The Indian Pharmaceutical industry had been practically nonexistent but over the last 30 years there has been a huge leap in its existence. It is one of the leading industries in the world. With the existing price wars and patent drug complications, this paper highlights all the problems associated with pricing of drugs which includes Pricing Strategy, Research and Development cost, Differential Pricing and Government Policy in the sector.
“The Indian pharmaceutical industry is a success story providing employment for millions and ensuring that essential drugs at affordable prices are available to the vast population of this sub-continent.” (Richard Gerster 2000)
The Indian Pharmaceutical Industrytoday is one of the most successful of India's science-based industries with huge prospects in the complicated field of drug manufacture and technology. More than 5,00,000 people are engaged in this sector, in approximately 20,000 firms. Another 2.5 million jobs are thought be taken up in the pre- and post-production sector.(Richard Gerster 2000).
Globally the Indian pharmaceutical industry is one of the highly organised sectors with an approximate value $ 6 billion, growing at about 13 percent annually. It holds the 4th position in terms of volume (with an 8% of global sales), 13th in terms of value (with a share of 1% of global sales) and produces 20-24% in terms of value. The Indian industry is highly recognized in the third world in terms of technology. The industry is 17th in terms of export value of bulk actives and dosage. Exports include nearly 40% of the production with formulations contributing 55 per cent and bulk drugs 45 per cent. (IBEF, 2007)
The complete range of pharmaceutical formulations, i.e., medicines ready for consumption by patients are being catered by about 250 large and about 8000 Small Scale Units, and bulk drugs, i.e., chemicals used for production of pharmaceutical formulations by about 350 units.(Pharmaceutical and Drug Manufacturers, 2009)
It plays an important role in promoting and maintaining growth in the imperative field of medicines with approval from the regulatory authorities in USA and UK. (Pharmaceutical and Drug Manufacturers, 2009). Market leaders control 7% of the market share out of the 70% controlled by leading 250 companies. (Confederation of Indian Industry, 2008). It is an extremely disjointed market with harsh price competition and government price control. (Pharmaceutical and Drug Manufacturers, 2009)
Subsequent to the de-licensing of the pharmaceutical industry, producers have the freedom to produce any drug duly permitted by the Drug Control Authority. The pharmaceutical industry is technically strong and totally self-reliant. In India there are low production costs, low R&D costs, excellent scientific manpower coupled with national laboratories and an increasing balance of trade.” The Pharmaceutical Industry, with its rich scientific talents and research potential, sustained by Intellectual Property Protection regime is well set to take on the global market.”(Pharmaceutical and Drug Manufacturers, 2009)
The sector is currently experiencing incomparable change mostly due to the country's introduction, on January 1, 2005, of a system of product patents; before that, only patents for processes were legally recognized to be issued, a fact that has been instrumental in the domestic industry's huge success as a worldwide exporter of high quality generic drugs. (KPMG International 2006)
Objectives of Pharmaceutical Companies
Indian Pharmaceutical companies have numerous objectives. These objectives are based upon the company's various expenditures. The main objective however remains to Maximise Revenue. It important to investigate whether funding of drug studies bythe pharmaceutical industry is coupled with results thatare encouraging to the funder and whether the approach of trialsfunded by pharmaceutical companies vary from the approaches in trials with other sources of support. (Joel Lexchin et al, 2003)
Pharmaceutical research companies strongly embrace the neoclassical innovation model. The companies end up spending millions of dollars over a number of years to produce newly patented products. The industry is categorized by high fixed costs and low variable costs. The first mover incurs all the research costs while the free riders namely generic drug companies have significantly low cost structure (Arora, Ceccagnoli & Cohen, 2008).
Prices are high because pharmaceutical innovation is expensive (Outterson, K 2004). Drug companies set prices for the products in which considerable time and money has been invested. (Merges et al, 2006)
The research and development (R&D) enterprise must be nurtured, generating the next generation of break-through therapies. As much as this is true, we cannot overlook the fact that that without financial access, innovation is useless. Innovative marvel drugs won't improve health unless patients actually get them. (Outterson, K 2004)
In order to make this investment valuable companies patent/copyright these drugs. The copyright gives them the right to exclude others, namely generic manufacturers from cheaply producing and profiting from their inventions. (Madson, 2005).
For the honour of the drug to be upheld, these patents are acknowledged on a global scale rather than the company's home country. (Agreement on Trade-Related Aspects of Intellectual Property Rights, 1994)
The brand-name firm may have an incentive to use a limit-pricing strategy to deter entry. The Limit Pricing Strategy is where a business keeps prices low, restricting its profits, so as to deter new rivals from entering the market (Sloman and Sutcliffe, 2001).
This strategy however is reversed, it consists of fixing the highest price which deters entry. Since the brand-name firm can produce pseudo-generics, two sub-strategies exist. On is to deter entry by producing only the brand-name good and the other is to deter entry by producing the two drugs. (Granier, L. & Trinquard, S. 2006).
Another way by which pharmaceutical companies can avoid competition is to merge. This is where Oligopoly comes into play.
“Oligopoly occurs when just a few firms between them share a large portion of the industry.” (Sloman and Sutcliffe, 2001). This basically refers to market sharing amongst a few firms.
This is clearly evident in the pharmaceutical industry considering the mergers and acquisition technique chosen by them to ban competition for their highly researched products. The brand name firm purchases one generic firm before entry to the market majorly termed as “anticipative merger”. (Merges et al, 2006)
This merger is equivalent to a premium paid by the brand name firm to prevent competition. It puts the brand name firm in a situation to enjoy oligopoly profits. The oligopoly can extract consumer surplus by selling the most valued drug to each consumer since the branded firm may not sell pseudo-generic drug, thus eliminating the chances of the branded drug to run in competition with the generic drug. The swiftly growing and largely profitable pharmaceutical industry has been rapidly merging. There are other pharmaceutical companies that are forming alliances for distribution and marketing. Considering the current pharmaceutical industry trend, the numerous drug mergers over the last decade have directed the drug corporations to load on enormous debt, over $300 billion. In turn, to recover that money companies have raised prices thereby increasing the costs for hospitals and insurance programs. (Industry brief: Pharmaceuticals, 2003)
Pharmaceuticals, it is argued, are not normal market goods to be distributed primarily to the wealthy. Innovation and quality must be balanced with access and cost. Outterson, K (2004). The invariably huge R&D expense causes difficulties in setting the price of the goods for several reasons (Danzon, 2003).
Firstly, R&D cost is a globally joint cost which is fixed for the countries that use it. As the composite is developed to provide for wealthy nations, no additional R&D cost is needed to provide for low income nations. Secondly the marginal cost mostly depends upon the time the product is launched. As the drug progresses during its life cycle and is initiated in more and more nations, country specific launch cost are dejected. (Danzon, 2003)
The marginal price includes only the variable cost of producing and selling extra units, which is generally very small. If there were no exclusive rights, generically equivalent “copy” products would enter the market and force the marginal price down (Danzon, 2003).
The marginal cost pricing would be adequate to envelop the expenses of ‘copy' goods that only have low production and distribution cost with negligible R&D cost. But marginal cost is inadequate to envelop the R&D cost borne by innovator firms. Thus free entry and marginal cost pricing are inadequate with sustained incentive for R&D. This is where the economic function of patents comes into play. Its very purpose is to ban the entry of copy products for the term of the patent and to offer the innovator firm to charge above the marginal price thereby recuperating the R&D costs (Danzon, 2003).
Selling the same product to different groups of consumers at different prices is known as Price Discrimination. (Sloman and Sutcliffe, 2001)
In the neoclassical economic model, goods are sold at a single market-clearing price. Clever selling businesses understand that some consumers will pay more than the market-clearing price. The selling firm increases its profit by selling each item at the maximum price each particular buyer will pay. The economic literature identifies this process as Price Discrimination, which is synonymous with differential pricing for our purposes. (Outterson 2004).
Differential pricing is common. The same product is frequently sold at different net prices to various buyers. The seller segments the markets for its product, and charges what each market segment will bear. E.g Airline industry. On almost every flight, passengers will have paid many different prices for the same service. The market has been segmented into multiple buyer groups, including business travellers, vacation travellers, frequent flyers, and last minute purchasers.
A selling firm might attempt to differentiate its prices on an individual sale basis, a pure form of differential pricing which Pigou labeled First-degree price discrimination (Pigou 1920). “First-degree price discrimination is where the firm charges each consumer the maximum price he or she is prepared to pay for each unit.” (Sloman and Sutcliffe, 2001)
First-degree price discrimination is also known as perfect price discrimination, since it fully extracts all consumer surpluses for the benefit of the producer, providing cash flow for pharmaceutical innovation but weakening access through higher consumer cost. (Outterson 2004)
If the number of market segments is kept relatively small, however, the marginal revenue may exceed the marginal cost, resulting in second- or third-degree price discrimination.
“Second-degree Price Discrimination is where the firm charges customers different prices according to how much they purchase. It may charge high price for the first so many units, a lower next for the next so many and so on” (Sloman and Sutcliffe, 2001).
In second degree price discrimination, purchasers segment themselves into price levels. Third-degree price discrimination is where consumers are grouped into two or more independent markets and a separate price is charged in each market. (Sloman and Sutcliffe, 2001). The producer segments the market, generally using monopolistic power to distinguish the different prices customers are willing to pay. Global sales of patented pharmaceuticals offer examples of both second- and third-degree price discrimination. (Outterson 2004).
Government Regulation influences many factors. Two main legal classes are predominantly relevant to pharmaceutical arbitrage: IP laws and National drug regulatory agencies (NDRAs).
- Intellectual Property (IP) Laws
IP laws sustains differential pricing by creating patents, trademarks and copyrights which prevent substitution during the patent period by identical compounds. (Hiebert, 1994).
2. National Drug Regulatory Agencies (NDRAs)
The TRIPS Agreement generally leaves the drug approval process to individual countries. In the U S, the national drug regulatory agency (NDRA) is the Food and Drug Administration (FDA). Each country has a unique drug regulatory environment, with different approaches to substitution, approval issues etc. Each country's market will vary due to other significant factors such as economic development and demand elasticity. (U. S Food and Drug Administration, 2008)
The acknowledgement of TRIPS is expected to transform the direction of Indian companies towards R & D. Indian companies are investing in intricate R & D activities. The advantages of conducting R & D in India are low costs and population advantages. (Indian Pharmaceutical Industry: Strategies, Trends and Opportunities, 2007).
Lower costs: Due to lower labour and human capital costs, Indian companies R&D expenditure is far lower than in the developed countries. (Indian Pharmaceutical Industry: Strategies, Trends and Opportunities, 2007)
Population advantages: India, a highly populated country facilitates clinical trials for diseases especially prevalent in developing countries. Indian R&D efforts should be focussed upon infectious diseases that are especially prevalent in Asian countries. (Indian Pharmaceutical Industry: Strategies, Trends and Opportunities, 2007)
The paper concludes by putting into effect the strong benefits of patents and recognizing why R&D costs affect and will continue to affect the pricing strategy followed by various pharmaceutical companies.
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