of Health Economics Understanding the methodological issues Manufacturers’ prices or final selling price to the payer? Brands or generics or molecules? Sample size and selection (value versus volume, degree of market coverage) Bilateral versus multilateral Match single pack, match product form or price per unit (tablet, DDD, IMS SUs, Kg)? Volume weights: unweighted, own country (Paasche) or foreign weights (Laspeyres)? Choice of exchange rate What exactly is the question you are trying to answer?