Brand Name Prescription Drugs Antitrust Litigation (1999) Presented By: Zhou Ge & Stephen Stults

Pharmaceutical Market  2003 US market value of US$217.5 billion  Accounts for 47% of world market  8.4% forecast annual growth rate  Projected 2008 market value US$325 billion ( Datamonitor, Industry Profile Pharmaceuticals in the United States, November 2004, datamonitor.com)

History of the Industry  Up to the 1970’s the health care industry was quite fragmented  Individual insurance companies would pay for drugs on behalf of patients and had little bargaining power with drug companies  Doctors decisions on what to prescribe were made on a case by case basis

History of the Industry Emergence of managed health care in late 1970’s concentrated buying power –Managed care providers would represent many insurance companies when contracting patient services and purchase of prescription drugs –Doctors now were limited to what they could prescribe based on the rules of the health care provider

Formularies of Drugs A formulary is a list of prescription drugs (established by a hospital or managed care organization) that may be prescribed –Doctors can only prescribe drugs on this list –Certain drugs can be given preferential status on this list –Some drugs may even be given exclusive status for a therapeutic class

Increased Buying Power Managed care is able to exert greater bargaining power as they… –represent larger patient groups –are able to influence doctors prescribing habits based on status on formulary –can stimulate competition among drug manufacturers for patients business

Greater Concentration Percentage of privately insured population under managed care  1980 about 5%  1987 about 25%  1997 over 75% Today about 170 million, or 65%, of Americans are covered by managed care providers (Cutler and Sheiner, National Bureau of Economic Research, Managed Care and the Growth of Medical Expenditures, working paper 6140, August 1997)

Distribution Distribution to managed care providers and retail pharmacies are handled by drug wholesalers. Discounts are given to managed care providers and to other large buyer groups such as HMO’s and hospital groups. Discounts are given in forms of chargeback, where the manufacturer will pay the wholesalers back, and through rebates.

The Trial

 Retail drug stores claim that pharmaceutical manufacturers –Price discriminate against retail drug stores (violation of Robinson-Patman Act) –Conspired with distributors to refuse discounts to retail drug stores (violation of Section 1 of Sherman Act)  Separate trials were scheduled for the violations of the separate claims

Some reach settlement  The plaintiffs were some 40 thousand retail pharmacies which were subsequently consolidated into one class  17 pharmaceutical manufacturers were being sued, of which 11 chose to reach settlements totaling US$700 million –a defendant will settle if it believes that (Prob. of loosing x damages) + legal fees is greater than settlement amount

Conspiracy The charge of manufacturers and distributors conspiring to refuse discounts to retail drug stores was tried under the Sherman Act. The Sherman Act requires that there be proof of “unlawful concerted action” by all defendants. The case went to trial in the fall of 1998.

Focus of Trial  Focus was on whether manufacturers colluded in their refusal to extend the same price discounts to retail drug store –Plaintiffs claimed that trade association meetings provided opportunity for collusion –An opportunity for collusion relies on speculation, and fails to prove that there was an actual collusive agreement  Discounts arose out of defensive measures to prevent lost sales in the managed care sector as such buyers became more aggressive

Status of “Price discrimination” Case  Some of defendants have reach settlements with plaintiffs  A trail has not be on schedule.

PRICE DISCRIMINATION & PRESCRIPTION DRUGS: THE ROBINSON-PATMAN ISSUE

Conventional Robinson-Patman Act Case: Buyers are in head-to-head competition but some of them pay a higher price than their rivals pay. Buyers are in head-to-head competition but some of them pay a higher price than their rivals pay.

Plaintiffs Claim: This is just their situation. This is just their situation. Defendants Claim:  The favored consumers are not in head-to-head competition with retail pharmacies.  As discussed earlier, retail pharmacies are dispensing agents rather than intervention agents.

Defendants maintained :  Rebates and chargebacks should be viewed as “Functional Discounts”: payment for a marketing function.  Their discount to managed care and hospital consumers began as a defensive reaction, named “Meeting Competition”.

What is “Functional Discounts”?  Different from the “quantity discount”: Prescription drug discounts are paid for intervening on a large scale in the prescription process, not for dispensing large quantities of prescription drugs. Prescription drug discounts are paid for intervening on a large scale in the prescription process, not for dispensing large quantities of prescription drugs.

For example American Association of Retired Persons (AARP) operates one of the largest mail- order pharmacies. But, it did not receive rebates or chargebacks because it does not control prescription patterns. American Association of Retired Persons (AARP) operates one of the largest mail- order pharmacies. But, it did not receive rebates or chargebacks because it does not control prescription patterns.

Supports to the discount interpretation-1  If volume discount were granted to a large drag store chain, this would not increase total sales of any particular drug. Because retails, even large chains, do not have formulary control.

Supports to the discount interpretation-2 The rebates and chargebacks were arrived at on a contract-by-contract basis: The rebates and chargebacks were arrived at on a contract-by-contract basis:  one discount for listing a brand name prescription drug on a formulary  A large discount for giving that drug preferred status on a formulary  An even large discount for an explicit market share achievement

Supports to the discount interpretation-3  Retail pharmacies are offered discounts for products where they are positioned to influence the interbrand choices of consumers.  For example: multisource drugs, over-the- counter medicines and consumer medical products.

What is Meeting Competition? Under the Robinson-Patman Act, a seller is permitted to charge a lower price to one consumer if the lower price is offered to meet the low price of a competitor. This is called the “meeting competition” defense to a charge of price discrimination. Under the Robinson-Patman Act, a seller is permitted to charge a lower price to one consumer if the lower price is offered to meet the low price of a competitor. This is called the “meeting competition” defense to a charge of price discrimination.

How to check the “meeting competition”?-1 We cannot simply to compare nominal price:  Because two offers with different nominal prices may be viewed as equally attractive.  For example : different price for different quality; lower price of new supply for switching cost; attractive price in order to meet the price of bundle.

How to check the “meeting competition”?-2  In this case, it is offering a price low enough to get on a formulary.  Because firms are profit maximizers, they do not want to discount much more than to meet the competition.

Third Degree Price Discrimination, Prescription Drugs, and Consumer Welfare

 The manufacturers’ pricing practices are best explained by the theory of third degree price discrimination.  Retail pharmacies’ demand are less elastic because they cannot maintain formularies or steer prescriptions to particular drugs.

Plaintiffs’ Discount:  Uniform pricing would cause all prices to fall to the levels paid by the most favored customers.  Uniform pricing would increase aggregate economic welfare.

Defendants’ Discount:  Such a ruling would cause prices to seek a higher, uniform level.  Uniform pricing would decrease aggregate economic welfare.

Why third degree price discrimination may increase aggregate economic welfare?

One reason:  Ramsey pricing principle: In markets where scale economies are so great that marginal cost pricing is neither feasible or desirable, welfare-maximizing prices in different segments vary according to the inverse elasticity rule.  Danzon (1997) argued further, in the pharmaceutical industry, scale economies lodged in low marginal production costs and high, fixed research and development costs. So, Ramsey pricing is optimal. Price discrimination that arise in competition are better than uniform prices.

Another reason:  More elastic managed care occurred, result in discounts from the manufacturers.  The demand elasticity outside the managed cares are not affected, so the discount paid to managed care did not cause price increase for any patient.  Price fall in one segment but did not rise in another segment. The effect of discrimination prices on aggregate economic welfare would be positive.

REFLECTIONS ON BNPDAL

The last quarter-century of antitrust has stressed consumer welfare and economic efficiency more than protecting small firms. The last quarter-century of antitrust has stressed consumer welfare and economic efficiency more than protecting small firms.

Retail pharmacists’ problem  Is not manufacturers’ refusal to discount, but their own reluctance or inability to “moving market sharing”.

CONCLUSION

CONCLUSION-1 In the 1970s and 1980s, the price competition is more intense. In the 1970s and 1980s, the price competition is more intense. The reason is : The reason is : Managed care organizations, along with hospital and nursing homes, began to direct groups of patients to particular firms to secure lower prices. Managed care organizations, along with hospital and nursing homes, began to direct groups of patients to particular firms to secure lower prices.

CONCLUSION-2  Retail pharmacies, merely dispense the product but do not prescribe or control its use.  The retails cannot leverage this competition to their advantage.